The SushiSwap Saga and What It Means for DeFi

If you’ve been following crypto in the past two weeks, you probably heard of SushiSwap, a DeFi protocol forked from Uniswap but with an added governance token.

DeFi Yield Farmers swarmed Uniswap as providing liquidity to the protocol offered mouth-watering yield in its native token. SushiSwap's total value locked quickly crossed over $1.8 billion and the token traded up to an ATH of more than $11 from less than $0.80 only a few days earlier.

However it all came crashing down as it’s anonymous founder, Chef Nomi, withdrew about $14 million of developer funds and nearly sunk the entire project. Suddenly FTX and their founder Sam Bankman-Fried jumped into the fray in an attempt to right the Sushi ship. Presenting himself as the savior, Sam’s entry turned a potential exit scam into a drama worthy of a cypherpunk soap opera, with real implications for the future of Decentralized Finance.

Here’s a recap of what happened and why it’s important:

SushiSwap, the community-owned DEX, is born

An anonymous developer who goes by the name of Chef Nomi forked open source code from Uniswap, a decentralized crypto exchange, to create a rival project called SushiSwap. SushiSwap was announced on August 26th as an “evolution of Uniswap” because it added a native governance token, SUSHI, as well as token rewards for liquidity providers and token holders.

For context, Uniswap works by replacing the order books of centralized exchanges with pools of tokens paired with ETH or other ERC-20 tokens, ensuring that a “swap” can always happen. In Uniswap, there is no governance token, and trading fees are distributed among liquidity providers. In SushiSwap, trading fees AND SUSHI tokens are distributed to liquidity providers. A portion of the trading fees also get converted back to SUSHI and distributed to SUSHI token holders, so that liquidity providers that hold SUSHI tokens can continue to receive part of the protocol’s fees even after they stop providing liquidity. Just as important, SUSHI was designed as a governance token meaning the users and liquidity providers would have a vote in the direction of the protocol.

Chef Nomi claimed altruistic intentions, saying that SushiSwap would not give preferential treatment to traditional VCs and advisors (Uniswap is led by a centralized team and backed by traditional VCs like Andreessen Horowitz and Union Square Ventures); instead, the project’s own community of token holders would own, control, and profit from the new exchange.

Vampire Mining, the growth engine that ate Uniswap’s lunch

On SushiSwap, SUSHI governance tokens can be earned by staking Uniswap v2 liquidity pool tokens through a process appropriately named “vampire mining”. In other words, early participants in SushiSwap would earn SUSHI tokens by depositing Uniswap’s LP tokens and then swapping them for the underlying asset so that Uniswap liquidity becomes SushiSwap liquidity.

The technical details of “vampire mining” can be confusing, but the main point here is that SushiSwap not only copied Uniswap but also stole a lot of its clients through financial engineering and clever incentive mechanisms. This may seem unethical or echo the “greed is good” days of 1980’s Wall Street to some, but in the open-source and interconnected world of DeFi, this was perceived as fair game. Uniswap’s deposits increased from $300 million to $1.8 billion on September 4th as investors flocked to the exchange in hopes of bigger profits on SushiSwap.

The Betrayal: Chef Nomi cashes out

Despite Chef Nomi’s initial altruism, on September 5th he betrayed his community. To fund SushiSwap’s future development, the anonymous founder allocated 10% of all SUSHI tokens (~$14 million) to the development fund of the project. Since Chef Nomi was the only developer, he took the fortune for himself and then traded those funds for ETH on Uniswap, causing the price of the SUSHI token to drop more than 80% in one day. The community was outraged, accusing Chef Nomi of executing an exit scam. Nomi initially defended his actions, arguing he did it because he cared about the community and wanted to focus on technical development rather than price fluctuations of the SUSHI token.

Apology, transfer of control, and an altruistic future

The actions resulted in a severe backlash from the crypto community including Sam Bankman-Fried, CEO of a centralized derivatives exchange, FTX. FTX and many other high profile crypto players had been big participants in SushiSwap with a significant amount of capital at risk. SBF, as he is frequently called, made several proposals to “save” SushiSwap and take control.

The saga was simultaneously the best and worst of what decentralized finance can offer and a hint at the future. The anonymous founder attempted an alleged exit scam with no recourse to the SUSHI holders, and SBF, as a significant stakeholder, pulled together governance and a future for SushiSwap coordinated across Twitter and voting proposals.

Ultimately Chef Nomi decided to face the music, return the funds, and publicly apologize for his actions on crypto twitter:

“I would like to apologize to everyone who I have caused troubles to. I was emotional, I was greedy, I was afraid. I made bad controversial decisions under pressure. And it hurt everyone. I failed your expectation and I am sorry.

I have returned all the $14M worth of ETH back to the treasury. And I will let the community decide how much I deserve as the original creator of SushiSwap. In any currency (ETH/SUSHI/etc). With any lockup schedule you wish.”

As part of his apology, Chef Nomi decided to step down and give up control of the project to SBF, who proposed a plan on how SushiSwap should progress moving forward.

Last week, on September 9th, SBF officially completed the project’s migration to its own decentralized exchange, executing on SushiSwap’s initial plan of bootstrapping its own liquidity by draining nearly $1 billion from Uniswap. He safely transferred user's funds from Uniswap to SushiSwap, and then returned control of the project to its community. What might be referred to as a “hostile takeover” was then complete, as SushiSwap became one of the leading decentralized exchanges on the market just two weeks after launching.

What this means for DeFi

The DeFi space has evolved dramatically in the past three months. From yield farming on Compound and Curve to 100% community-owned tokens like Yearn’s YFI and YAM, where no advisors, investors, or team members got allocations, DeFi is gaining steam as the both the Wild Wild West and the incubator for the future of finance. This will inevitably lend itself to some skirmishes and questionable behavior (much like the ICO boom in 2017), but the future for DeFi looks bright as each new project pushes innovation, financial models, and user expectations forward.

Governance and stakeholder engagement was long the promise of the decentralized economy. The idea was always that users of the product would also be the owners of the product/protocol, or at a minimum, they share in the upside. It shall be seen whether a governance token is the best way to achieve that, but it certainly feels like those DeFi protocols that don’t adapt run the risk of eventually getting forked.

The SushiSwap story has made it clear that DeFi protocols are now expected to share governance, control, and revenue with their users. It appears evident that there is no sacred cow, liquidity doesn’t provide the same moat as it does in traditional finance, and some early adopters and innovators have the opportunity for outsized returns. It also very clearly presents the risks of experimenting on the cutting edge of financial innovation. Sushiswap was nearly an exit scam, but was saved by the users themselves.

Legal Notice

This blog post is being distributed by Amalgamated Token Services Inc., dba “CoinList,” or one of its subsidiaries. This blog post and use of the CoinList website is subject to certain disclosures, restrictions and risks, available here.