Thinking About Acquiring FTX IP...
Inside: rationale, valuation, investment returns, mock term sheet and suggestions to improve exchange operations and 'proof of reserves' mechanics ...
Hi All,
Let’s buy FTX? Well, not all of it. I’ve been speaking to Crypto_Joe and we think that there may be a case for the acquisition of FTX’s intellectual property (IP). The best parts of the IP could then be launched as a standalone new crypto exchange - Maven
With renewed corporate governance, a revamped business plan, and industry-leading decentralised custody, compliance & control measures - there’s an opportunity here.
In this post, we approach this in three parts, (i) rationale, (ii) investment and returns profile and (iii) suggestions for operational improvements. By the end, we share a mock term sheet. Usual disclaimers at the bottom.
In short, here’s the case of launching Maven, a crypto-exchange for crypto natives.
Reach out to us on my Twitter or Crypto Joe’s Twitter to discuss this further…
At the end of the blog is the link to a MOCK draft investors letter + Term Sheet
Let’s dive in.
1. Rationale
UI/UX/Tooling is what brought users to FTX, not celebrity endorsements
Simply, users loved using FTX. FTX as in the actual app. It had 1+ million users and the 50 largest claims from the bankruptcy are from customers owed $21 million+ each ($3.1bn+ total) - two users are each owed $200m+! The shock on Crypto Twitter alone and its widespread impact on the largest players demonstrate that FTX was the place for super users - crypto natives.
Other options are Coinbase, Binance, and Kraken. Goes without saying, these are platforms focused on beginners/HODL’ers (we use all three).
Similarly, FTX was loved for its usability; the metaphorical iPhone of the crypto world. It *felt* like a tool that was built by traders, for traders. Its optionality was also much loved. This was expressed in spot & derivative markets, equity-wrapped products, margin lending, sub-accounts, and the number of tokens they listed. Over time, users flocked to FTX and it became the second most liquid exchange behind Binance for a variety of products/assets.
Frankly, the reason users loved using FTX was not the brand. It was the intuitive familiarity with the software and the products they offered.
We believe that much of the value FTX created resides in the intellectual property, which can be purchased, rather than the brand itself.
Today, Binance dominates a growing market. There remains a gap for an exchange for crypto natives
The next best alternative for native users is Binance, which currently does 30x more volume than the next exchange (Coinbase) in Bitcoin/USD volume. Still, Binance and Coinbase target newer users. There is seemingly a behemoth monopoly within the crypto industry, which gives room for smaller entities to offer a competitive product and gain market share.
A new exchange, without toxic governance (board seats for both investors and experts), lack of oversight/compliance and backing user assets 1:1, we believe that FTX’s front end and back end could be the building blocks for an industry-leading crypto-exchange for crypto natives.
However, it needs some changes to get there.
See here for my earlier investment report on Kraken. In chapter 5 I considered industry observations that suggest it is still early from crypto.
2. New Business Plan
Maven is a crypto exchange that generates revenue from:
Revenue Generation
Maven Trading - Spot and derivative trading platform
Margin Lending & Borrowing - Live lending markets for assets that can be lent and borrowed based on demand
Maven Staking - Interest rate pass back on stablecoins and crypto staking
Interest Rate Pass Back
Users can commit their idle stable coins to Maven. This is converted to fiat and held with regulated third-party banks
This cash is then held as USD saving products that return a yield to the bank, thus to Maven, and thus to the clients
Current short-term US govt. Bond yields are trading at c.4.5%, far higher than deFi yields. In cases where the defi yield is higher, these are associated with significant transaction costs and smart contract risk
The costs include: (i) a yield cut to the partner bank, (ii) transaction costs switching crypto dollars to fiat to interest producing paper and (iii) technical infrastructure costs
Crypto Staking
In proof-of-stake protocols, users can “stake” their crypto in return for a payout. Maven would consolidate and stake on its infrastructure on behalf of consenting users. This removes the need for technical know-how and the need to have threshold amounts of a certain asset to stake
For this benefit, Maven retains a portion of the yield earned from staking as well as a flat fee
N.B: the trading platform would be built out first ahead of other revenue streams due to technical challenges, longer-term institutional roll-out and potential challenges with securing a banking partner.
