Happily Ever After? Exploring the Fei-Rari merger
Level 3 - Virgin DeFi Analyst
Welcome Avatar! The merger of Rari Capital (RGT) and Fei Protocol (TRIBE, FEI) has been approved by governance.
Those of you that know DeFi Education know that some of us come from Wall Street. There is no way we would miss the opportunity to cover the first ever DAO merger.
Not only did we analyze the structure and public negotiations, we followed along on governance forum discussions throughout the process. Let’s dive in.
Background
Rari Capital and Fei Protocol are combining into a single token under one DAO. Fei Protocol’s TRIBE tokens are to be minted and exchanged for RGT tokens at a predefined ratio. Total supply of RGT is converted to 30.5% of the total TRIBE supply post-merge.
Autist note: we use the term “merger” here since that’s how the proposals reference the deal. In reality this is a friendly acquisition where Fei is acquiring Rari Capital - TRIBE holders get overwhelming majority control of the combined DAO and also keep their token while RGT is discontinued.
What is Rari?
Rari is a permissionless money market protocol. Think of Rari as Aave for degen cryptoassets. Rari’s “fuse pools” allow anyone to create their own money market. These pools are isolated, meaning the risk of each pool is confined to the pool itself. Fuse pools allow Rari to facilitate borrowing and lending of higher risk assets that protocols such as Aave and Compound will not approve.
What is Fei?
Fei is a dual-token stablecoin protocol. Fei uses Protocol Controlled Value (“PCV”) aka asset reserves to maintain peg for the FEI stablecoin. When FEI is below peg, the protocol uses its PCV to buy FEI up to peg. When FEI is above peg, the protocol will mint more FEI and push the price back down to peg. FEI can be redeemed for ETH at $0.95 per FEI subject to redemption limits.
Merger Strategic Rationale
FEI Network Effects + Rari’s Oracle
Rari’s fuse pools consist of a wide range of cryptoassets. To take in more assets, Rari uses oracle feeds from liquidity pools. Liquidity can be added with FEI to create a liquid market on which to base a TWAP oracle. For example:
Someone wants to add a hypothetical OWL coin to a fuse pool
OWL DAO provides OWL via Ondo
Fei Protocol seeds the other side of the liquidity on Ondo
Fei collects fees. OWL DAO takes on impermanent loss risk
This pool creates an oracle feed to power the fuse pool
As more assets are paired with FEI, network effects for FEI grow
As more assets are available on Rari, fuse pools grow
In essence, Fei will seed liquidity for fuse pools. While this probably could be managed as a partnership, the merge aligns incentives around a unified DAO and token.
Eliminates Rari Debt
In May 2021, 2,985 ETH ($11.6 million at the time) was stolen from Rari. Rari established a $11.6 million liability (“REPT-b”) to reimburse users for their funds. Rari generates ~$5.6 million in annualized revenue, meaning it would take over two years to repay the liability if all revenue was diverted to repaying the debt. As part of the transaction, Fei would repay Rari’s REPT-b liabilities in full in FEI.
Contributor Talent
Pretty self explanatory. There are talented devs / contributors behind both protocols. From the outside looking in, we can’t opine on how well the teams will mesh in practice. They seem confident they’ll work well together and most contributors are supporters of the deal.
Autist note: one area to consider is how the Rari contributors will feel about being subordinated in voting rights to TRIBE holders. RGT goes from having 100% voting rights over Rari Capital to being a minority stake (30.5%) in TRIBE. Some of this could be mitigated by crossholdings but we doubt Rari contributors have anywhere near as much control post-merge. We are *not* speculating on how they feel about it (we don’t know them personally and haven’t spoken to them), but it’s something worth monitoring.
Deal Structure
Independent third party GFX Labs released a proposal on the Fei and Rari governance forums with a deal structure in place. This proposal outlined:
High level strategic rationale for the merger provided by Joey and Jai from Fei and Rari, respectively
An exchange ratio of 1 RGT for 26.71 TRIBE calculated as a $1:$1 ratio based on 7-day TWAP as of November 27th, 2021
“Ragequit” for TRIBE holders that do not wish to participate (their TRIBE would be exchanged for FEI at a premium to the price of TRIBE, adjusting downward dynamically depending on amount of ragequits)
~$11.6 million of Rari debt would be repaid by Fei in full in FEI (USD stablecoin)
TRIBE would be minted to purchase RGT. Post-merge, RGT would hold 30.5% of TRIBE and existing TRIBE holders would hold 69.5% (dilution from newly minted TRIBE is adjusted depending on ragequits)
In simple terms, RGT tokens would be retired and holders would receive TRIBE in exchange per the ratio outlined. Post-merge, RGT holders would have 30.5% of the total TRIBE supply. TRIBE holders’ total ownership would be diluted but they remain the majority “owners” of the DAO.
