Rehashed - #17 Value Capture within the Web 3.0 Stack

Web 3.0 Stack

The arrival of the cryptocurrency and blockchain universe has brought with it the Web 3.0 concept. To provide context, Web 1.0 was simply the first iteration of the World Wide Web; a set of static websites with a load of information and no interactive content. Think dial-up modems and MSN messenger. Web 2.0 is the internet as we know it today, bringing faster speeds, interactive content and the age of social media. As recent data privacy scandals have highlighted, it also marked the mass stockpiling of data in centralized servers with the likes of Amazon and Facebook as some of the largest culprits.

Web 3.0 is the next generation of the web in which decentralized applications (dApps) operate on top of a shared data layer where users have control of their data and the ability to move between dApps with little to no switching costs. Kyle Samani of Multicoin Capital, a large U.S. crypto-fund, recently published a thorough description of the current state of the Web 3.0 Stack, with a chart depicting the various infrastructure layers.

As the introduction of cryptocurrencies has eroded the barriers to investment for the wider public, it is in our best interest to approach valuation with an analytical eye. In valuation circles, analyzing the formation of the web stack and subsequent value accrual is a useful tool for understanding the investment landscape.

 

Revisiting the Fat Protocols Thesis

Joel Monegro (ex. Union Square Ventures, now Placeholder Capital) originally published the fat protocols thesis, which argues that value will accrue low in the stack at the protocol level because protocols will capture the value of all of the applications built across them. The result is a ‘fat’ protocol layer complemented with a ‘thin’ application layer. Essentially, we can expect much higher returns from the protocol layer.

This is in direct contrast to Web 2.0, where much of the value has been realized at the application layer. Although internet protocols (HTTP and TCP/IP etc.) have provided immense value, they have remained ‘thin’ as these protocols were not monetized. However web applications, built upon the foundations of these protocols, have multi-billion dollar valuations attached. In fact, FANG stocks (Facebook, Amazon, Netflix, Google) have grown so strongly that today, their combined market capitalization is nearly a full percentage of the S&P 500's total.

 

Thin protocols of Web 2.0 vs. fat protocols of Web 3.0

 

Under the fat protocols premise, we could expect general purpose protocols such as Ethereum to capture the value of the dApps leveraging its blockchain. Jake Brukhman of CoinFund has pushed back on the idea of fat protocols, arguing that the notion of a protocol is arbitrary- you can draw a protocol-application boundary at any level of abstraction you like along the functionality stack. Furthermore, compared to Web 2.0, protocols are much more siloed; picking the right base protocol is no different from picking the right startup or the right application from a diversification perspective.

 

Recreation of protocol value capture depicted by Jake Brukhman

 

Teemu Paivinen arrives at a somewhat hybrid conclusion between the above mentioned. He suggests that although these protocols in aggregate are likely to capture most of the value, due to competitive forces and relative ease of forking, there will be multiple protocols with minimal value. If a protocol is ‘fat’ and capturing a disproportionate amount of wealth (as in Monegro’s depictions), parallel protocols will pop up to compete. We have already seen this play out, with the Bitcoin Cash fork attempting to challenge Bitcoin. And many general-purpose platforms are in an arms race to compete with Ethereum. EOS just launched their proprietary network and several exciting projects such as Dfinity, Tezos and RChain are gaining traction.

 

Paivinen’s modification of the fat protocol thesis

 

Personally, I’m inclined to agree with themes of the fat protocol thesis - but more from a velocity standpoint. I believe that the high velocity of dApp tokens may render them nearly valueless in the long run; the “speculation premium” will collapse and a token’s price will ultimately reflect the price of whatever scarce resource it represents. Thus, the underlying protocol is likely to remain the reserve currency for the applications built on it and will have a much lower velocity. As velocity generally has an inverse relationship to price, a lower velocity will result in a higher price and subsequent valuation.

 

What does the data have to say?

For now, the data backs up the fat protocols thesis. According to Satis Group data, although half of all crypto-assets are built on other platform networks, nearly 90% of the value resides in coins/platforms. Furthermore, the median platform network trades at ~4x the total value of the overlying tokens built on it. The market is placing a significantly larger valuation on the underlying protocol over the various dApps leveraging those platforms. It’s still early days; we currently derive limited utility from underlying platforms. Ethereum is the stand-out, and as more general purpose platforms go live, we will have a better understanding of the platform to application valuation dynamic, and the workings of the wider Web 3.0 stack.

 

In the News

Augur, a long awaited blockchain-based predictions platform, has been launched for the general public.

An anonymous gambler has bet $6.3 million that the price of bitcoin will exceed the stock price of Berkshire Hathaway by 2023. Bitcoin trades around $6,000, while a share of Berkshire Hathaway goes for $287,100.

The Robinhood stock-buying app has added support for bitcoin cash and litecoi

Billionaire Steven Cohen has invested in Autonomous Partners, a hedge fund that focuses on cryptocurrencies.

Jeffrey Wernick, an early investor in Uber and Airbnb, explains why he bought bitcoin in 2009.

A new paper from researchers at Imperial College London claims digital currencies are primed for mass adoption.

 

Upcoming Dates

27 July - Blockchain Forum Auckland

 

As always, thanks for joining - see you next week for Rehashed.

Freddie Archibald

 

View previous issue: Rehashed - #16 Rise of the Stablecoin

View next issue: Rehashed #18 On ASICs and Mining Monopolies (Part 1)


About the author:

Capital markets to crypto convert. From Christchurch →  Boston → New York, Freddie became intrigued by the potential of the digital asset economy after plucking a book on Bitcoin off a New York library bookshelf in 2016. Her parents are thrilled that she is chasing magic money on the internet.

 

Disclaimer:  The above references an opinion and is for informational purposes only. The opinions expressed by the author do not represent the opinion of BitPrime.

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