Client Acquisition Strategy
Trading discounts for FTT holders
For a limited time, Maven would offer a transaction fee discount to users that held FTT at the time of FTX’s collapse. These users would have been die-hard users and would be a great substrate to launch Maven
Publication Splash
Upon the agreement of a non-binding offer, the investor team may announce it with articles by news platforms such as Coindesk. However, such a transaction would receive a broad range of coverage
3. Revenue Estimates
Now we can estimate Maven’s run rate revenues.
Maven Trading Revenues - Estimated using Trading Fees
Maven would offer fees starting at 0.02% and 0.07% maker and taker fees respectively. This is a cut on spot and futures transaction volumes. This would decrease as users’ usage (trade volume) increases - separated into tiers. This is standard with other exchanges
Historical FTX fees (Wayback Machine) Ahead of estimating trading revenues, we can note the following:
Spot Volumes: Kraken’s trading volume was c.$600 billion in 2021 and c.$207 billion last quarter (as of Sep-22). Note, we assume that Kraken is mostly spot volume
Derivative Volume: dydx have roughly c.$500m volumes per 24hr
The top 10 exchanges regularly have daily volumes > $200m (CoinGecko) even in the current crypto winter
As per the below charts, FTX’s average monthly spot and derivative volume are c.$70bn and c.$300bn respectively. Note the incorrect RHS vertical axis title in the spot volume chart
Hence, see below for how Maven’s revenues would track with trading volume
We are assuming averaged blended fees are between 0.03% - 0.04% including discounts for larger sizer’s & market makers. Assuming average yearly trading volumes between $200bn - $500bn, revenue estimates could range from $60m - $200m per year. Let’s call it $140m.
Other thoughts:
Considering the macro backdrop, lower volatility and depressed prices, it is easy to predict these revenues may be lower in the shorter term. Similarly, there may be further fee compression as competition increases
Again, for a period of time, users that had FTT as of 06-Nov-22 would have reduced fees based on the amount of FTT owned
Maven Trading - Using FTX buy back & burn as a proxy for revenue check
We can sense check this $140m estimate by using FTX’s burn schedule to estimate FTX’s trading revenues
Since its inception, FTX has allocated 33% of all trading-fee revenue to burning the FTT token on a weekly basis - wayback machine.
Hence the sum of the burn amount over the past year provides an estimate of revenues. From the Block:
On this basis, FTX averaged $3.8m of burns over the course of 2022. Given the burns made up 33% of FTX trading fees, we can estimate revenue was:
$3.8m * 52 / 33% = c.$600m from trading fees alone!
The potential upside here is attractive…
Staking-as-a-service | Interest Rate Pass Back - Using US Treasuries & relevant exchange comps as a proxy for staking revenue
Below we can see the total value of relevant dollar-denominated stablecoins is $127bn. Source - Defilama
While we will discuss the issues with proof of reserves later, Nansen provides a useful tool to estimate how many stablecoins are held by other crypto exchanges
From this, we can see that successful exchanges have >$1bn+ in stablecoins on the platform
From this lower bound of $1bn (c.0.8% of all stable coins), let’s assume Maven’s users choose to send 25% of stablecoin assets to the savings product - $250m
Let’s aggressively assume Maven offers customers 3% and costs for the technology and bank partnership are 0.7%. Below shows that the current 3M US treasury rates are 4.34% vs USDC defi yield rate that is much lower.
Therefore, Maven’s “Take Rate” is 0.64%
= US 3M Yield (4.34%) - Customer Offer Rate (3%) - Tech and bank partner rate (0.7%)
Below we can see what the revenues would be on Maven collecting a range of 0.05% - 0.8% vs $bn eligible amount for saving products
As the amount of eligible stablecoin increases, this becomes lucrative but indeed depends a lot on the partner bank and technology costs as well as interest rates. We can see that this may generate $10m+
It goes without saying that as rates fall, Maven would offer lower rates until US rates are less than the partnership/infrastructure costs
Crypto Staking as a service - Using ETH Staking to estimate revenues
While there are several tokens that may be relevant for staking, to be conservative, we can focus on the ETH opportunity
We can assume that the yield on staking Ether is 4.5% and $ETH token price of $1,223.61. Coinbase and Kraken charge an admin fee of 10% and 15% respectively
As yield has been relatively constant at 4.5%-5.5%, we can flex ETH deposited and the admin fee
Hence:
While these numbers appear to be low, once the Ethereum merge allows reversible staking, thereby increasing liquidity, staking Ether may materially increase revenues. Naturally, Ethereum prices drive this revenue stream. Without increased $ETH prices and meaningful customer participation, there is little upside
Moving forward, we estimate Maven makes c.$152m in run-rate revenues
$140m from trading fees + $10m from USD interest rates + $2m crypto staking
4. Investment Considerations
By now you hopefully agree with our rationale for acquiring FTX IP! But does the investment make sense?
