The Investment Case for Rari Capital
Over the weekend Rari Capital suffered from a hack, losing USD10m worth of Ether to an attacker. This represents 60% of user funds that were held in one pool of Rari’s yield aggregator. It is against this backdrop that we now publish our investment case for Rari.
The severity of the hack that has just taken place cannot be dismissed. It demonstrates code auditing errors that the team has acknowledged. At the same time, it would be wrong to write off a project because of such a setback. By way of example:
- In 2017, Polkadot lost access to 306,276 ETH as a result of a hack on one of its wallets. At the time this was worth about USD90m and today it would be worth USD1.3bn. Despite never recovering these funds, Polkadot continued to build out its platform and now has a market cap of over USD36bn.
- In February 2021, Alpha Homora was hacked for over USD37m. The project has recovered from this and today has a market cap of over USD500m.
- Yearn’s yDAI vault was exploited earlier this year, leading to the loss of USD11m. Yearn reimbursed those affected and the event had only a short-term impact on the perception of the project. Today the protocol is worth over USD2bn.
We believe in the Rari Capital team and in their ability to create innovative new products in the coming months and years. The recent exploit will be a challenge for this team to overcome. We believe that they will do so and that it will make the protocol more resilient in the long run.
Summary
Rari Capital is building something unique. At face value, it is a yield aggregation platform that allows users to easily earn yield on crypto assets. But look beyond the slick exterior and you find something far more interesting. Rari Capital is a collection of extremely young and hungry crypto-native software engineers that are building products at break-neck speed. They are innovating and iterating at a pace that other projects cannot rival. While the investment case for Rari centers around what the team has built to date, the real value in this investment will come from what the team creates in the future. Their target is to “build Finance 2.0” and we believe that the Rari Capital team is on the road to making this happen.
In this article, we will summarize the rationale for our investment into Rari Capital, focusing on the team, technology and product, governance, the RGT token, adoption, risks and projections.
Team
The Rari Capital team is extremely young. The founders - Jai Bhavnani, Jack Lipstone and David Lucid - are all under 20 years old. The vision of this team is a direct result of the crypto-native mentality of its founders; their earliest financial experiences were through the use of digital assets and not through legacy financial systems.
While youth is often a sign of inexperience, these three founders are more experienced than many crypto entrepreneurs. Before building Rari, Jai and Jack created Ambo, a mobile wallet designed to help Gen Z interact with digital assets. They sold this company to MyCrypto, the most established Ethereum wallet provider, and went on to work at MyCrypto as VP of Strategy and Director of Business Development respectively. The founders of Rari have been at the coal face of DeFi since its inception and are now pushing the boundaries of what DeFi can offer.
Technology and product
The Rari Capital mission is to “enable anyone to earn yield. Easily.” The team believes that yield can be generated without the need for investors to speculate on volatile crypto assets. Instead, it can be generated from utilizing existing assets. Today, Rari offers three main products Earn, Fuse and Tranches. It has USD80m of total value locked (TVL) in these products.
Earn
The first product that Rari released was Earn, which is a yield aggregator. This allows users to deposit USD stablecoins or Ether and earn interest from the deposit in one of three pools: the Stable Pool, Yield Pool and ETH pool. The way that interest is accrued in each pool is through the protocol lending and yield farming across various DeFi protocols like Compound, dYdX, KeeperDAO, mStable, yEarn, and Aave. By aggregating across these products, Rari aims to always provide the highest returns to investors. With its Earn product, Rari acts as a “Robo-advisor” in the crypto space.
Many crypto investors spend their time scouring the ecosystem for the highest yielding protocols. Rari’s goal is to remove this pain point and provide investors with a one stop shop in which to deposit their funds. Rari’s strategy is to automatically rotate funds between the highest yielding protocols in order to offer investors the best returns possible. Rari has a comprehensive Strategy Assessment Framework that it uses to evaluate every protocol that it integrates with. On top of this, Rari has been cognisant of risk and audits its contracts prior to release. In the case of Rari’s recent hack, the code that was compromised had been audited by Quantstamp, a leading smart contract auditing firm. This experience has led to the team implementing additional security procedures going forward that includes preventing deposits and withdrawals in the same block to mitigate flash-future loan attacks. They are also looking to enlist the services of additional smart contract auditing firms in the future.
Tranches
The second product that the team released was Tranches. Tranches offers a direct integration with another DeFi protocol called Saffron Finance. Using Tranches an investor can decide on the level of risk and reward that they take when investing into an interest-bearing capital pool. The AA tranche is the safest, with investors earning less interest but being compensated through coverage in the case of loss from the platform. That covered capital comes from the principal and interest of the riskier A tranche. The partnership between Saffron and Rari brings added functionality to Rari’s DAI pool (a USD stablecoin) and is the first time that a tranching mechanism has been added to a yield aggregator.
