Takes from Permissionless - "The State of Crypto"
Long time no see my fellow readers.
Before going through the most important takes that I got from Permissionless, one of the most important conferences in the Web3 ecosystem, I would like to announce that there will be some formatting changes in our newsletter.
It will no longer be a weekly newsletter, but instead, we will be focused on writing articles making a deep dive with the most relevant things happening in the space.
This having said, I want to bring you some of the takes that I got from Permissionless. However, to offer you the best user experience possible and not make it too long, I decided to break down the article into 5 different parts;
The State of Crypto
Stablecoins! The Crypto’s Killer App
Decentralized Finance
Regulation
Metaverse & Gaming
Let’s dip into this week’s newsletter, “The State of Crypto”
The State of Crypto
The cryptocurrency market is clearly in a bear market now. For the first time ever, Bitcoin and Ethereum (alongside most of the other cryptocurrencies), recorded the 9th straight red candle in the weekly chart.
Although it was well known that markets, in general, could face drawdowns due to the macroeconomic forces and the anticipated hikes in interest rates, this unparalleled movement has taken many cryptocurrency investors by surprise. Especially institutions that have recently entered the space and are not used to the extreme volatility of this particular market.
As a matter of fact, the bear market narrative was all over the place at Permissionless for various reasons. Most of the panelist attending the conference have already been through multiple bear markets and they know when to recognize it. Terra (LUNA) and UST’s failure was very recent at the time and this unprecedented Black Swan event helped pushing the bear market narrative.
For those of you who do not know, Do Kwon’s project happened to be one of the largest fiascos in cryptocurrency’s history. A total value of US $60 billion was wiped out overnight making retail and institutions lose a ton of money. The failure of this algorithmic token that claimed to be “stable” will surely attract regulators and put the focus on developers building applications in Web3. To be honest, this is the kind of perfect “excuse” that regulators were waiting for to take the first step toward cryptocurrency and stablecoin specific regulations, alleging a potential threat to the stability of the financial system and consumer protection. And as extrange it may sound, I’m supporting it.
However, a bear market should not always be considered as a bad thing. People who have been in crypto for a while know that bear markets are where real innovation and opportunities are born. A good example of this is the creation of the first DeFi protocols and NFTs that happened back in 2017-2018, after the ICO boom took over the market and entered into a bear market for two years.
Hence, my recommendation for this bear market is to stick around the industry, to keep reading INERTIA’s newsletter, and have the patience to take action in due time.
Shoutout to a16z and Chris Dixon for one of the best panels in the entire conference and for releasing a report on the State of Crypto that will help us go through today’s newsletter.
A16z is a true believer that software is eating the world as we know it today. The company is leading the revolution in the Web3 economy by both, being vocal in the space and supporting Web3-oriented startups with their numerous funds. A16z just released its fourth crypto fund, totaling US $4.5 billion. Of that, US $1.5 billion will be dedicated to seed investments, and US $3 billion to venture investments. This brings a16z’s total crypto/web3 funds raised to over US $7.6 billion.
Crypto’s “Golden Era”
Every 10 to 15 years takes places a technological revolution that brings incredible opportunities for companies and investors to take advantage from it. Over that period of time, there is always a two to three years gap period where all the key applications are built. Let’s see where the cryptocurrency industry is right now and what are the next steps for itself.
Firstly, the infrastructure, which takes the longest, needs to be built. The cryptocurrency space is entering into that phase where all the infrastructure layer will soon be finished. Ethereum is about to face the migration from a Proof-of-Work to a Proof-of-Stake consensus mechanism (hopefully… haha the Ethereum foundation has been claiming this since 2017 lmao), Layer 2 networks that allow a cheaper and a better user experience are being created (Optimistic Rollups, ZK-Rollups, etc.) and alternative Layer 1s, the so called “Ethereum Killers”, are being introduced to the market.
When building infrastructure and uses cases are not still clear, most of the people are very sceptic about the technology that is being built, however, the vast majority of people who tend to criticise innovation, do not even understand the underlying technology and tend to declare the industry and companies that are focusing oriented to this innovation as a bubble. Although 99% of the active projects that are being built in the moment won’t make it into the future, the projects that survive will reign the market in the coming years. A similar thing happened back in the day with the internet and computers. Therefore, expect many cryptocurrency and Web3 related companies to be annihilated in the coming years, however, this does not mean that the market is dying, but instead, it is a clear sign that it is maturing.
Secondly, once the infrastructure layer is built, developers need some time to experiment and understand the limits and characteristics of the technology before being able to launch good applications to the market. Thus, whenever developers get familiar with it, the market enters into that two-to-three years gap period where the most important and revolutionary applications are built. The cryptocurrency market, is in my humble opinion, about to enter into that period of time, making the next 2-3 years to become into a potential inflexion point in the industry.
