🦄 Revenge of the Unicorn — Issue No. 109

On Wednesday, September 16th, 2020, the team building Uniswap launched a token and airdropped it to every address that had ever executed a trade using the protocol. It will also be distributed to liquidity providers who add their capital to key Uniswap pools on an ongoing basis. The new token is called UNI, and it will be used for governance of the Ethereum-based decentralized exchange (DEX). Link.

Uniswap has been around for two years now, and is by far the most popular DEX in the crypto ecosystem. Until now, both the current version ("V2"), and the previous version ("V1"), had functioned autonomously on chain. So why does Uniswap need a governance token now? The decision to add and distribute UNI is, undoubtedly, tied to the launch of SushiSwap, a source-code fork of Uniswap that used governance token farming in an attempt to suck liquidity away from Uniswap itself. I covered the drama around SushiSwap in the previous issue of this newsletter. Link.

In this issue, I'll look at the UNI drop, covering the many things the Uniswap team did right, but also why I still have reservations about the new token and what it means for the future of the ecosystem.

The UNI Drop

UNI was distributed to every address that had ever used the protocol, along with those who had provided liquidity. Any address that had executed a trade qualified to claim 400 UNI. The total supply of the token will eventually reach 1 billion, then inflate continuously at a rate of 2% per year.

Since the token was launched, some cool stories have been trickling out of users who received unexpected payouts. At one university in Turkey, for example, students were required to try out Uniswap as part of an introduction to cryptocurrencies class. The 400 UNI earned by each student for completing the assignment are valued at more than half the cost of their yearly tuition. Link.

Stories like this highlight one of the things the Uniswap founders did right. By distributing the tokens far and wide, to the many thousands of users who have used Uniswap in the past, the team naturally engendered positive emotions about their product. It's hard not to feel good when someone gives you something worth a couple thousand dollars.

The decision to give the same number of tokens to any address that had used the protocol— regardless of how many transactions they performed or how valuable those transactions were— was also a good one. One of the big issues around "yield farming" schemes for the distribution of tokens is a sense of unfairness. The rich get richer, since they have the capital to risk to earn the governance tokens. Then, as governance token plutocrats, they can use their power to direct the protocol in ways which only further enrich themselves. Uniswap short circuited this by making equal distributions to their thousands of users, a unique asset which few other projects in the space have.

Distributing the tokens to liquidity providers on an ongoing basis also helped fend off the vampire attack from the SushiSwap fork. It seems to have worked. At the time of this writing, Uniswap liquidity has risen to nearly $2 billion, while SushiSwap liquidity has fallen to less than one fourth of that.

Why Tokens?

While I’ve said the Uniswap team did a lot right in this token launch, the question remains, why launch a token at all? Well, I’ve already mentioned one reason— to fend off a vampire attack from SushiSwap that threatened to drain away Uniswap’s liquidity. Is there more to UNI than that, or are these governance tokens little more than viral marketing schemes? Does UNI add value to the Uniswap protocol, or was it purely a defensive play? And why would anyone want to own and hold UNI in the long term? Some of you out there who received UNI may be wondering if you should keep it or sell it.

I’m not going to give investment advice, but I do remain skeptical about the actual utility of UNI. The reason I’m skeptical is because Uniswap itself has proven that a DEX can function autonomously on chain for years without intervention. The question is, does enabling governance— that is, allowing changes to the protocol based on token votes— enable Uniswap to do something powerful it couldn’t before? Or does it simply introduce a rather large attack surface with little tangible benefit? We’ll have to wait and see. With the Uniswap team teasing version 3 already, I’m eager to learn what they’re cooking up in terms of governance.

The other question is, why should anyone want to hold UNI tokens? The only logical answer, other than to speculate on the price others will be willing to pay for them, is that Uniswap governance will eventually enable changes that direct cash flow from exchange fees to token holders themselves. Will Uniswap have a sufficient moat to demand a premium paid for fees, or will we see a price war between DEX protocols that drives fees to zero? This is quite literally a multi-billion dollar question, and I don’t pretend to know the answer. Anyone who does is probably lying to you, or themselves. Time will tell.

Because Tokens

Zooming out from the specifics of Uniswap, the launch of UNI is indicative of where the ecosystem is heading. From here on out, I expect most major projects to have a token. In many cases, they may not be more than viral marketing mechanisms, but the thing about viral marketing mechanisms is that they work, and can be quite powerful.

Incentives for developers in this ecosystem are already less than ideal. Builders working on “public goods,” like the software for running the nodes that power the networks, for example, are often under-compensated relative to their fair market value, let alone relative to the public value their work generates. UNI shows that an appetite exists for governance tokens. In fact, they’re almost required to prevent a competitor from eating your lunch. Whether a token is actually useful or not, it’s hard to blame developers for including one in such an environment.

If you reward a behavior, you can expect to get more of it. For the time being, the ecosystem is rewarding builders that add token distribution mechanisms to their projects. After years of eschewing this route, Uniswap has followed suit, and done so in a smart way. In the short term, this strategy seems to be working both for Uniswap and the entire DeFi ecosystem. Whether it's sustainable and healthy in the long term is yet to be seen.