Enzyme Finance (MLN) Memo - Activist Investment #1
Disclosure: Hartmann Digital Assets Fund, LP as well as Hartmann Ventures LLC are currently invested in $MLN. Hartmann Ventures also holds one of the 11 seats on the Enzyme Council. Opinions expressed in this Memo are the opinions of Felix Hartmann and not the Enzyme Council at large.
How it Started
In June of 2020 the tipping point had been reached for on-chain trading and on-chain lending. I asked myself what this maturation would unlock in new primitives that initially were not feasible due to dependency on trading and lending capabilities. In my research I came across Melon Protocol (now rebranded to Enzyme Finance), the only on-chain asset management protocol at the time, with a live product, growing TVL, and incredibly strong team. The UI was clunky and the capabilities limited but it was the first mover in the space and could be the next step in the ‘retail-ization’ (r)evolution that has started with online brokers and went mainstream with no-fee platforms like Robinhood, and breached into asset management with copy trader tools like eToro.
Despite allocating with an average purchase price of around $4, we (HDAF + HV) continue to be net positive buyers since that day, and I am a bigger bull on Enzyme than I was when I first got involved, even now, 30x later. When we take on these rather long term and arduous activist positions, we are shooting for projects that we can see go from 7 figures to 10-11 figures. Nothing less.
While this is our first memo on Enzyme, our involvement has been well documented, not the least of which is in being elected onto the Enzyme Council in September of 2020.
In this memo I want to share my renewed and expanded thesis to bring color to why MLN continues to be our largest portfolio allocation (by choice, as we accumulated on the open market with no lock-up).
The MLN Mega Thesis
Financial Transparency Layer
The financial world is littered with stories of financial fraud. From Madoff and 1MDB on Wall Street, to One Coin and Bitconnect in crypto. In all situations there was a disconnect between returns that were presented, and what was actually produced. The total damages were around $4.5 billion, $19 billion, $19.4 billion and $3.5 billion respectively (combined around 300x the fully diluted market cap of Enzyme).
But how can it be solved? In many of these horror stories you had the most reputable accounting firms entangled. Big 4 firm Ernst & Young seems to be on a quest to catch em all as clients, from 1MDB, Madoff, and even the most recent Wirecard scandal.
The solution has to be immutable records that need no auditing in the first place. Human-executed financial audits enable not just human error but corruption. Enzyme’s first use case is to serve as Ethereum’s financial transparency layer. One wallet can create endless enzyme vehicles, however each vehicle has independently tracked performance and immutable transaction histories. Nothing can be added after the fact, nor can anything be removed or purged. This is the most obvious use case when looked at from the current Enzyme lens of decentralized funds, but it becomes even more powerful when considering that every single entity of the future will use Enzyme for treasury management (see Thesis 4).
More near term, many DeFi protocols have questionable yields that could gain trust by being tracked via an Enzyme vehicle. We have seen first protocols like Rari Capital move some of their aggregators to Enzyme as early adopters of this thesis.
What value can being the financial transparency layer create for the Enzyme ecosystem? Here’s a few real world benchmarks to keep an eye on:
Fund Administration industry $8b - $12b in total market size
Global financial auditing market was valued at $123.32b in 2019
Value accrual tied to being a transparency layer could come in the form BPS on assets on Enzyme, which Enzyme is implementing with ENZIP7.
On-chain Custody
Being transparent is great, but it does not prevent situations where asset managers or founders disappear from the face of the earth from one moment to the next, taking all assets with them. In crypto we even coined a term for this: ‘the rug pull’ or in short, getting ‘rugged’.
Every feature comes with a challenge, and while blockchain’s private key cryptography is an immense feature for owning your own assets, it presents a problem for any entity or asset manager. If key ownership equals asset ownership and ability to ‘run off with money’, then we face an infrastructure hurdle for the times we do want to delegate custody of our funds for specific reasons. Say you want to enable someone to trade but not lend your assets. Or you want to let someone farm for yields, but not withdraw your funds to their own wallet and disappear.
