
The Orca Investment Thesis
March 7th, 2023
Web 3.0 is being built on blockchains. Critical components of Web 3.0’s infrastructure (compute, storage, and communications), the primitives for hyperscale applications, are being built today. While Gravity primarily focuses on infrastructure investments, Web 3.0 infrastructure is on the cusp of allowing for hyperscale applications, and we expect the first hyperscale applications to target crypto native users, i.e., decentralized exchanges, wallet software, etc. We will actively target the first generation of Web3 hyperscale applications as they come online. We believe Orca* has the potential to be both a critical piece of DeFi infrastructure and a hyperscale application.
A couple of disclaimers before you dive in:
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We publish both sector and individual investment theses for free, and many have gleaned insights from them, but nothing herein is investment advice. Publishing our theses allows us to synthesize, generate feedback upon and further refine them. Do your own research.
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In each thesis, we borrow liberally from other authors, founders and investors who have already delivered amazing insights on a given topic. Any accidental plagiarism of those authors/founders/investors is unintentional and will be corrected.
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I and/or Gravity Fund own assets discussed in this report. Core holdings are marked with an asterisk throughout.
Decentralized Exchanges (DEXs) are a centerpiece of both decentralized finance and broader crypto markets. A DEX is a peer-to-peer marketplace where users can trade cryptocurrencies in a non-custodial manner without the need for an intermediary to facilitate the transfer and custody of funds. DEXs substitute intermediaries—traditionally, banks, brokers, payment processors, or other institutions—with blockchain-based smart contracts that facilitate the exchange of assets without a centralized point of trust and control.
Compared to traditional financial transactions, which are opaque and run through intermediaries who offer extremely limited insight into their actions, DEXs offer complete transparency into the movement of funds and the mechanisms facilitating exchange. In addition, as user funds don’t pass through a third party’s cryptocurrency wallet during trading, DEXs reduce counterparty risk and can decrease systemic entralization risks in the Web3 ecosystem.
There are several DEX designs, each offering different benefits and trade-offs in terms of feature-sets, scalability, and decentralization. The two most common types are order book DEXs and automated market makers (AMMs). Automated market makers are the most widely used type of DEX as they enable instant liquidity, democratized access to liquidity provision, and—in many cases—permissionless market creation for any token. An AMM is essentially a money robot that is always willing to quote a price between two (or more) assets. Instead of an order book, an AMM utilizes a liquidity pool that users can swap their tokens against, with the price determined by an algorithm based on the proportion of tokens in the pool.
Some popular AMM DEXs across all chains include Bancor, Balancer, Curve, PancakeSwap, Sushiswap, Trader Joe, and Uniswap. Monthly DEX Volume has been increasing ever since the introduction of AMMs. The vast majority of DEX volume is currently generated on the ETH blockchain.
DEXs have experienced tremendous growth in terms of both users and trading volume over the past three years. To put that growth into perspective, it is helpful to compare trading volume on the largest DEX (Uniswap) to the largest US exchange (Coinbase).
As of the writing on this report, Uniswap and Coinbase are essentially equivalent in terms of daily trade volume, with each clocking anywhere from $1B to $1.8B volume on any given day. Zooming out even further, we can see that, in aggregate, DEXs account for, on average, 10% of total crypto trading volume. In February 2023, total DEX spot volume was $59.83B and accounted for 5.87% of total crypto spot trading volume, which was just over $1T for the month. Using today’s BTC spot to futures volume as a proxy (a ratio has been relatively consistent), where futures volume is roughly equivalent to spot volume, we can double the spot volume number to arrive at total volume of $2T per month. CoinGecko 24h total exchange volume data, including spot and futures, confirms this, showing 24h combined CEX and DEX volume of $70B, or $2T on a monthly basis. Annualized, this means we’re looking at $12T in spot market volume and $24T in total market volume. Impressive numbers near the bottom of the cycle. For context, annualized US equity market volume runs at approximately $125T as of the writing of this report, and annualized global equity market volume was approximately $168T in 2021.
