Tl;dr: 1confirmation invested in Nexus Mutual at the seed round. They shared their investment memo on Twitter. Read to understand how a venture capital investor thinks about investing in a company and how they communicate it to their partners and potentially their limited partners.
About the VC investment memo
Nick Tomaino shared it on Twitter with “Our @NexusMutual investment memo (August 2019)”
I’ve nothing else to tell you!
About Nexus Mutual
Hugh Karp, the founder of Nexus Mutual, believes that blockchain technology in general, and the power of the Ethereum platform in particular, can revive the idea of a mutual insurance and create an alternative risk sharing platform.
Here’s how it works:
- Everyone can become a member of Nexus Mutual by buying the NXM token. Building a mutual insurance on the blockchain makes it much easier to collect and manage the capital of members and manage the community of those members. The token purchase is based on a bonding curve concept enabling a continuous building up of the capital pool (versus a one-time large raise through an ICO or similar).
- Nexus Mutual uses this capital pool to provide cover for smart contracts so that anybody can secure risk and potential bugs in smart contract code. In the future, Nexus plans to offer crypto wallet coverage, as well as more standard products, like earthquake coverage.
- Members of Nexus Mutual with specific insights / knowledge on smart contract risks can stake their tokens against specific smart contracts, signalling their confidence that a specific contract has a lower risk of being hacked than the average smart contract.
About 1confirmation
Founded by Nick Tomaino and backed by individuals like Peter Thiel, Marc Andreessen, and Mark Cuban and institutions like Horsley Bridge and Runa Capital, 1confirmation is a venture fund that supports exceptional founders fueling the decentralization of the web and society.
Usual caveats
No investment memo made voluntarily public will ever be 100% as it was. The pressure is just too high for VCs to look smarter, and not make founders uncomfortable, etc. I highly praise the VCs that share their thought leadership so we can all learn.
If you’re learning to make a VC investment memo, don’t assume the memos are what you exactly need to do. Information will be redacted. Assume anything “delicate” or sensitive is not in the memos.
The only memo that is 1 to 1 is the Youtube memo because it was in a lawsuit.
Nexus Mutual Venture Capital Investment Memo
[pdf-embedder url=”https://wordpress-153384-440792.cloudwaysapps.com/wp-content/uploads/2021/12/Nexus-Mutual-Investment-Memo-August-2019.pdf” title=”Nexus Mutual Investment Memo (August 2019)”]Summary:
Nexus Mutual is an Ethereum-based insurance mutual. Smart contract cover is the first product the mutual is offering. Since launch on July 12th, there’s been close to $1M of smart contract funds covered.
From The DAO hack to the Parity multisig bug, Ethereum smart contracts have a history of losing money for users. Security audits are one solution to mitigate the damage of smart contract hacks but audits are not foolproof. Compound and 0x, for instance, have seen critical vulnerabilities discovered even after robust security audits.
Users are increasingly demanding ways to insure money sitting in smart contracts, which Nexus provides. We are becoming a member of the mutual and purchasing $1M worth of NXM tokens. $200K will go to the capital pool and $800K will go to the foundation to fund development of Nexus. In addition, we will take a board seat on the foundation to support founder and CEO Hugh Karp and govern how foundation funds are allocated.
Key assumptions for Nexus Mutual:
- Insurance is important for new users adopting DeFi products and there’s a big competitive advantage to being the first DeFi insurance product to Lending Dai at 12% APR on Compound or dYdX is attractive but many users are averse to putting large amounts of money in a high-yield money market account due to the black swan risk of losing all of one’s money in a hack. We think insurance products are important for the next wave of users adopting DeFi, and traditional insurance companies are far from touching this space. Nexus is first to market, has real traction and is well-positioned to lead the category and benefit from the network effects at play around insurance mutuals.
- The total addressable market for smart contract insurance will grow significantly. Currently there is 6M ETH locked in DeFi. If Nexus Mutual covered 10% of DeFi today then total market value of NXM would grow 5X+. If the value locked up in smart contract grows, the market value of NXM is likely to grow proportionally. Furthermore, Nexus Mutual is not limited to just smart contract insurance but can expand the mutual model to bigger insurance markets like wallets and PoS validators.
- Hugh can attract talent around the project and navigate the regulatory landscape. Hugh comes from the insurance world and has done a lot with a little to date. He’s outsourced development work so far and only has one full-time team member. First priority is hiring a lead dev who can take ownership of the codebase. It’s important for Hugh to become better at effectively telling the story, attracting talent to the project and navigating the regulatory
Team (8/10):
Nexus Mutual is a decentralized autonomous organization that’s long-term success is based on not a centralized team but a collection of participants from around the world (see below). But to date founder and CEO Hugh Karp has been the driving force behind the project.
Engineering is currently outsourced to Somish Solutions, a blockchain dev shop based in India led by Ish Goel and growth of the direct team working under Hugh will be important for the next few years.
Founder and CEO Hugh Karp
Hugh Karp has 15 years of experience in the insurance industry, most recently serving as the CFO for Munich Re’s life insurance operations in the UK and Ireland. Despite being relatively new to the cryptocurrency space, Hugh has quickly developed a crypto-native understanding of smart contracts and DeFi and has done an incredible job accomplishing a lot with little resources to date.
