The value stack is shown above. The question is what it will look like when the system is at scale? Does the base ‘processing layer’ capture the majority of the value or does the application protocol capture it or is it split? How can we tell?

One can answer these questions by applying aggregation theory. The theory states that “the value chain for any given consumer market is divided into three parts: suppliers, distributors, and consumers/users. The best way to make outsize profits in any of these markets is to either gain a horizontal monopoly in one of the three parts or to integrate two of the parts such that you have a competitive advantage in delivering a vertical solution.”

For the new blockchain age, it should be: “the economy for any given decentralised vertical is divided into three parts: base protocols, application protocols, and consumers/users. The best way to capture outsized value in any vertical is to either gain a horizontal monopoly in one of the three parts or to integrate two of the parts such that you have a competitive advantage in delivering a vertical solution.”

So, what does that mean? It means in this case that whichever protocol can aggregate two parts of the system or own an entire horizontal layer (e.g. processing smart contracts) will dominate. If it can dominate then it can extract more value and thus maximise its network value.

Let’s examine the first option, horizontal monopoly in one of the three parts. How likely is it that a base layer protocol will grow to dominate an entire horizontal? And even if it does, will this allow it to extract value? Let’s consider Ethereum in the smart contracts horizontal. Currently, Ethereum captures the ‘transactional volume’ or processing fees of smart contracts using it, which should grow in number. But, Ethereum is also implementing various scaling solutions, and so the fee required to process each transaction will drop. Scaling, coupled with competition from EOS, NEO and Tezos (class action lawsuits aside), should commoditize the ‘processing layer’ and may drive fees to near-zero. Secondly, the open-source nature of these network protocols allows for forking, which enables bespoke designs for niche use-cases and thus reduces the competitive advantage of ‘general’ base protocols. Lastly, projects like Cosmos, Polkadot and Blockstack are already virtualizing the blockchain by providing interoperability. This would further commoditize the processing layer, and in turn these interoperability layers could try and extract value by becoming the aggregator. Thus, it is unlikely that even a project like Ethereum, with its team of savants and current smart-contracting domination can gain a horizontal monopoly; and even if it did, the current value proposition is likely to be commoditized away in the pursuit of ever-cheaper transactional capacity

What about the second option “integrate two of the parts”. How likely is it that a protocol can be utilised by consumers and provide value? Application protocols should ‘own’ the end user because of their proximity. It is significantly easier for application protocols to aggregate end users than a base protocol. Users will share in the value captured by the economy of correctly designed application protocols through owning the tokens. This creates evangelist users who spread the application and its protocol and further increase use and value at the application protocol layer. These users will likely be completely unaware of the underlying processing protocol. Effective interoperability between application protocols and a myriad of base protocols in the stack below will further drive commoditization as applications simply search for the base protocol which optimizes a core mix of security, throughput and cost.

Two points worth emphasising. Firstly, the correct design of application protocols refers to the crypto-economic design and this is critical. An incorrectly designed system may suffer from hyper velocity, which would limit its ability to capture value. Conversely, a correctly designed economy ensures the application protocol is a Value Trap that captures the ‘transactional value’ or value of all transactions in the economy, within a vertical stack (i.e. identification verification). Secondly, not all application protocols have the correct economic design, or are even genuine projects. I.e Buyer Beware! In the short term, this creates trust and selection issues; however, the market is quickly correcting. Badly designed token economies (and scams) are less likely to raise significant capital than even two months ago.