We anticipate that the aggregate DEX market share will increase during the next cycle. We already see significant DEX market share growth tailwinds heading into the next cycle, and the previous cycle has made many market participants weary of utilizing centralized platforms. In addition, we’ve seen DEX UI/UX improve dramatically, making it more retail friendly and, in some cases (hint: Orca*), on par with the ease of use of the most popular CEXs. We believe these trends will continue to drive DEX market share capture in the coming market cycle.
The vast majority of DeFi activity today occurs on Ethereum. We can use Total Value Locked (TVL) as a proxy to gauge this. As of the writing of this report, ETH TVL stands at $29B while the aggregate TVL, with the aggregate of other chains (excluding Tron and BSC) accounting for a total of $7B. Thus, ETH accounts for approximately 80% of all DeFi activity. Considering ETH L2s, this number is closer to 90%.
An oil painting of a treasure pile of USDC and Tether coinage by Thomas Moran
Within the ETH cohort of DEXs, Curve and Uniswap have dominated. As of the writing of this report, Curve accounted for $4.94B TVL and Uniswap accounted for $4.14B. At the peak of the previous cycle, Curve held $24.3B TVL and Uniswap held $11B TVL.
While Orca* will compete with these DEXs indirectly, in the sense that every DEX is competing for users and TVL, and some users are chain agnostic, Orca* is not fighting for users or TVL directly on-chain with these behemoths. We highlight the competitive environment on ETH because we believe there are parallels to be drawn to Solana*. We believe competition will be fierce in the early days, but value will ultimately accrue to one or two dominant DEXs. Furthermore, we also believe that Solana* is approximately one cycle behind ETH in terms of its protocol lifecycle (see our Solana* investment memo), and the top one or two Solana* DEXs will scale similarly to how Curve and Uniswap scaled on ETH during the previous cycle in terms of users and TVL, which will translate directly to market cap. Uniswap peaked at a $22.5B market cap last cycle.
Zooming in further, excluding ETH L1, we can see that the DeFi market is very fragmented. As of today, Solana* accounts for only 0.53% of aggregate TVL. However, this was not always the case. Prior to the FTX implosion, DeFi on Solana* was the clear, ETH-excluded, market leader accounting for 6% of all TVL. Looking back, we now know that DeFi on Solana* during that period was heavily imbalanced to favor Alameda Research, the hedge fund of FTX founder Sam Bankman-Fried. Thus, Solana* was experiencing significant DeFi growth, despite the predatory practices of a significant bad actor in the ecosystem. The decline in market share over the past six months is the result of FTX/Alameda fallout. We believe this is a blessing in disguise.
The reason Solana* DeFi was scaling so rapidly was because Solana* offers all the benefits (speed, low fees, etc.) of ETH L2 DeFi, without the abstraction and complexity that comes with ETH L2s. DeFi builders were attracted to Solana* in the first place because they could build directly on the Solana* L1 and outperform ETH L2 in terms of speed and fees, without needing to build on an L2. Solana’s* underlying infrastructure advantage has not changed in this regard, and the bad actors have been flushed out of the system.
One last note on ETH L2s – Coinbase launched its BASE chain in February of 2023. The chain is built upon the open-source Optimism tech stack. We expect it to become a major DeFi player in the ETH ecosystem, potentially with Coinbase launching its own DEX. Again, this would represent indirect competition to Orca*.
