October 24, 2017

Crypto Franchising: Out With The New, In With The Old

by Kyle Samani

Franchising is a widely understood model for retail food businesses. Many of the oldest and most successful retail food businesses in the world are franchises: McDonald’s, Subway, etc.

Newer retail food businesses such as Chipotle and Starbucks never adopted the franchise model. I can’t prove it, but I think was possible because of the Internet. Before the Internet, it was too hard to centrally plan, open, and manage thousands of stores across the world given local nuances and idiosyncrasies. The Internet changed everything. Centrally managed companies used Google Maps, richer retail and real estate data, more granular demographic data, and a plethora of other tools to efficiently plan and grow their retail businesses across many cities.

This is exactly why Internet companies don’t franchise: they use data from the Internet to determine go-to-market strategies, manage customer acquisition funnels, and refine their products.

But crypto tends to decentralize everything that it touches. Crypto pushes value to the edge of the network.

I’ll walk through two examples that illustrate how some of the best protocols in crypto use the “franchising” model to maximize reach and probability of fulfilling their respective visions, which will in turn accelerate returns to token holders.

0x: Decentralized Exchanges With Off Chain Order Books

The 0x protocol is a free, open source protocol with a native token, ZRX, that provides a way for relayers – independent businesses – to host off chain order books that settle on chain. There are about 10 relayers building on the 0x protocol today, each of whom are, for the most part, directly competitive with one another, and with centralized exchanges such as Poloniex and Bittrex.

Relayers don’t pay the 0x team for using the 0x protocol— the 0x protocol is free and open source. Rather, relayers are motivated to build and manage order books because users will pay fees, denominated in 0x’s native ZRX token, to relayers in exchange for hosting an order book.

Relayers have dramatically lower operating costs than traditional centralized exchanges. Unlike their centralized counterparts, who custody customer assets, 0x relayers are not money transmitters and do not impose any counterparty risk on their users. You can think of 0x relayers as “Craigslist on steroids.” 0x relayers help parties find one another who want trade – by hosting the order book – and then connect the parties so they can transact directly on chain.

Because 0x relayers never custody user assets, they don’t need to build processes and infrastructure to accommodate traditional “know your customer” (KYC) or anti-money laundering (AML) laws. Centralized exchanges have massive teams that must deal with these issues because they custody user assets. This gives 0x relayers a major cost advantage over traditional centralized exchanges.

The 0x team depends on relayers. If relayers don’t host order books, the ZRX token would have no utility and therefore no value. The 0x team spends money and commits time to help relayers establish their operations. Once relayers are up and running, they market to attract users. Every 0x relayer will independently market its offering. Each relayer can develop unique products and messaging for every niche on the planet: margin traders, fee-conscious traders, people who want pre-packaged bot-based trading, high API limits, etc. There are dozens of ways in which 0x relayers can differentiate, compete, and market their products to users around the world.

ZRX holders benefit from this competition. The relayers are doing the hard work of marketing and consumer education. The 0x team and ZRX holders don’t spend any money, time, or energy marketing directly to consumers, and yet they benefit from network growth as relayers compete for consumers and drive demand for ZRX tokens.

FunFair: Online Casinos

FunFair has created a “casino in a box” with all kinds of games: blackjack, craps, roulette, slot machines, etc (though no multi-party poker). Each game is provably fair. Consumers who gamble using FunFair tokens, FUN, know that the house isn’t gaming the odds and taking advantage of them (this was a huge problem in the first wave of online casinos in the 2000s). Unlike a traditional casino, FunFair based casinos never custody consumer assets. All wins and losses are transmitted in real time between the consumer and the house. This is a win-win situation: casinos take on less risk and liability, and consumers aren’t exposed to counterparty risk.

Casino operators can take everything that the FunFair team has built for very low cost (perhaps free). Casino operators then stake a pool of capital in FUN tokens as the house’s reserves and market to get consumers in the door. That’s it. The FunFair protocol handles everything else – game logic, random number generators, payments, etc. Because FunFair runs on chain, the online casinos don’t even need to deal with account creation (although they could add this on to enable other features).

We will quickly see a plethora of small teams setup and run online casinos. These teams will be exclusively focused on marketing and customer acquisition. Dozens of them will pop up overnight. Even if they don’t have capital themselves, they’ll easily raise capital from their friends and family since the FunFair protocol guarantees they will generate profits by acting as the house. Their businesses will quickly evolve into a customer acquisition race. These teams will A/B test every marketing message and customer acquisition channel possible. They’ll serve every niche. A single team can never do this. But 100 teams? They’ll try everything.

All the while, FunFair token holders will benefit as the casino operators vigorously compete to educate and attract consumers. Best of all, FUN holders don’t directly take on downside risk of running failed experiments. If a casino operator overspends on acquiring customers such that long term revenue from the customer is lower than customer acquisition cost, FUN holders still benefit, even if the individual casino operator does not.

Crypto Franchises vs Traditional Franchises

The crypto franchise model described above is actually better than the traditional retail franchise model. In the retail franchise model, the hub organization taxes franchise operators by taking a fraction of revenues and/or profits, and imposing other restrictions. In the crypto franchise model, the hub organization doesn’t tax franchise operators at all. In fact, the hub organization – which is often the one with the most resources as a result of an ICO – is incentivized to spend money to help franchise licensors launch as quickly and effectively as possible.

This behavior is playing out in the crypto ecosystem today. The 0x team is working closely with relayers to help them launch, and is providing grants. Tezos, which raised substantially more money than expected (about $230M at time of ICO that’s now worth about $400M), announced a fund to invest in projects building on the Tezos platform. Although EOS hasn’t announced anything yet, they are likely going to do something similar given that they’ve raised about $300M through their lengthy ICO.

These networks have created incentive structures that were never possible before. With new incentive structures, network participants are going to innovate in all kinds of new ways, creating new paradigms for value capture and network expansion that are in some ways reminiscent of retail franchising, but in many ways native to the unique characteristics of crypto.

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