Lastly, every technological wave usually enters into a phase where developers start mastering the technology and applications tend to become unbelievably good, leading into mass adoption. The cryptocurrency space is still far from reaching this point, which makes me still be bullish in the industry and scares me a little bit at the same time. The investment opportunities to make gigantic gains are out there and there will be tons of them over the next years. However, similar to what happened in the dotcom bubble, many of them won’t survive. Even those projects that seem too big too fail projects (a.k.a Bitcoin and Ethereum) could face a potential extinction in the long run.
In a nutshell, the key difference between the 2018’s and 2022’s bear market is the lack of maturity that the market was facing back in 2018. The industry was not mature enough to have interesting applications built on top of it, making the sector extremely speculative. Do not get me wrong, speculation is still all over the place, however, some interesting applications with real utility such as Gaming, NFTs, decentralized metaverses, DeFi protocols, Stablecoins (with a wider adoption and uses cases than in 2018) and decentralized social media apps that allow the cryptocurrency market to capture more users and increase the network effects have been building over the last year.
Increasing the user base and creating larger network effects is key for the growth of the network. According to Metcalfe’s law, the value of a network grows by the square of the network’s size. This means that a bigger user base leads to bigger network effects. Hence, the bigger the network effect, the more the accrued value of the network.
To sum up, we are heading into a phase where all metrics in crypto start to have exponential growth. In fact, it is already happening.
As seen in the charts above, the annual compound growth rates for developer activity (68.6%), startup activity (62.5%), and social media activity (83.1%) is insane. The mix of all these ingredients, make networks and applications more valuable, thus increasing demand on owning projects through tokens and making the price of those tokens increase in value.
It ccould also be argued that the flow is actually the contrary. Because of the price appreciation of the tokens, developers activity increases because they see a clear opportunity to make some money, thus, they decide to create their startups with more sophisticated and useful products. Lastly because those applications allow users to be “owners” through tokens and these tokens provide economical incentives to users, people start engaging with products and communities through social media trying to spread the popularity of those applications through CT (Crypto Twitter) and Normies (Non Crypto-Native people).
Well, either way, the competition of developers and startups to launch a better product increases and brings a wider use base to crypto, making network’s overall value to increase.
Block Space
One of the key concerns for people who are used to traditional financial metrics is the difficulty to measure the value of a Layer 1 network.As mentioned before, one of the key metrics to look at to understand the value of these networks is the user base and activity of those users. In a nutshell, this is translated into Blockspace demand. Blockspace is basically ownership bandwidth.
Looking at the history of computing, every 10 to 15 years a major computing wave happens where in each wave, there are kind of key new resources to look at when building the infrastructure. For example, with the internet it was Broadband, with PCs it was CPU and so on. Now there are tons of developers building applications on top of Layer 1s, however, one of the scarcest resources that developers need to face at the time to start building on these systems is the block space itself.
Similar to what happened in every other wave, one of the key concerns of the industry is to see if it really needs that much block space and if users will be able to fill all the supplies that being created. The exact same thing happened with Broadband back in the day. People overestimated the demand for these resources, and I believe the same will happen with both, Layer 1s and Layer 2s.
As seen in the table above, the transaction fees paid by users in a 7 days average is very disproportionate between chains. Ethereum is by far the Layer 1 with the most blockspace demand, however, I do not like to have this chart as the main reference for blockspace demand since the transaction fees paid on the network depend on multiple variables.
For example, Ethereum cannot handle as many transactions per second as BNB Chain and other alternative Layer 1s. In addition, the block space is smaller in Ethereum too. These factors combined with a pretty high demand on the Ethereum’s network make the network’s users to pay more for the blockspace in general. At the same time, people are willing to pay for that blockspace whereas maybe they would have not in other chains.
In my opinion, blockchains could be compared to Real Estate in major cities. For example, you do not get the same apartment for paying US $3,000/month in NYC or in St. Louis. NYC is a very demanded city where the space is limited but all the interesting people to meet is there. A similar thing happens with blockchains. If you want to be in the blockchain that everybody else is active, you will need to pay more to make transactions, which at the end of the day should not be considered neither as a good or bad thing. Having to pay relatively large amount of transaction fees to have transactions introduced into the next mined block is often explained as a layer of security too. The chance of facing a 51% attack in the network is less probable if making this move carries a large amount of money. This is why Bitcoin’s network is considered as the safest.
There are many active discussions around these specific topics in the cryptocurrency space. Unfortunately, I really think that I do not have the perfect answer for all of them and it would not be fair to just express my opinion.
What is clear and is a fact is that Ethereum is by far the most demanden blockchain in terms of blockspace and the vast majority of developers are choosing to build in this network over any other.
It is true that EVM (Ethereum Virtual Machine) compatible networks allow developers to migrate any DApp and development made in Ethereum, for me, Ethereum is the gold standard when we talk about Smart-Contract platforms.
It could happen that in the near future it gets replaced by a competitor, as it has happened with many industry leaders before. However, we are fortunate enough to see the evolution of this technology and take a decision about Ethereum and other alternative networks by looking at proper metrics.