Rekt Police: Merger Price
No easy way to say it. RGT holders got rekt on pricing. The method for calculating the price and the manner by which the proposed exchange ratio was disclosed left a lot to be desired. Here are the main issues:
Calculation method: The TRIBE:RGT exchange ratio was based on the USD price of each token relative to the other. Specifically, the 7-day TWAP as of November 27th, 2021. There was no explanation given as to *why* this pricing method was used (7-day TWAP). There was also no comparison to other methods/calculations.
Date selection: The merger was proposed on November 16th, 2021. The exchange ratio was calculated 11 days post-merger announcement (meaning the merger news was already being traded on). In financial markets, even mere speculation of a merger can impact pricing. As such, it is extremely unusual to determine pricing post-merge announcement. Strangely, the TRIBE ragequit snapshot is based on November 16th, so there seems to be an acknowledgement of the pre-merger period as being important.
Lack of accountability: GFX Labs stated (on their own proposal) that they are not taking a view on price or valuation.
Quite peculiar. What is the purpose of an independent agent in a merger transaction if they don’t justify the price? In traditional M&A, you have an agent (banker) on *each side* negotiating price. Having agents also allows a merger to take place without the teams on each side fighting each other on price (bankers fight on the team’s behalf).
Rari founder Jai also did not want to engage in price discussions.
No one pounding on the table for RGT holders.
No bueno.
Having the community arrive at a price on their own might have worked (although a representative would be better) if not for one issue: the GFX Labs proposal included its own exchange ratio calculation which served to *anchor* people to that ratio. There was no way TRIBE holders would be willing to pay a higher price after seeing the initial exchange ratio. Not without a major concession (or perhaps strong disapproval from Rari’s core contributors).
Even if you *say* you are not taking a view on price, a price and relative valuation still have to be determined to execute the transaction. You can’t opt out of taking a view on price whether you explicitly do so or not. Implicitly, the view taken here is that a $1:$1 swap based on 7-day TWAP is a fair price.
Some RGT community members realized they were getting bad pricing and put together a proposal with (in our opinion) more fair pricing (namely, using the November 16th pre-merger date). You can read the proposal in detail here. The proposal passed on the RGT side and was shot down by TRIBE.
Based on their calculations, the price of RGT should be $41 (vs. $29.1 as approved).
That’s $512 million in FDV versus $364 million approved - a whopping total of $148 million in value leakage. And that’s assuming there should be no control premium (a discussion for another day). Even if you pull out the $11 million in debt, the deal still represents a fairly substantial discount to Rari’s market value.
We did some of our own calculations as well and any way we look at it, we do not think the deal was done at an appropriate market valuation.
But what about intrinsic value?
That’s a tougher (and more subjective) question to answer. Rari has a strong product and over $1.2B in TVL. However, its value capture is quite low ($5.6 million in annualized revenue). Fei has $1.2B in PCV and $295 million in its treasury. At 30.5% post-merge ownership, RGT holders have “claim” to ~$366 million in PCV and $90 million of treasury assets (rough numbers). Comparatively, Rari has only ~$2.5 million in its treasury (and $11.6 million in liabilities!). With only $5.6 million in annualized income, Rari is *capital constrained* in a DeFi environment where capital and competition are abundant. Fei solves this.
From a fundamental perspective, we like the deal. Fei has good strategic fit with Rari’s product and, perhaps even more importantly, a large warchest to bootstrap growth. These points should not be overlooked as they give Rari a fighting shot against the big boy money market protocols long-term. Fundamentals certainly make the rest of the deal a bit more palatable.
The Broader Questions
To us, this merger raised some important questions. What is the duty of members of a DAO? Is their duty to build the best possible products at all costs or is it to maximize value for the tokenholders of the DAO?
On one hand, there are plenty of great “DeFi 1.0” products whose tokens have severely underperformed. Why should people allocate their capital to support your DAO and your product if you disregard the token?
On the other hand, tokenholders can miss the big picture and overreact in the near term (you see this time and time again when market is down, something goes wrong, etc.). This behavior distracts from product goals and executing on a long-term grand vision. It’s hard to know what the long-term value maximizing outcome is in the near term - many times you only find out if you were right after the fact.
We’re not sure there is a definitive answer to these questions today.
In TradFi, public M&A deals have to demonstrate they are value maximizing for the equity. We don’t think ignoring token value is the right approach. Furthermore, a rising token price is not only great marketing but it attracts talent to DAOs.
At the same time, we think the quarterly earnings mentality should be left to die in the TradFi world and that teams want to (and should) build for/with long-term diamond handed holders.
What do you think, anon? Let us know in the comments below.
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Until next time…
Disclaimer: None of this is to be deemed legal or financial advice of any kind and the information is provided by a group of anonymous cartoon animals with backgrounds in Wall Street and Software.
Sounds like there’s a business opportunity for DeFi m&a advisory
Great post as always!
Looks like Brain is back. Glad to see him!