In this section, we consider the valuation of FTX’s IP and returns profile. At the end of the blog is an example Letter + Tender Offer.
Acquisition Perimeter
Using filings from the bankruptcy proceedings, for now, let us define IP as:
Front-end and back-end technologies that supported the following named constituents of the “WRS SILO”, FTX US, LedgerX, FTX Derivatives, FTX Capital Markets, Embed Clearing, FTX Vault, and the following named constituents of the “DOTCOM SILO”, FTX.com and licenses for subsidiaries in non-US jurisdictions.
Some of these are really handy to own vs building another platform yourself. Happy to discuss more on Twitter.
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Investment Valuation
Now we have defined IP, let us think how about how much to pay!
Motivated Sellers
Ahead of reading the analysis supporting the football field, note that the FTX bankruptcy proceedings are motivated sellers.
There is a significant hole with creditors alleged to receive <35% recovery (opinion and not legal advice). Hence a sale of the FTX IP would be sorely appreciated. Naturally, this firesale comes with a discount.
Valuation Summary
As we can see above, the absolute highest price for FTX’s IP is $200m
However, with the short-term back macro backdrop, distressed sellers, bankruptcy proceedings, precedent transaction valuation of $0, comparison to Coinbase and revenue multiples, opening bids would be lower than closer to $50m!
Historical CEX Valuations
Above are the CEX valuations that I pulled as part of my earlier Kraken investment considerations report. While FTX has had $1.7bn+ invested into the company, trading is only one part of its historical business model - had a VC arm, invested in companies and funds as well as allegedly real estate…
Precedent Crypto Transactions | Voyager Asset Sale
Voyager Digital is another crypto exchange that is going through bankruptcy proceedings. It gives us a precedent transaction to hang our hat on. Indeed, initially, FTX had secured the acquisition of only Voyager’s crypto assets for $1.4bn. Following the collapse of FTX, Binance is now set to acquire only Voyager’s crypto assets for $1.02bn.
What’s more, the Binance.US bid, which was selected by Voyager amidst other bids, is only going to see c.$20m transferred to the bankruptcy estate. The remainder comes from what a Voyager press release calls “the current market prices for its assets”, noting that the final value will be set in the future. This $20m is the cost to acquire customers (3.5m) from Voyager.
Plainly, Voyager’s IP was valued at $0 by both FTX and Binance. $0 for a platform with $1bn+ in assets and 3.5m users!
Coinbase Trading Comps
Coinbase is a perfect publicly listed company to compare Maven to with transparent & audited filings. Let’s look at the facts. Coinbase is valued at $8bn but has $5bn in cash. Hence the market values the business at $3bn.
Compared to Coinbase, FTX has 1% of clients, <10% of client assets, and is active in much fewer countries. Considering the business is inactive, this IP must be worth <$30m (1% of $3bn) but again needs a significant haircut.
Given more time I’d compare considerations (valuations) of acquisitions in the Asset Management space as a percentage of assets under management. Still, I predict valuations are typically <1% of AUM.
Simple Revenue Multiple
Earlier we saw that revenues can reach up to c.$100m+. Gone are the days of x10 EV/Revenue valuations. Recently, relevant tech companies have seen valuations closer to x2 - x5. This gives a valuation range of $200m - $500m. However, this company is defunct and is not in operation. Again, this comes with a severe discount.
Moving forward, we estimate $152m in revenues and an acquisition value of $50m
(Not advice!)
5. Investment Return | Potential Exits
As we have seen, there is an opportunity to create a worthwhile company in its own right. While there have been a few crypto exchanges taken public, historically, most exchange exits have been M&A.
Using the following rubric, we have more thorough insights regarding Maven’s return profile. But reach out to us to get this.