Until now, the most common solution to this problem has been multi-sig wallets. The problem is that multi-sigs are awfully slow and inefficient due to dependence on human coordination (I know, I’m part of a few). However what Enzyme has introduced is the first ever on-chain custody solution. This is something as a council member I like to see expanded on, but even today, you can use an enzyme fund to delegate trading privileges to your traders, similar to sub-accounts on centralized exchanges. This in itself is a technology that gives traditional crypto funds a reason to use Enzyme even if they pay a few basis points on AUM.
And even for investors, it is comforting to know exactly what Enzyme fund managers can do with their money, and rest assured that funds cannot be withdrawn.
What value can reasonably be generated by being the leading on-chain custodian? Let’s explore:
Currently, leading crypto custodians like Coinbase Custody charge 50 BPS annualized for their custody services.
Value accrual tied to being the leading on-chain custody layer could come in the form BPS on assets on Enzyme, which Enzyme is implementing with ENZIP7. As a council member, while dissenting from the majority, I am in favor of raising these to more closely resemble the crypto custody numbers standard in the industry which would significantly raise value accrual for MLN.
3. Defi Mega Aggregator
DeFi is the future of finance. There is no argument about that. However the future of finance can hardly be hundreds if not thousands of disjointed services across different websites, with different security standards, and varying degrees of user friendliness. There is a reason why Binance has seen massive success in becoming a one-stop-shop allowing you to trade spot, futures, margin, lend, borrow, stake and more.
While crypto natives are tech savvy enough to jump between dApps, smart contracts, and even now different chains via bridges, it’s unrealistic to expect retail to embrace DeFi unless it is simple and all in one place. Yearn Finance has proven the power of aggregators as it turns what would usually be complex transaction flows across multiple protocol into one click vaults. Enzyme however is taking it a step further and uniting all of DeFi under both one infrastructure layer as well as one UI. Already today you can access: Uniswap, Paraswap, Synthetix, Uni Pools, Staked ETH 2.0, Compound, Aave. With the Sulu roadmap you will be able to access even more, including Curve, Balancer and Idle.
By mid 2022 I expect Enzyme to cover 90% of DeFi by TVL. As a result I equally expect most of new retail customers to set up Enzyme funds to manage their crypto portfolios similarly as they create Binance or Coinbase accounts. A sleek UI, all performance visually tracked, most tools under one hood, and higher levels of security as the UX removes the need to hop between websites is a killer use case. I love Zerion and Zapper, but being able to not just track but use all protocols is unmatched.
What value can reasonably be generated by being the leading DeFi Mega Aggregator? Enzyme in a way plays the role of middleware which traditionally is rewarded via revenue sharing of the volume it brings other platforms. While this has not been proposed or in any way shape or form been agreed upon by the council, I am a strong proponent of introducing revenue sharing as a council member as Enzyme is already now providing significant daily volume percentages to some DeFi protocols. To get an idea of how much that could be I point towards the following data from TokenTerminal.
On any given day within the past 90 days, DeFi applications generate a cumulative $6-8 million in revenue A DAY.
To get an idea on how much of this revenue Enzyme could be a contributor off I look towards one of the most popular middleware players in crypto that could be used as a case study: Paradigm.
Paradigm now contributes about 20% of the options volume done on Deribit.
If Enzyme lives up to this thesis and becomes THE DeFi Mega Aggregator, it too could contribute north of 10% of all DeFi volume and thereby revenues. Already now (and we are still very early) that would be $600k-$800k worth of contributed revenue a day. How much of that should be shared with Enzyme for providing the demand side? 30-50% tends to be a normal rate for revenue sharing for middleware products. Assuming a 10% contribution, this would mean $180k to $400k worth of additional daily revenues for Enzyme, a number that puts any kind of ENZIP7 projections to shame. Once that clicks you realize how underpriced MLN really is. And a revenue share is not a tough ask when there are half a dozen nearly identical projects for every use case.