Fuse
The most ambitious and latest product that Rari has released is its Fuse pools. Fuse is a protocol that allows users to create any lending/borrowing pool that they want and set the parameters of the pool. For example, a user may have 4 crypto assets that they would like to borrow against. They can create a pool with those 4 assets, set the interest rate curves and decide on which price oracle to use. The user can then borrow against that basket of assets as long as they can find a corresponding lender, willing to lend against these assets.
Today, there are numerous money markets available across a host of DeFi protocols like Compound and Aave. However, the markets that are available are decided upon by the protocol developers. Fuse changes this, by allowing Rari users to create money markets for any asset, with parameters of their choosing. Any crypto asset that has a price determined by an oracle can now be added to a money market in Fuse. This is a unique proposition that has never before been available.
Over USD50m of assets are now locked in Fuse and there is the potential for a tidal wave of assets to be added to the product. The Rari yield aggregator is looking to integrate directly with Fuse to provide liquidity. On top of that we are starting to see other DeFi projects, like PoolTogether, exploring integrations with Fuse in order to broaden the asset types that can be deposited into their own products. In DeFi, capital migrates rapidly between protocols. We foresee this happening with Rari, owing to the wide range of possible Fuse integrations.
Governance and the RGT token
In line with the ideals of its crypto-native founders, the Rari protocol is targeting to be fully governed by a DAO rather than a centralized organisation. The Rari DAO is responsible for decision making and this DAO is controlled by RGT token holders. Token holders can:
- Create new proposals that will improve the Rari Protocol or expand Rari’s product line
- Vote on these proposals
There are 10,000,000 RGT tokens and the value of the protocol is captured by these tokens. The protocol is already earning fees from its product lines and these fees flow into the Rari Treasury, which is controlled by the DAO. It is up to RGT token holders to decide on what to do with the funds. While full on chain governance is not yet enabled, the team is looking to transition to this.
The Rari community is a vibrant place to be with regular proposals submitted to the DAO and a flurry of conversation happening in the Rari Discord channel at all hours of the day. The value of a project often comes down to the strength and conviction of its community. In this regard, Rari Capital has one of the strongest communities that we have come across for an early stage project, full of ideas, excitement and drive. It is a community worth backing.
Adoption
As the Rari protocol operates on Ethereum, its usage statistics and complete finances are available on chain. As of 6th May, the protocol was generating USD81k per month and there was USD79.6k in the treasury. The total fees generated to date from the yield aggregator are USD256k and the use of these fees is decided upon by the Rari DAO. To date fees have been spent on hiring engineers and code audits, with the full list of requests to the DAO available on the Rari governance portal.
Rari now operates in two distinct verticals within Defi; as a yield aggregator (through its Earn product) and as a money market creator (through its Fuse product). Compared to the leading DeFi aggregators and money markets, Rari is in the minor leagues. Rari’s Fuse product has less than 1% of the total locked value of platforms like Maker, Aave and Compound, which each have over USD10bn of TVL. However, we have seen capital flow rapidly between protocols. We are also witnessing a stunning inflow of capital into the DeFi space, with over USD85bn now locked in DeFi contracts on Ethereum, up from USD900m a year ago. Rari Capital is well placed to benefit from both a migration of funds as well as the entrance of new funds.
Risks and the impact of the ETH Pool hack
The largest possible downside risk for Rari became a reality over the weekend. A flaw in the codebase was exploited in one of their products leading to the loss of user funds. There are two knock-on effects of this. Firstly, user funds need to be returned, which is no small endeavour. Secondly, the reputational damage of this hack needs to be overcome, so that investors once again feel confident in depositing funds on the Rari Capital platform.
In terms of returning funds, one solution proposed by the team is to pay back affected investors in RGT tokens. Specifically, 2m RGT tokens from the Community Treasury had been earmarked for the Rari Capital team. The suggestion is for these tokens to be re-directed to investors who are now missing their Ether from the hack. Another proposal submitted by a community member is to issue a new token that earns a portion of protocol fees for the next 10 years. Proceeds from the sale of this new token could go towards making hacked investors whole. We believe that a solution will be reached by the community that will not negatively impact the project over the long term.
In terms of reputational risk, evidence from projects that have suffered similar setbacks suggests that DeFi users are forgiving. The engineering team will undergo much scrutiny in the coming weeks. The fact that their contracts had been audited gives the team a little breathing room, as does the fact that this hack is not Rari specific, but applies to any integration with Alpha Finance V1. That being said, there can be no more mistakes going forward. This episode will renew the focus on security and should help harden the team and protocol for longer term stability.
Projections
Rari Capital is building innovative products for its vibrant community. This investment summary has focused on what Rari has built to date, without touching on any of the layer 2 integrations that the team is working on or the new products like Tanks that are in the pipeline. DeFi opens up a new world of possible financial applications. The winning teams will be the creative ones that are able to conjure up entirely new paradigms as well as engineer them into existence. While there is value in what Rari Capital has created to date, we think that there will be surprise successes coming from this team over the years to come.
Having been in touch with team for a number of months, we have gained increasing conviction of its pedigree. It is rare to find creative ideas bundled with a focused work ethic from such a young team. An investment into Rari is an investment into the future. We are excited to support the team on their journey.
