Who would have thought M&A would ever come to the world of crypto? One or two years ago, the mentioning of M&A at any public blockchain event would have caused some confusion: “did he actually mean S&M? What does M&A mean?”. Oh how the space has matured, and rapidly. Indeed, 2020 appears to be the year of consolidation, with Tron buying Steemit, Binance buying CoinMarketCap and BitGo buying Harbor to name a few. A marketplace where everyone was raising capital until recently has bifurcated into buyers and sellers….
What is driving this wave of consolidation and why now?
One reason has been too many market participants in a market that has failed to grow substantially. The total market capitalization today of c. $270bn (CoinMarketCap, June 7, 2020) is still below where it was 2 years ago ($346bn). Tokenised securities which were still showing some promise this time last year have, for various reasons, failed to begin their much-anticipated transformation of global financial markets.
Ambitious and often initially well-funded platforms and projects have continued to burn cash hoping the watershed moment for digital asset would materialize through institutionalisation and mass adoption. Always “a year out” from breaking even, those who acted fast raised second rounds of capital on ambitious business plans. Those who did not realised too late that markets were closed as COVID struck.
Infrastructure platforms (like exchanges and custodians) with market leadership positions have continued to enjoy strong cashflows despite tepid growth and have generally been well shielded from the effects of COVID. Despite this, margin compression has been a threat to contend with for all actors in the infrastructure space and many are now on the move to construct protective barriers. The strategy of choice has been vertical integration not dissimilar from the model deployed by traditional market infrastructure players 10 years ago in the face of rapidly compressing margins. By controlling the value chain end-to-end, platforms are able to offer a clearer path for its users and can enjoy a much higher degree of financial resilience. It is also fair to say that some platforms make little sense operating in isolation – BitGo acquiring Harbor is a perfect example of how synergies can be created by vertically integrating a standalone platform into a full (and necessary) stack of financial infrastructure and services.
We can easily wrap our heads around the logic for M&A in the crypto infrastructure space, but how about M&A involving decentralised networks, and is it actually possible to “acquire” something which, by definition, isn’t owned by a central counterparty? The answer is “yes and no”, and it depends a bit on what an acquiror wants to achieve. Many decentralised networks will have some form of foundation or research entity that will usually hold a larger amount of the token supply, and in some cases a platform that brings utility to the users of the network. A successful M&A deal requires not only the acquisition of this central entity, but also sufficient support from the network participants to allow the acquiror to carry out its intended strategy. What “sufficient support” looks like depends from case to case and is a function of the network’s governance model. If an M&A deal does not enjoy this support, the participants on the network can simply create a “hard fork” and those who do not approve of the acquiror will simply move to the new network, taking substantial value with them. A prime example of this is Hive, which is a hardfork of Steem resulting from a significant proportion of network participants not approving of the acquisition made by Tron.
The support of network participants is also essential for any acquiror who is looking to restructure the network it is buying into. In fact, the very reason it is possible to buy out the central entity of a network is that some form of change to the network is needed. This could either involve the network’s resource or token-economic model, or it could be down to the utility of the network itself. Either way, any change to a decentralised network will require broad-based support for participants.
Finally M&A involving decentralised networks poses a unique set of challenges. For instance, how do you put a price on a company that derives part of its value from traditional cash flows, and another part from a complex token economy that it only partially controls? How do you calculate the synergies resulting from a deal and the interaction of one crypto-economic system with another? This is where decentralised network M&A gets interesting…
M&A for decentralised networks is happening. So far, we have been involved in two such situations (Steemit and WORBLI, an EOS sister chain) but we are seeing more and believe 2020 will be an interesting year for crypto consolidation. As this domain continues to evolve Zero1 Capital is confident in our strong market positioning and the insights gleaned from early case studies.