4. DAO infrastructure
If you were to start a Decentralized Autonomous Organization today, what would be your tech stack for treasury management? Aside from protocol governance (voting on upgrades), a key aspect to DAOs is decentralized treasury management. Just like every other thesis, this is not a hypothetical, but a live feature today. Since earlier this year, Enzyme partnered up with Gnosis Safe to bring full fledged multi-sig digital asset treasury management to organizations. Mutli-sig holders can now vote together on what they want to do with their treasury, whether that is holding their assets in a diverse portfolio ranging from most major crypto assets to many major traditional currencies, commodities like silver, gold and oil, and equity indeces or even individual stocks like TSLA. Beyond just deciding on what to hold, Enzyme enables DAOs to have capital efficient treasuries by tapping into lending integrations like Comp, Aave, and Curve. The Enzyme Council was the first to experiment with this with the creation of its $1mm+ Enzyme Treasury Vault, stored on Enzyme and directed through Gnosis Safe multi-sig interface.
I subscribe to the thesis that nearly every LLC and corporation of the future will both be a DAO and be on-chain. In an ever-globalizing world it only makes sense to have borderless entities with trustless infrastructures. Enzyme may be a key infrastructure piece for every single entity of the future. To understand the market size of treasury management I looked at the following:
S&P 500 non-financial companies are sitting on net cash and short-term investments of $592 billion
Value of all cash and investments held by US corporations: $2.5 trillion
Here too, value accrual can come both in the form of being the leading DAO treasury management layer which can be realized in the form BPS on assets on Enzyme, which Enzyme is implementing with ENZIP7 or via middleware revenue sharing as proposed in thesis 3, which here would come with trillions in volume rather than millions.
5. Capital Raising Protocol
This thesis, saved for last, may be a bit obvious given the nature of Enzyme enabling decentralized funds to raise money as its primary use case. However with the transferability of Enzyme Fund tokens, Enzyme can now not just be used to raise money for a fund but also for an investment manager (the GP). Funds can have someone invest into their management structure, sharing the performance upside. While this is not native yet, it can be set up via a simple Airswap transaction where one trades OTC some of the fund ownership tokens in exchange for say USDC or ETH. The same of course applies in conjunction with the DAO thesis, where startups could raise money from investors and give them ownership in the enzyme vehicle. Ultimately an enzyme fund can become synonymous with a balance sheet, as every debt and every asset will be tokenized and tracked within the vehicle, including contracts around IP and more. From this perspective enzyme funds can be used with a whitelist from the Seed Stage all the way to the IPO, at which point the whitelist is removed and anyone can purchase the Fund Tokens. Note that fund raising for liquid assets within a fund have been around since V1. GP share transferability is a new feature as part of the Sulu roadmap. Finally as a council member, I am looking to push for further DAO infrastructure additions, to enable Enzyme to live up to this vast opportunity within a still deep blue ocean. In 2020 alone VCs invested $156.2 billion in US based startups alone.
The Road to Mass Adoption
Theses are nothing but ideas, based on the foundation that has already been built. As Enzyme continues to grow and expand, so do our capabilities. Every year the Enzyme Council has a 300,600 MLN budget, which a year ago today was just around $600,000. At the time of writing this, the same amount of MLN is giving the council a budget of around $24mm USD for the year 2021. Given this strong boost in our own balance sheet, In 2021 I want to see more third party developer activity for the ecosystem. My best recommendation to any teams and developers out there seeing the vision that I just outlined in this post, is to approach us with lean and niche proposals that can help push any of these theses closer to fruition. Start lean, deliver, and grow with us into becoming one of many core teams as Enzyme becomes a multi-billion dollar protocol.
Many thanks for all the work that went into getting Enzyme to where it is now goes to the team at Avantgarde, the one and only Mona el Isa, the Enzyme Council, the 300+ Enzyme fund managers, and the 5,000+ Enzyme token holders. Onwards.
DISCLAIMERS:
This is not an offering. This is not a buying recommendation. This is not financial advice. Always do your own research.
Our discussion may include predictions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this presentation. Please keep in mind that we are not obligating ourselves to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events.
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