A little over a month ago a new NFT marketplace called LooksRare was launched on Ethereum. But unlike OpenSea, the largest NFT marketplace, LooksRare decided to turn itself into a DAO, launch a coin, and basically vampire attack its incumbent instead of going the classic venture backed equity route. Why and how they did this, the ramifications of the strategy, and everything that has happened since (only 1 month!) are in my opinion the best parable for many of the important lessons investors need to learn about crypto and why we're not in Kansas anymore.
One of our core theses at Starkiller for why crypto markets are likely to continue growing so quickly is the ability for entrepreneurs to use them to bootstrap liquidity and network effects with an economic incentive.
Consider Uber for a second. When this now massive marketplace launched, it had to fight tooth and nail to gain the necessary liquidity on both sides of its platform, as do many other markets, in order for the service to be valuable to either side. Not enough drivers and Uber is useless to riders, and vice versa. The overall utility of the system for either side relies on enough liquidity (users). Traditionally, entrepreneurs solve this problem through a mix of growth hacking and spending money on marketing. More recently (the past decade), with incredibly low interest rates and plentiful VC money to be thrown around at promising platforms looking to scale, subsidization of the cost of the service for consumers has been used to artificially lower the barrier to adoption while accepting that the business is going to take on massive losses (on a unit economic basis) in order to scale the network. Uber basically spent a decade fighting a war against all other upstarts by subsidizing its platform to such an extensive level that it bled its competitors dry, it was a race to see who could burn more VC money fastest. Then one day Uber and Lyft decided to call a truce, agree that the market would be a duopoly, and mutually disarm so that both could build real businesses. Of course this meant that the real price of the service for consumers had to go up, the subsidization war was over, but by that point these were utilities many people had come to rely upon. They had solved the bootstrapping problem, consumers were going to pay to use these services, even if we all grumbled about the increases in prices for a time.
Crypto provides a different path to solving this problem, one that I believe is the reason more and more entrepreneurs will choose crypto vs the one above when they build their businesses.
The basic concept is that instead of burning money on marketing or subsidizing the service, you hand out "equity" (tokens) in the business to the users in several different ways. The chart below lays out how LooksRare decided to divide up its tokens.
The section to focus on here is "Community". In order to get things started LooksRare airdropped 12% of its float to Ethereum wallet addresses (including myself) who had previously transacted on OpenSea. This is what we call a vampire attack. Because all of these transactions are recorded on the ETH blockchain, it's relatively trivial to find all of the users of another platform and in a sense market to them by just handing them tokens. Now, there's a pretty fat line between simply spamming someone's wallet by sending them tokens (which happens all the time with scams), and spreading the word through the community that someone can come and "claim" the tokens if they are eligible. Who doesn't like free money! (Gas fees aside). This amounts to a viral launch strategy that the founders are paying for in 12% of their equity. I wonder how much equity the Lyft founders would have paid to be able market to every single Uber rider and driver at the time.
44% of LooksRare tokens will be handed out to the actual users of the platform over time (years) as they transact. LooksRare charges a transaction fee of 2% (OpenSea at 2.5%), but instead of that fee going to the company for the next few years, in this case it goes back to the users pro rata to their percentage of the fees they paid each day. Eventually LooksRare will stop handing out those fees to users and at that point the platform will have to stand on the merits of its utility.
19% of the tokens will be handed out over time (years) to the holders of $LOOKS who stake their tokens. You get more "equity" simply for holding the tokens. Holders of $LOOKS also get 100% of the fees from the platform (after paying out the users who transacted). This is the pure cashflow of the platform.
LooksRare is employing several different economic incentives to: create awareness of its competing platform to OpenSea, get people to use it, and get people to invest in its equity so that the equity is worth something so that people will care about being rewarded with it.
If this all sounds a bit crazy, it is!!! The gambit here is that they are attempting to compress a normal marketplace growth cycle, both from a users and a cap table standpoint, from years into weeks! But if you're the LooksRare founders, what's to lose? If you tried to compete with OpenSea simply on the basis of launching a better platform, you'd be behind the 8 ball for quite some time trying to build adoption. When it comes to marketplaces, having the best product is rarely the differentiator between winners and losers. But if your product is within some reasonable margin of quality and you employ this type of vampire attack, your odds of winning go way up.
