Our Crypto Investment Thesis

Wendy Xiao
9 min readJul 24, 2018


Founded in 1996, Northzone has grown to be one of the most established and successful European early-stage venture funds with 7 unicorns exits and 9 IPOs, including Spotify ($28bn), iZettle ($2.2bn), and Avito ($2.7bn). We began investing at the first signs of consumer internet adoption in Europe and have continuously refined our view of technology through the dotcom bubble, the social era, and the mobile era. We are currently investing out of our $400M eighth fund and are excited to share our view on the emerging developments shaping the formation of Web 3.0.

The Evolution of the Web

The web grows when more people interact in more ways online, and this is a function of trust and technology working in tandem. The adoption of internet protocols such as TCP/IP provided a trusted basis for transmitting information, which powered the formation of the web. However, these protocols didn’t define much else. Web 1.0 was an anonymous place, where you could trust that content will get from point A to B, but there was very little trust in the content itself. The only business transactions were 1-to-many, for the access of static information, from a few large trusted content producers.

AOL Homepage ~1995

There was very little economic activity in the “read-only web” due to commoditization of information, but it gave us the information age. Starting in Web 2.0, institutions built tech platforms to create trustworthy environments online, forming new markets where many-to-many business transactions could take place. This is what we know as the “read-write web”. Participants were able to interact online for the first time because they trusted the platforms to dictate and enforce the rules of engagement. As a result, these Web 2.0 intermediaries took a large cut of the value and defended their positions using network effects and data monopolies.

Facebook Homepage 2018

In the current era of the web, the beginning of Web 3.0, technology standards are being developed to establish the trusted basis for transmitting value as well as information. These protocols also allow the creation of automatic dependencies between value and information transfer. By extension, they create trusted environments online where participants could interact without the help of an institution. In many circumstances, these protocols will out-compete Web 2.0 platforms because they extract less value from the ecosystem. They will also erode institutions over time by significantly decreasing the cost of coordinating economic activity.

Protocols Powered by Tokens

Tokens are the powerful incentivizing force which allow protocols to coordinate trusted economic activity on the web. They help bootstrap a network by first providing liquidity for future network value. This then attracts early adopters to contribute specific work, data, and capital for the network (in exchange for tokens). Last, as the supply side becomes more robust, the demand-side participants can buy and pay (via token) for the network’s services.

Tokens also create bigger markets by adding financial incentives to the non-financial incentives powering most of the web today. Whereas previously, someone contributes to open source, social media, and search for user utility or social rewards only, crypto protocols can also reward its contributors with financial incentives on top.

Finally, we are just beginning to see how tokens can create powerful economic building blocks for Web 3.0. Examples of these are curation markets, bonding curves, NFTs, and staking mechanisms. These will enable new types of markets to be formed, the likes of which we can’t even imagine yet. Trying to do so would be as fruitful as trying to imagine Google’s current business model when the only use case for the internet was email.

Protocols vs. Institutions

If you reduce the role of an institution or a protocol down to the very core, the aim is to get a bunch of people and machines to work together towards a common goal, and usually that’s the production of some sort of good or service. It then stands to reason that whichever entity can do this cheaper will have an advantage over the other and grow, while the other shrinks (adapted version of Coase’s Theorum). Well-designed tokens allow crypto protocols to coordinate people and machines more cheaply than institutions by cutting out middlemen, simplifying contracts, and reducing political friction.

We haven’t yet seen the line drawn between where companies end and protocols begin, but bolstered by tokens, protocols have a lot of room to grow and can be expected to take significant share from current companies. One hypothesis is that the future of the web could be composed of a few widely-used crypto protocols responsible for much of the transactional, low-value tasks in addition to thousands of highly specialized institutions focusing on user experiences.

Which Protocols Will Win?

Protocols must compete with each other for participants, and the differentiation in the long run will most likely not be technical since much of the tech is open source. One possible area of differentiation between protocols is, again, efficiency in coordination. Because networks must coordinate behavior between a complex group of individuals, threading the adoption string between entrepreneurs, developers, early adopters, and mass adopters can be a real challenge. Each has different motivations, preferences, and behaviors, and each group strongly dictate how incentives are structured for the following groups. The protocol is a living, constantly evolving thing, so both understanding and adapting to its various participants’ requirements throughout its evolution is a competitive advantage. In the most successful protocols, the earlier adopters will help design an incentive mechanism and experience that highly appeals to the later-comers, even though their own incentives differ.