Looking at Orca’s* competition on the Solana* chain, its main competitor is Raydium. At the time of writing this report, Orca* had processed $164M in total volume over the previous week, and Raydium had processed $52M. The third largest Solana* DEX is Saber, which processed $21M over the same period. A comparable valuation metric is Fully Diluted Market Cap to TVL. Orca* is at an attractive 1.77 vs. Raydium at 4.14. Both Raydium and Saber were built on a middleware central limit order book called Serum. A close association with FTX/Alameda led to Serum’s demise and crippled the functionality of both Raydium and Saber. Both have scrambled to recover. Saber was the first Solana* DEX to launch. Raydium launched soon after and quickly became the market leader on Solana*. Orca* did not build on Serum and had very little exposure to FTX/Alameda. This, along with a technically superior backend, and easy to use frontend UI/UX has allowed Orca* to overtake both Raydium and Saber as the top DEX on Solana*.
The Solana* DEX daily active wallet data also tells a compelling story relative to Orca’s* growing dominance. Jupiter (red) is a Solana* DEX aggregator that routes users to the lowest fee alternative. Approximately 40% of all trades that happen on Jupiter are routed to Orca*.
Another element to Orca’s* success is its composability. Just as Orca’s* interface is designed for usability, Orca’s* open-source Software Development Kit (SDK) is designed for easy integration into other applications. This has led protocols like STEPN (purple) to integrate Orca* “under the hood” to facilitate swaps for their users. Jupiter, STEPN and native Orca* volume combined account for the vast majority of all daily active DeFi wallets on Solana*.
Developer and user growth on the Solana* chain is a prerequisite to Orca’s* success. Developers build apps and protocols that users want to use, and when users want to use those products, it creates demand for those projects’ tokens. When a vibrant ecosystem of such products emerges, demand to trade those tokens also emerges, which creates demand for a DEX to service that ecosystem. So, an investment in Orca* is also an investment in the Solana* ecosystem. We would expect to see the first signs of healthy ecosystem development in the Solana* developer data.
This is where Solana* really shines. First, let’s look at 2021 because it was a big year in terms of onboarding Web3 developers regardless of chain. In 2021 Solana* was the only Layer-1 platform to nearly 5x the number of developers building on its platform. We see this same trend play out with regard to full time developers. In a year that most chains experienced significant developer growth, Solana* stands out as the clear winner.
Now let’s look at the same data for 2022, a year that marked the bottom of the crypto cycle. In 2022, Web3 developer activity, as a whole, grew by 5% YoY. That doesn’t seem like a lot, but it’s quite impressive in an environment where prices declined 70% YoY. But the real story of 2022 was Solana’s* continued developer growth.
Solana* was again the fastest growing mature ecosystem, clocking 83% growth in total developers and 45% growth in full-time developers. This is very impressive when gauged against its mature peers, as well as the 5% industry wide growth rate for the period.
Suffice it to say, developer growth is happening on Solana* faster than on any other mature chain. The first necessary ecosystem prerequisite to support a DEX is in place.
The next prerequisite is users. Web3 user data, when combined with Web3 developer data, gives us a more complete picture of where Web3 network effects are accruing, and where healthy ecosystems are emerging. Again, Solana* really shines here in terms of rapid growth. Looking at the 2021 data, Solana* started the year with 500,000 total user addresses and ended the year with nearly 8-million.
Total address count only tells a partial story. We also need to consider how active users are on a given network. To do that, we look at unique active addresses in a 24-hour period, which gives us a good proxy for Daily Active Users (DAUs). Again, Solana* excels on this metric, growing DAUs 293x in 2021.
Solana* also experienced robust user growth in 2022, and compares very favorably to ETH today in terms of user growth, even though it’s a full cycle behind. Solana’s* number of monthly active addresses sits around 15M, versus ETH’s 13M. Solana* is adding 5M new addresses per month, versus ETH’s 2M. These are all encouraging KPIs in terms of where the Solana* ecosystem stands today versus the gold-standard ecosystem in the Web3 space.
The second prerequisite, users, is clearly in place alongside developers.
But what about Orca’s* traction within the Solana* ecosystem?