Possible outcomes include (1) Wipeout, (2) Acquisition when tech is in working order, (3) a situation where Maven does not get much traction, (4) M&A to tradfi player/broker, (5) M&A to a crypto native player, (6) successful IPO, (7) IPO as the next Coinbase at 20% of Coinbase’s IPO valuation.
Before looking at M&A and IPO (great reading for what makes a great IPO - here) more simplistically, investors can scale exists via stake sales.
Stake Sale
Maven could sell stakes to venture investors, private equity, traditional financial institutions, and crypto-focused companies. Such investors are useful as they:
Can help to build relevant oversight (board seats) and halo-effect as expert know-how enters the business
Establish background technology infrastructure and best-practices (corporate structure and custody). Improves product features such as on-ramp/off-ramp fiat etc.
Improve relationships with other crypto players and enables partnerships with relevant portfolio
Below is a list of institutions that could be targeted.
Exits
6. Roadmap | Suggestions for Operational Improvements
To make Maven a realistic possibility, there are several things that must change, which are outlined below.
As a summary:
Creation of an official board of directors that includes industry experts and investors
A new corporate structure, with a tiered hierarchy system similar to traditional banking roles. Responsibilities are clear
A rigorous compliance division that works directly with regulators
Big 4 auditing, published liabilities that could be pushed on-chain
Renewed banking agreements with major payment providers, banks and regulators
A market-leading crypto custody solution that decentralises exchange custody via MPC and account abstraction. This would improve “proof of reserves” as we know it
1. Introduction of Board Seats
I can’t believe that we need to write this! Simply, Maven will have a board that includes investors, crypto native experts/founders and individuals that formerly led government planning around crypto legislation or are traditional finance executives.
Examples of board members could be Avi Felman (Head of Digital Asset Trading @ GoldenTree Asset management), Jeremy Allaire (Founder of USDC), Christopher Perkins (President at CoinFund), Charles Cascarilla (Founder of Paxos), Troy Rohrbaugh (Global Head of markets at JP Morgan), Itay Tuchman (Global head of FX at Citi).
Such a board would be in place ahead of launching Maven.
2. Corporate Structure
Here, Maven would build on tried & tested corporate structure models which have been executed well within traditional financial institutions, as well as executed in publicly listed exchanges such as Coinbase.
There would be a clear chain of responsibility and there would be “no-regret” hires with sufficient experience to get this right the first time.
There will also be financial, regulatory, compensation, and technology committees to insure accountability at all times.
3. Compliance & Controls
The lack of rigorous compliance led to a failure of controls to prevent uninformed and unethical behaviour.
Within traditional finance entities, there exists an embedded compliance division which monitors and regulates activities within the entities to ensure there are no conflicts of interest, “chinese walls” remain and the entity is obeying laws within that jurisdiction.
The creation of a rigorous compliance division led by an experienced Head of Compliance is crucial in re-inspiring faith in the exchange industry.
Along with this, working with local and international regulators as well as exchange peers (establishing standards) will be an important element of future success.
4. Big 4 Auditors
The development of independent compliance divisions can be supplemented by the introduction of an established audit firm. The introduction of audits by an established auditor will provide renewed insight into the company’s liabilities and balance sheet.
5. Banking/Brokerage/Other Agreements
The acquisition perimeter includes licences with banks and regulators from all over the globe. Maven would leverage these. Where needed, language would be tidied and steps can be introduced to improve transparency.
While Silvergate provided fiat rails to a number of centralised exchanges, the opaqueness and solvency of these operations are still relatively unknown. Maven would avoid this provider.
Similarly, the introduction of a trusted and well-known banking partner legitimises Maven as an exchange and facilitates liquidity into a new staking-as-a-service US interest rate product.
6. New proof of reserve system (infographic)
The central grievance to all customer concerns is the safety and collateralization of user funds.
Limitations of Proof of Reserves
We agree with critics that the current state of Proof of Reserves (PoR) using Merkle Trees is a fundamentally unsound method of ensuring the collateralization of user funds.
This is because snapshots can be taken before and after wallet transfers, and more importantly, it does not take consider liabilities or margin loans. This, therefore, undermines the legitimacy of the current structure of proof of reserves.
Account Abstraction
We think that account abstraction can transform the current custody-based exchange infrastructure into a more decentralised version of customer custody.
“AA breaks the account coupling and makes the authorization of a transaction programmable by turning every account into a smart contract” - Argent
Within Maven, in addition to usual/typical exchange accounts, users can have smart contract accounts - think of these as crypto vaults.