Usually, a network is launched with a specific type of intended network effect, but in order for the network to grow exponentially, the meaning of those network effects needs to be expanded over time to become more appealing to those outside the network, creating a bigger and bigger incentive for them to join. In the the early days of Facebook, the draw to join was basically to scope out other single Harvard students. However, as more people joined, it became a way to communicate with all of your college friends, then a way to share photos with your friends and family, and now a way to consume all types of media content, curated by your social graph. In Web 2.0, the direction and scope of these compounding network effects were shaped by a central firm, but in a protocol, it will be shaped by the participants themselves, according to the order they enter the network.

This process of decentralized decision-making is often referred to as governance. I provide here a few high-level principles we look for in protocol governance.

  • The chance for success for either probably depends on what the network advertises hence, the kind of participant it attracts
  • People within a network value governance differently, so the system has to account for that or else we will always have suboptimal decision-making
  • To avoid a plutocracy, we probably need an identity solution
  • The most successful system probably involves several different systems each with its own, conflicting incentives constantly grinding against the others

Where is the Investment Opportunity?

After the founding of Bitcoin, it took a several years for a critical mass of people to get mentally comfortable with the idea of money existing as a digital recollection between its participants. Then a flood of private investments in early 2014 funded the ability to more easily custody and trade this value via exchanges and wallets, providing the on and off ramps into the ecosystem. Next, Ethereum familiarized the idea of the internet of agreements and for the first time enabled deals to be made and executed across a distributed network. ICOs brought more private capital to the ecosystem, but more importantly demonstrated the power of tokens for bootstrapping a decentralized community and marketplace. Then, non-fungible (unique) tokens cemented the idea of digital scarcity into cryptoassets. Now, we are seeing cryptoeconomics primitives such as curation markets being built and incorporated into the toolkit for building the future decentralized business models.

Many of the key infrastructural layers have been established, but currently the gap between these protocols and end users is massive. Other than speculation, there is very little that users, and even to some extent, developers can do on the most robust protocols. Yet, due to network effects and community momentum, it’s likely that many of these base layers, or interoperable replacements, will become the fundamental building blocks of Web 3.0 and that solutions will be built on top to make them more usable. We believe there is a significant opportunity to invest in these layers in between. These layers provide valuable services like identity, off-chain oracles, curation, decentralized exchange, as well as developer tools and interoperability. Most of this layer of infrastructure is being developed right now, with some positioned to become as dominant as a Web 3.0 operating system and perhaps even more valuable than the underlying protocols themselves.

We will also be following the user adoption movement closely as these connecting layers become more robust, monitoring for the first signs of adoption. We have already observed interesting momentum in the gaming sector where many of the crypto-economic primitives can be experimented upon rapidly. In addition to existing layer 1 infrastructures, we believe there are opportunities in function-specific protocol layers that will become more important in Web 3.0 such as file storage, CDN, transcoding, location verification, etc. to provide cheaper, more decentralized alternatives to existing incumbent solutions.

Where Will Value Accrue?

We look at the future protocol stack in many inter-operable layers, similar to value chains, and protocol layers can be even more distinct and numerous compared to firms. Some of these layers will become commoditized, reinterpreted, and their positions may also shift in relation to one another. How much value accrues to the protocol depends on the specific market dynamics — such as competitive advantage, centralization of the surrounding layers — as well as token dynamics around each layer. At the highest level, a protocol accruing value is not too different than a firm monetizing a business in that it relies on the user to pay a fee, based on her utility, for the network’s services. A part of the fee will be distributed directly to the supply side of the protocol, and a part of the fee will be paid by the user incurring a cost to hold the protocol token (due to price volatility and complexity). The total price will be determined by the user’s utility for the network’s services in conjunction with her utility for the token itself.

Our Approach

We are a nimble team with a transparent thesis and process. We hope to be the first partners along the crypto entrepreneurs’ journey and be committed to the success of the project long-term. We will work with our teams to build and refine their crypto-economic models as well as contribute actively to the network and community in the early days. We will also continue to monitor and invest into the seed ecosystems developing on top of the protocols we back. We will leverage our 20+ years of venture experience to help teams think through go to market and product design.

If you’re interested in learning more about our investment process, please read more about our thinking here.



Wendy Xiao

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