Looking at volume trends on Orca*, we can see that it was running between $100M-$200M per week throughout Q4 2022 and has been running at $150M-$350M throughout Q1 2023. Monthly average volume has increased 22% in 2023, even when including the huge Nov 2022 volume spike in the Q4 2022 data set that was the result of the FTX/Alameda blowup. Normalizing that week in November to the volume of the weeks preceding and following it, results in a 92% QoQ monthly volume growth rate. Orca* is averaging $876M monthly volume in 2023, while its nearest competitors are averaging $289M (Raydium) and $95M respectively.
Traction is also measured in terms of product improvement and new-build ship cadence. This is where Orca* really shines. The Orca* SDK GitHub (the repository that allows developers to build on Orca*) has been used by 154 developers, compared to 124 on Raydium and Saber not offering developers an SDK. In December of 2022, Orca* integrated Stripe as a fiat on-ramp partner, making Orca* the only Solana* DEX with an integrated fiat on-ramp. Again, this is testament to the quality of the Orca* development team, and we believe this feature will further distance Orca* from its competition.
ORCA* is Orca’s* Solana*-based SPL governance token. Orca’s* token launched in August 2021, almost six months after the protocol went live. The initial supply of ORCA*, 5.25% of the total supply, was retroactively airdropped to early traders and liquidity providers (i.e. platform users). 20% of the total supply was allocated to the team, with a 3-year vesting schedule and 1-year cliff. Since the airdrop, ORCA* has been used primarily for liquidity incentives (e.g., Aquafarms) and fundraising.
A little over one month after launching the token (September 2021), Orca* announced an $18 million Series A led by Three Arrows Capital, Polychain Capital, and Placeholder. Other investors included Jump Capital, Sino Global Capital, Solana Capital, Coinbase Ventures, and DeFiance Capital. These investors received 9.6% of total ORCA* supply, with a 3-year vesting schedule and 1-year cliff. This appears to have been a token only round and even if those tokens were issued at a discount (likely), they were probably issued in the $2-$5 ORCA*/USD range. This bodes well for us, as we intend to allocate in the $0.80 range through a dollar-cost-average allocation approach, and we have a strong Series-A syndicate that is not incentivized to sell at a price point below our price targets. A 10x return for those investors (on the low end of Series-A investor return expectations) would represent a 25x-60x for our position.
Although the Orca* team has not published a formal emissions schedule, we do know that since inception, emissions have averaged 1.1M ORCA* per month. AMM emissions are generally heavier in the early years of a protocol’s lifecycle as they are used to bootstrap initial liquidity in the market, which requires significant incentives. This also creates selling pressure in the early years, as these incentives are liquidated on open markets. This bodes well for our ability to allocated at an attractive price point today. We have already seen emissions become more capital efficient with the release of concentrated liquidity pools. However, for our purposes, we have assumed that monthly emissions hold constant relative to their current pace, and we have stress tested accelerated emissions scenarios.
Under our base case scenario (emissions held constant to historical monthly average), we forecast 49.8M ORCA* in circulation as of Q1 2025. Assuming 49.8M ORCA* in circulation, a price of approximately $24 would correspond to a $1.2B valuation. This would be in-line with the all-time-high valuations of Raydium and Serum, and would equate to 5% of the Uniswap all-time-high valuation ($22.5B). This outcome would represent a 30x for our Fund. We believe that the Solana* ecosystem has grown significantly since Raydium and Serum achieved those all-time-high valuations, and that a growth premium will be reflected in the leading Solana* DEX in the coming cycle. A doubling of the Orca* valuation projection, $2.6B, would still only account for 10% of the Uniswap all-time-high, and would result in a 60x return for our Fund. These valuations would represent a token price of $24 – $48, which again, would only represent a 10x for Orca’s* Series-A investors. This is a good sanity check in addition to the DEX comps.
Ultimately, we feel that the Orca* tokenomics are very compelling. Valuations in the Solana* DeFi ecosystem have been punished in the wake of the FTX/Alameda blow up, and Orca* was not spared. This presents us with an opportunity to invest in Orca* at a very attractive price.