Long Take: What Layer 1 protocols must learn from the Telecom crash
We analyze the market dynamics around Layer 1 and Layer 2 alternative networks, and get to the root of how growth is being incentivized.
Gm Fintech Architects —
Today we are diving into the following topics:
Summary: We analyze the market dynamics around Layer 1 and Layer 2 alternative networks, and get to the root of how growth is being incentivized. The $290MM Avalanche ecosystem fund for the “Multiverse” is an example of such a strategy. We discuss the manufacturing of decentralized computation, its relationship to builders and users, and the price dynamics that result. Finally, we close with a comparison to traditional marketing programs, corporate venture capital, and the collapse of the Telecom industry after the Internet bubble.
Topics: crypto, computation, marketing and growth, technology
Tags: Ethereum, Avalanche, Fantom, Near, Polygon, FTX, Solana, Amazon, Apple, ConsenSys
If you got value from this article, please share it. Long Takes are premium only, and we need your help to spread the word about how awesome they are!
We were a surprised by one of the main investment themes of 2021 — alternative layer 1 networks competing with Ethereum for decentralized applications. It just wasn’t something we focused on deeply.
Ethereum had seemed to be so entrenched in the community. Of course it was, and still is. Our logic was that during the 2017 ICO boom, there were so many fake projects pretending to be competitors to Ethereum (e.g., EOS, Cardano) that the theme wasn’t really worth focusing on, especially as all these applications were launching with differentiated substance.
Meanwhile, investments in Solana, Polygon, Fantom, Near, Avalanche, Arbitrum, Cosmos, Polkadot, and a variety of other Layer 1 and Layer 2 protocols became increasingly profitable. These trends are relatively weaker this year, but still hold for things that anchor to Web3 operationally.
Our thesis is driven by the understanding of these protocols as manufacturers of a particular good, that good being decentralized computation. Such computation can power any type of software, but is particularly apt for digital scarcity, property rights, and provenance. Decentralized computation has a supply, a certain amount of demand, and a variable price in the shape of the cost of gas. Not dinosaur bone gas, but the digital one used to turn on the global network machines.
The other framework is a war over developers to build applications within particular standards regimes. This is the story of Betamax vs. VHS, Apple vs. Windows, iOS vs. Android, as well as the Chinese super apps. There exist some number of relevant platforms — let's say more than 1 but less than 5 — which can provide substitute versions of a particular operating stratum. Those platforms are valuable only if gardened by third party gardeners, i.e., the developers that make the applications.
If there are many applications, users appear and use them. Users often have the highest willingness to pay. You might think Facebook is free, but remember you paid $1,000 to Apple for the privilege of having a phone. Thereafter, if there are users in your platform, developers value that as a distribution channel in addition to a technology enabler. This creates positive viral loops and network effects, which allow certain equilibria to hold, and others to collapse.
So Layer 1s do both — they provide the computational unit, as well as the market context in which that computational unit is generated and executed.
Anyway, we were very closely staring at developers and the apps they made, like NFTs, DeFi, the Metaverse, the face-melting singularity, the Zuck Bucks, and so on. We were less concerned about the competition around platforms, because don’t incumbents win the power law game? Well yes, if the game doesn’t change. But there are ways to bribe and overpower the game. You can see that play out today in the value locked, i.e., collateral, moving around things like Terra, Avalanche, and (still) BSC. In September of 2020, ETH had 90% of the assets on the market, and today it has about 50%. It is important to understand how and why.
Here’s the news that caused this write-up.
Avalanche is launching a $290 million incentive program to grow the applications built on its technology. The protocol’s fully diluted marketcap is about $30 billion today. So we are talking about a 1% spend of the marketcap on platform growth and recursive customer acquisition.