Fundamental questions around web3/blockchain value accrual

Bear markets are useful for examining theses around where value will accrue. Let’s look at some fundamental questions of where value accrues in the coming decentralized internet, aka web3 or ”blockchains.”

In nascent technology, does value accrue to the innovators or to the stagnant?

Bitcoin maximalists believe that Bitcoin will accrue all value, because it will become digital gold. That’s a great meme. It’s obviously inspired many to buy and hodl BTC to the current tune of $80 billion in market cap.

The maximalists are right that Bitcoin is likely to become digital gold, but they don’t seem to realize that this is a very limited goal. Gold is a niche asset that is not even 1% of wealth worldwide. In fact, most estimates have it at about half a percent. It serves a purpose, but a very limited purpose.

Similarly to gold, Bitcoin’s value comes from a meme. It has fanatics, much like a religion. There will always be goldbugs, and there will always be Bitcoin maximalists. Facts, logic, and empirical evidence be damned! As a memecoin, Bitcoin can still appreciate in price even beyond its current all time high.

But, like gold, Bitcoin has a low ceiling because it has a relatively small total addressable market. It has chosen not to pursue any meaningful scalability and thus can never become the native currency of the internet.

Ethereum (or web3 in general) has its eye on a much bigger goal: being the transaction layer (ie, ”money” or “store of value”) for all wealth in the world.

Pareto-chain or multi-chain?

Does value accrue relatively equally across a bunch of chains or does one chain win a Pareto-like 80%+ of the value by being the native currency of the internet?

The answer here is dependent on the following question: does scalability or interoperability happen first?

If you think that Ethereum (or something like it) scales first by a significant amount of time, then that chain probably accrues the vast majority of value. Network effects are real. If everyone is developing on one scalable chain, then a dapp developer will prefer lower latency by being on the same chain.

If you think that interoperability happens before scalability, then you’re betting that lots of chains will exist but that much of the value will occur in many chains, including the interoperability chain.

Personally, I’m betting that scalability happens first. On some level, interoperability is just scaling but with the added complexity that non-native chains are….well, non-native. To me, it is hard to see how that beats a native scaling solution.





Basechain or app layer?

Over the past 18 months, investing in basechains has been the winner. I’d argue that this due to the fact that blockchains are still nascent technology, combined with some influential investors/thought leaders who convinced the herd that there was value to a plethora of basechains who offered very little in the way of fundamental innovation.

[Broadly, I’m including layer 2 solutions here as “app layer,” because I think in the future many layer 2 solutions will be functionally part of the app layer.]

I believe that the app layer will accrue significant value. As I tend much closer to the “pareto-chain” idea than I do to the multi-chain thesis, I believe that the market for hyped up “Ethereum killers” will evaporate. Of the current Ethereum competitors that have live main nets, all have compromised decentralization by using something like DPOS, yet gained surprisingly little in terms of scalability.

It’s important to note: if you compromise decentralization, then there is no long-term value. You may as well run a centralized database on AWS with ~20 nodes that can be censored at will by governments and corporations. Short-term market irrationality is definitely possible, but I’d bet heavily against any sort of long-term value accrual for centralized basechains.

[Side note: if you solve scalability, then you also solve privacy, so I’m skeptical about the long-term future of most privacy coins]

What will we see at the app layer?

I wrote a thesis over 2 years ago arguing that the “pills, pr0n and poker” way of making money on the internet would be the same thing that would happen in early days of web3. We’re still early days! People who are marginalized by any current way of doing things are the people most incentivized to look for something new that is difficult to use.

I would add to my thesis that some things are also “web3 native.” A good example is stablecoins. A furtherance of that idea is “DeFi” or decentralized finance. The idea of a permissionless open financial system is attractive because banks are often frustrating and much of the world does not have a stable banking system. Furthermore, I can imagine niche insurance products gaining a foothold - people look to hedge out risks that they cannot buy reasonable insurance for.

I’m definitely not a Pollyanna about some things at the app layer. Particularly in 2019, I’m skeptical we see mass adoption of things like blockchain ticketing or security tokens. They will come eventually, but not yet.

To Token or Not To Token?

As I indicated yesterday in my post on “useless tokens,” there are some projects which will be better served by having a token and those which won’t.

The question to ask is: will having a token right now help or hurt long-term network effects? Many of the early Ethereum projects have a built-in class of international supporters from all the people who hold their tokens. Some projects will leverage that to get short-term users, but also to spread the word about the project. There are limits to this, as token critics gleefully like to carp, but the effect is real.

However, for now there is additional friction, so if the network effects come from acquiring users pre-layer 1 scalability, then it’s likely better to be tokenless.

Fin

This current bear market is good for washing out the folks who care only about short-term money. I believe that clear thinking about fundamental theses will pay off in the long run.

Photo credit: from DeviantArt found by searching “free to use”