There are two legal entities behind the project: Nexus Mutual Limited and Collective Risk Services. Nexus Mutual Limited is a UK LBG company. This is the mutual that anyone who purchases cover or NXM tokens must join by providing KYC information. Collective Risk Services is a UK CIC foundation that funds development and manages the treasury of NXM tokens.
Product (9/10):
Nexus Mutual has four (not mutually exclusive) types of users: capital pool investors, coverage holders, risk assessors, and claims assessors. Joining the mutual requires the user to KYC; due to insurance regulations, users in countries such as China, Germany, India, Japan, Mexico, Russia, and South Korea cannot join the mutual.
Capital pool investors buy NXM with ETH or DAI from the bonding curve and the ETH or DAI goes to the capital pool that’s used to pay insurance claims.
Coverage holders buy cover on a certain amount and time period for a particular smart contract. The cost of cover (aka premium) goes to the bonding curve to buy NXM. The premium then goes to the capital pool and the newly minted NXM gets paid to the risk assessors. The total active cover amount on a specific smart contract cannot exceed 20% of the capital pool size.
Risk assessors stake NXM on smart contracts they think are secure and earn newly minted NXM (up to 50% of their stake amount) from the premiums for smart contracts they stake on. The amount staked on a smart contract also determines the premium cost on such smart contract. The target users here are security auditors who can stake to earn additional revenue from contracts they audited and think are secure. Currently ~5.3% of NXM is being staked.
Claims assessors vote with their NXM tokens whether a claim should get paid out. Not voting with the majority results in one’s NXM getting slashed.
The product went live on mainnet on May 23 and buying covers was enabled on July 12. We built a tracker for key metrics of Nexus Mutual’s growth and usage: https://nexustracker.io/
Community (8/10):
Nexus Mutual is governed by its members plus a centralized five-person Advisory Board. Governance is based on one-coin one-vote and proposals need both a majority of voters and 60% of the Advisory Board to pass. The 5-person Advisory Board members are Hugh Karp, Ish Goel, Nitika Arora, Graeme Thurgood, and Nick Munoz-McDonald. The Discord channel has a small but intelligent community of users who discuss various governance proposals such as lowering the MCR to 7000 ETH and raising the smart contract cover limit to 20% of the capital pool size.
Since launch, Nexus Mutual hasn’t done much marketing and mostly relied on organic growth from enthusiasts in the DeFi community. Nexus Mutual is currently discussing partnerships with projects like Argent to offer covers on their user’s funds and Compound to add a “buy insurance” button for distribution.
Token mechanics (9/10):
NXM is minted and burned through a bonding curve. NXM tokens cannot be transferred to members outside the mutual so exchanges like Coinbase or Uniswap cannot list NXM unless they become members of the mutual.
A bonding curve is a mathematical curve that defines a relationship between price and token supply. The current price of the NXM token is set by a point on the bonding curve. Buying into the bonding curve pushes the point upwards along the curve and makes the price higher for later buyers, and vice-versa is true for selling into the bonding curve.
The price of the NXM token is determined by the following formula:
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Based on the bonding curve formula, the price of NXM is directly correlated with the size of the capital pool, which is determined by more people contributing to the pool and new covers being taken out. The price of NXM is denominated in ETH, not USD.
We made two financial models for projecting NXM returns: one conservative model assuming the capital pool only grows from the premiums and one aggressive model assuming both the total addressable insurance market and market penetration of Nexus grow. Details of the financial models and their assumptions are here.
The mutual launched with an initial allocation of 3M NXM tokens and since then 846k new NXM has been minted from the bonding curve. The current token distribution (before our investment) is 24.6% to the foundation, 21.9% to Hugh, 11.0% to the team, 25.8% to seed investors, and 16.6% to other members in the mutual.
Key Risks:
- Lack of full-time engineering team. Outsourcing engineering is not preferred, but it is palatable in this case given that the product is already live with significant traction and the Somish team is passionate about the project and plans to continue supporting it in various ways. The top priority post-fundraise is to hire an engineering lead based in London and Hugh will need to get better at attracting
- Struggle growing the capital pool. If the capital pool just grows based on the smart contract cover fees accrued to it, the investment will have insurance-like returns rather than venture returns (see here). In order for this to have venture-like upside, the capital pool needs to grow significantly. The KYC aspect of the mutual could limit growth of
- Bonding curve liquidity. Bonding curves are a new and unproven cryptoeconomic The only way to buy and sell NXM today is through the bonding curve. No NXM can be sold if the size of the capital pool falls below the minimum capital requirement (currently 7000 ETH, but could change in the future). There could be a scenario in which our investment stake is too large – due to other investors selling early or claims getting paid out – to be able to sell. So there’s not the liquidity guarantee that exists with other tokens. There’s also uncertainty on how the SEC may view NXM – while we believe there’s a strong argument that it’s not a security, there is no guarantee. Being deemed a security could also negatively impact long-term liquidity.
Recap (Team + Product + Community + Token mechanics: 8.5/10)
Nexus Mutual fits in our sweet spot of a project that the crypto community needs right now and it can grow massively with the size of the total size of ETH locked up in smart contracts. It’s a complex system and there will be challenges along the way, but we believe despite risks about the team, regulatory limitations and bonding curve, the upside is massive given the product timing and size of the addressable market.
You can read the rest of the memos here: Venture Capital Investment Memo Collection