These vaults can be programmed to only authorize certain transactions (using trust lists), use multi-sig transaction security, access stake-as-a-service products and also social recovery for passwords. They are self-custody and funds within these “vaults” are completely controlled by the customer and not Maven,
Users can then transfer crypto to their Maven wallet for live trading and the Maven Vault for storage once the crypto has been traded. With time, there will be more use cases.
The exchange can work as a compliance layer and execution layer ensuring users are fully KYC’ed and maintaining the function of the exchange.
Argent is the leader in AA and we encourage you to learn more there.
Also, Vitalik agrees (follow the tweet for interesting discourse on MPC vs AA.
The above means that not only is it easy to demonstrate PoR but users are the only ones that can even touch their crypto. Classic case of “can’t be evil” vs “don’t be evil”!
While there is much potential for this form of decentralised custody based solution, much of it is still in development. Argent, for example, who are leaders in AA are working on ZKsync.
Liabilities
Maven will also establish a policy such that liabilities are accepted on-chain. These would be independently audited liabilities by a top 4 auditor of the Maven management company which will be published. Maven will have a web page that demonstrates this and how users can check for themselves on-chain, with liquidity & financials dashboards to display real time the health of the company’s financials.
Any liabilities or debt accepted via a bank will be strictly done via an SPV subordinated to Maven’s business vehicle. As such, this will be published publicly by Maven. .
How to Relaunch | Suggested Steps
Create a syndicate of investors - ideally with knowledge of the industry
Build an advisory team and board. To include industry experts/founders, former FTX super users, and representatives from the investors
Deliver a term sheet to FTX’s lawyers Sullivan & Cromwell LLP and the District of Delaware Courts allowing for due diligence and technical testing. Include clauses around exclusivity and no-shop based on willingness for an expedited process
Where possible, funds should be paid in tranches based on the long-term useability of the acquired technology
Should the above be positively received, build the executive team and continue testing and infrastructure building
Should the above be positive, re-connect with the investment syndicate and formally bid again
Ahead of close, leverage news agencies like Techcrunch and Coindesk to announce the bid and then a splash article upon launch
7. Risks
Operations Based:
Potential for declining volumes amidst a negative macro backdrop
operating results will significantly fluctuate due to crypto volatility
Securing a banking partner or banking licenses will be difficult
Employee arrangements (Non-competes & equity)
Token selection & leverage offerings to be reconsidered
Focus on regulatory approach could stifle progress
Other:
The extensive and highly-evolving regulatory landscape
Regulatory scrutiny & geography company incorporation
Cyberattacks and security breaches of our platform
Public perception/Brand Recognition as Maven is FTX’s “skeleton”
Concluding Remarks
Ooof! We hope that you enjoyed that as much as we enjoyed writing it.
In review, we’ve shared our rationale, suggested revenue streams, considered valuation for the value of a defined perimeter, presented returns analysis and proffered many operational improvements, board members, a launch as well as a never seen before digital custody solution!
In the link below you will find a draft tender letter (NOT ADVICE!) to acquire said IP, which could hypothetically be submitted to the court of Delaware.
Tender Letter & Term Sheet Link
Ultimately, as users of the original FTX, we see the value in an institutionalised exchange, with the front & back end of an exchange much loved by crypto natives but with the controls, compliance and cryptographic certainty it was missing.
Under the right leadership, with the right investors, and over a longer period of time, this could be an opportunistic acquisition with the chance to challenge a dominant monopoly, Binance, in a new and emerging space.
While we recognise the many challenges that come with such a spin-out, we believe that these can be overcome to realise the value that a new exchange like Maven could offer. Reach out on Twitter to discuss more!
Best,
Joseph & Crypto Joe - Happy New Year 2023
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Disclaimer
This post is neither financial, investment nor legal advice - it’s at best entertaining!
You should conduct your own research, and consult an independent financial, tax, or legal advisor before making any investment decisions.
Nothing contained in this report is a recommendation or suggestion, directly or indirectly, to buy, sell, make, or hold any investment, loan, commodity, or security, or to undertake any investment or trading strategy with respect to any investment, loan, commodity, security, or any issuer.
This post should not be construed as the solicitation of an offer to buy any business, security or commodity.