David Z. Morris: The Bear Case for Bullish is Spelled E-O-S

There was a wave of what I’ll call bemusement in crypto circles last Friday when blockchain firm Block.One and investors including Peter Thiel announced they would take the cryptocurrency exchange Bullish public. The listing would take place via a special purpose acquisition company (SPAC), or a merger with a listed company, at a valuation of $9 billion. There are a number of uncertainties swirling around the plan, not least because the exchange doesn’t exist yet.

In fact, Bullish was nearly invisible until May of this year, when Block.One announced that it was committing bitcoin and EOS tokens, then worth nearly $10 billion, to create a large liquidity pool for the exchange. The exchange itself is expected to launch later this year – when it will go up against a half-dozen far more established players in the U.S. exchange market, even as exchange activity trends downward as a bear market sets in.

All that is reason enough to question the wisdom of Bullish as an investment. But the real eyebrow-raiser for my money is the involvement of Block.One and its downtrodden smart-contracts platform EOS. Given years of consistently disappointing results from the company and affiliated projects, and a strange push to use EOS in the operation of the otherwise fully centralized Bullish, many crypto longtimers immediately wondered whether building a profitable crypto exchange is the only motive for the SPAC.

Block.one was founded in 2016 as a launchpad for EOS, a would-be “Ethereum killer” that raised a record $4.1 billion via an initial coin offering in the first half of 2018. Like many ICOs, that raise was later deemed an unregistered security offering by the U.S. Securities and Exchange Commission. Block.One paid a $24 million fine in 2019 – seen by many at the time as a comically paltry slap on the wrist relative to the amount raised.

Despite its massive war chest, EOS has failed to become even a remotely credible competitor to Ethereum, largely thanks to a failure to address deep design flaws. EOS was conceived by Dan Larimer, a co-founder of Block.One along with CEO Brendan Blumer, using a “delegated proof-of-stake” design that Larimer touted as the next generation of blockchain tech. But that didn’t really pan out: Within months of EOS’ launch, it became clear the voting process for selecting validator nodes was being aggressively gamed by cartels looking to capture block rewards.

That led to a “brain drain” as engaged, grassroots node operators were effectively pushed off the network. The problems also turned off developers: EOS currently hosts only one of the top 25 distributed applications (dapps), according to DappRadar. No EOS dapp has daily volume over $100,000, while Ethereum has at least 25 dapps with daily volume over $1 million. The Binance Smart Chain, Tron and Polygon systems have all attracted more activity than EOS, even though BSC and Polygon launched more recently.

Larimer joined that brain drain in January when he announced his departure from Block.One and EOS to work on “personal projects.” That continued a trend for Larimer, a once-prominent cryptocurrency leader who over time gained a reputation for moving on swiftly from projects he founded. That’s what happened at both BitShares, Larimer’s first big project, and Steem, a decentralized media project. BitShares is now essentially dormant, and Steem has struggled after Larimer’s departure.

Those missteps and failures led to abjectly awful bull market performance by the EOS token, which sank by more than 30% over the past 12 months in BTC terms. Since its peak in May 2018, the token is down nearly 95% versus BTC. Formerly a top 10 token, EOS has sunk to rank 27 by market cap, according to CoinGecko. EOS, remember, is Block.One’s reason for existing.

Block.one said in May that the exchange would use “EOSIO and the EOS Public Blockchain to produce a cryptographically validated, provable, and immutable audit trail of all transactions processed on the Bullish platform.”

This has led to some confusion that Bullish will be a decentralized exchange, or DEX – a category that has seen explosive growth over the last year. But Bullish would be just as centralized as Coinbase, with the slight addition of writing receipts to EOS. That could have some transparency benefits, but doesn’t make the exchange meaningfully decentralized.

But the architecture does hint at a possible secondary motivation behind Bullish: Whether it turns out to be a successful exchange or not, Bullish’s use of EOS for recordkeeping will make EOS seem more successful, or at least promising, by creating on-chain transaction volume as well as fees and other revenue. Block.One currently holds just under 6% of all EOS, worth roughly $250 million, according to EOS Authority.

(Transaction costs on EOS are quite a tangle. Some transactions are nominally free, but costs are arguably just moved around into staking requirements and RAM fees for onboarding dapp users. Last year Block.One introduced a pay-as-you-go fee option.)

Those fees and costs would ultimately be paid by Bullish users – to the benefit of Block.one. In other words, Block.One is creating a spin-off that will in essence be its own long-term customer, for a service of unclear utility.

Another compelling angle on Bullish came Friday from Sam Bankman-Fried, FTX co-founder, who in a Twitter thread focused on the $6 billion in crypto reserves that Block.One and other investors have injected into Bullish. Those reserves amount to about two-thirds of the proposed value of the Bullish SPAC.

That led SBF to speculate that, rather than a competitor to Coinbase or Bakkt, “Maybe Bullish is really another MicroStrategy.” In other words, maybe the real investment here is not in any innovation Block.One and Peter Thiel might bring to crypto exchanges, but in Bullish’s crypto reserves. The public listing will, like MicroStrategy stock, be investable by some entities that can’t directly buy crypto, such as (in theory) institutions. As the Grayscale Bitcoin Trust has shown , some investors are willing to pay a premium for these crypto-equity workarounds, though the near 50% markup on Bullish’s holdings might be a bit steep. (Grayscale is a CoinDesk sister company.)

Another key distinction is that while MicroStrategy has been laser-focused on bitcoin, the reserves behind Bullish will be much more of a mixed bag. The $10 billion supplied by Block.One to stand up Bullish in May (which has since declined in value) was over 90% bitcoin, but also included 20 million EOS tokens, or about 2.5% of the total. (It’s unclear whether these funds have already been moved from Block.One’s EOS wallets). As an exchange, Bullish would also wind up holding a mixed bag of other assorted coins.

So, hey, maybe there’s really demand for a public stock that’s like MicroStrategy but with a jumble of altcoins on top of a barrel of bitcoin! It certainly seems more likely than there being huge demand for yet another centralized exchange.