LooksRare launched on January 10th and in under a month it was doing over 15% the volume of OpenSea when you account for wash trading and other shenanigans going on to capture some of those rewards.
As an aside, because of how high ETH gas fees are, only about 66% of eligible wallets claimed their $LOOKS airdrop tokens, representing only 80% of the tokens. I guarantee these numbers will be much higher when all applications are launched on ETH L2s instead of mainnet.
But let's turn our attention back to OpenSea for a second. The company has raised almost $430M in funding with its last valuation at $13B. Right now NFTs are doing about $1B in trade volume per week on Ethereum alone, and at 2.5% fees that's $25M, or a yearly run rate of over $1.3B. So if we're just doing some really quick back of the napkin math here, OpenSea is trading at something like 10x current revs? It's hard to argue that's expensive given the massive growth rate.
But here's the thing. What does a crypto marketplace with no moat deserve to be valued at? A few weeks ago LooksRare was valued at over $1B (more on this later) and it just launched! What I'm getting at here is the normal ways we value marketplaces can't be the same in Web3 as it was in Web2 because of that lack of a moat. And that's a feature, not a bug. Crypto wallets allow users to own their data, not the platforms. There is next to zero switching cost to connecting your wallet to a different platform that gives you a better deal, and in this case equity in its business. And if you're the incumbent, your entire customer list is freely available to anyone who wants to give you a run. Think of it this way, in the case of Uber, the value accrued to Uber shareholders, not its users who helped build liquidity early on, and not the municipalities who have to deal with the roads that the cars drive on. You could argue though that a lot of value Uber created accrued to AWS for being the compute power that enables the platform. But in crypto, the value may not accrue to the marketplace given Web3 marketplaces have no moat, and will eventually just end in a race to the bottom on fees. Value accrues to the network over which the transactions take place, in this case Ethereum, similar to AWS.
How fast that curve bends we don't know, but it's my guess that in the long run these are the dynamics. In the short run, there will be incredible opportunities to invest in (trade) these platforms and protocols as they eat Web2 businesses. Every Web2 marketplace will end up being a crypto marketplace at larger scale, I guarantee it. The economic incentive for people with a crypto wallet (something on the order of 10M daily active users now) to participate in the launch of these things is too great, there's too much money to be made to ignore it. Maybe the growth rate of the NFT market makes the OpenSea valuation reasonable in the face of this threat, maybe it doesn't. And I would caution you from bemoaning the fact that everything under the sun is going to get "financialized". Yes, it will, that's the direction we're going, this is "the great online game", get used to it.
Another important difference between Web2 and Web3 is that while the OpenSea founders could theoretically do a secondary offering as part of a capital raise (they would have been insane not to in this last round), their stock isn't really liquid. They are going to need to either sell the company, go public, or coin themselves eventually. The LooksRare founders are already liquid, they can sell whenever they want. Their stakes were worth over $100M days after launch. And in fact we know from on chain analytics that they have been selling. Not only that, but interestingly enough they've been using TornadoCash to wash the sale of their tokens into wallets that aren't linked in any way to the ones they used to hold their $LOOKS tokens. Why? I'll let your imagination take over from here.
My point is, crypto is different when it comes to founder equity. You can vampire attack OpenSea, launch your platform, and somewhat sell out a few weeks later if it works. There's obvious game theory here for the founders regarding their sale of equity though, and the signaling to the market. But if you just made $100M for a few months of work, does your incentive to continue to build and make it into a real company still exist? What percentage of entrepreneurs will follow through after that? Maybe some decent portion of Web3 companies are more like projects. Maybe these DeFi lending protocols which are all pretty similar in nature to the point where you can "copypasta" (yes like pasta) the code from one chain to another are more like projects than companies. It's all too easy to build and launch, which is why it's incredibly dangerous to buy and hold these things, and also why the innovation in this space is moving so incredibly quickly.
And to wrap this all up, guess what happened a few days ago. Another NFT trading platform called X2Y2 vampire attacked LooksRare and OpenSea. You can guess what happened to the price of $LOOKS.
This is a wild space, and if you want to play you better understand the tokenomics and the competitive dynamics because we're not living in Web2 anymore, this is a whole new ballgame.