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Saxon Advisors Blog

The Equity-to-Token Model… A VC's Winning Formula for Billion-Dollar Exits in Crypto?

The borrowing and lending application Compound took the crypto world by storm last week when it began distributing its governance token — ticker COMP — to its users and early backers. Upon listing, COMP was trading at $16 and has since surged up by more than 1400%

Compound is among the few crypto projects that never conducted an initial coin offering (ICO) at the beginning of its lifecycle based on a white-paper promise. Instead, the company opted to take the traditional venture capital financing route, raising approximately $33 million from several titans in the crypto space including Andreesen Horowitz, Polychain Capital, Paradigm, and DragonFly Capital. The money was used to develop the product, find product-market fit, and attain network effects - all without using a token. 

From the outside, the VC backing may not look like a purchase of token, however, the VCs buying equity in Compound did so with the full intention of attaining a portion of future-issued governance tokens.

Governance tokens aim to empower users of an application, giving them control over the fate of the application, taking power away from the founding team. In theory, following the issuance of the governance token, the value that had accrued to the equity of the original operating entity is transferred to the issued token. The token holders attain voting privileges and potentially all future cash flows that the application generates (meaning that the governance token could evolve into becoming a capital asset). 

While we are still in the early stage of Compound’s journey to becoming a widely used lending and borrowing protocol/application, to say that the launch of the governance token has been a success would be an understatement. Today, the fully diluted market capitalisation of Compound is roughly at $2.39 billion

Although we are unable to calculate the exact internal rate of return (IRR) for the equity purchasing fund managers, the public-nature of the permissionless blockchain means we have full visibility of their COMP holdings and its worth:


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Source: Compound governance leaderboard 28.06.2020


Aside from the attractive ROI for the early VC backers so far (and it's still early days), Compound has also ensured that over 40% of the total supply of COMP tokens will be gifted to the actual “users” of the product. As a result, this has led to a crazy surge in demand and explosive user growth due to users expecting price appreciation of the COMP token — in what is being termed liquidity mining or yield farming. In less than a week, total funds locked in Compound have increased from around $100 million to nearly $600 million


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Source: DeFi Pulse


What we are now therefore seeing is the token-enabled network effect flywheel in full motion. The opportunity for users to earn a yield denominated in COMP token for simply using the borrowing and lending protocol leads to more users entering in search of yield, leading to more liquidity, leading to a better quality of service. 
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Technology adoption cycle





Concluding Remarks


The successful launch of the COMP token is a testament to the success of equity financing a high-quality team to build a valuable product, establish product-market fit, and gradually progress towards community ownership (decentralisation). 

Compound has now set the stage for the future of decentralised finance (DeFi) applications built on the blockchain. Get ready for more teams warming to tokenisation again as well as crypto VC investors demanding that their equity investments evolve into governance token allocations. 


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