Capturing Values from Layer 1 Blockchains
What’s this story about?
Nowadays, there are many layer 1 Blockchains with various purposes. So, especially in the bear market, I think many layer 1 struggles with the “value capturing” method, because there is no liquidity and hype at all. Now it's time to think about the real value of layer 1 blockchains.
In this article, I am defining the “Value Capturing” method as a tokenomics problem (interest alignment problem). So in a sentence, this article is about “Methodologies that can link the ecosystem’s success to native crypto’s success”.
Diving into the essence of Layer 1's native coin
Before we dive into value-capturing methods, we gotta understand the nature of layer 1’s native coin. There were and are a lot of debates about so what’s crypto. Is it a currency/commodity? or, Is it more like equities? Well, that differs case-by-case.
Opinion: It’s neither (or both) currency nor equity
But in my opinion, especially for layer 1’s native coin, it’s neither. Well, it could be the currency when we look at non-codable blockchains like Bitcoin. But when comes to layer 1’s after Ethereum, It sometimes works like a currency/commodity (Utility as a DeFi Reserve Currency, tx fees, etc…), but sometimes like equity(governance, buybacks, etc…).
So when we categorize the value-capturing methods, we can do it by categorizing whether is it a currency/commodity perspective approach or it equity perspective approach.
Capturing values from a currency/commodity perspective
Commodity perspective: gas fee
We can say the gas fee is a good example of a commodity perspective value-capturing method.
Let’s say you run a construction company. To build houses, you need to buy some commodities like iron, concrete, and copper. If the housing market is good, you will make extra orders for those commodities, and it will keep the upward momentum of those commodities.
It works the same in the blockchain ecosystem. Every transaction like using smart contracts, deploying smart contracts, sending crypto, and everything costs a gas fee. So, when DApps grow in blockchain, the demand for gas fees keeps upward momentum, and that keeps the crypto price high.
This makes sense in blockchains like Ethereum because the gas fee revenue itself is really high and the chain is sustainable by only gas fees.
But the gas fee value capturing model does not make sense in chains like Solana. One of their biggest edges is the chip gas fee, so the gas fee revenue is really small compared to the market cap. So, those kinds of chains will need another value-capturing method other than a gas fee.
Currency perspective: being a reserve currency in DeFi
In DeFi protocols like DeXes, Lending protocols, etc… the most dominant liquidity farming pools are always linked with the native coin. Even in Uniswap V1, it was the only option. There was no such thing as a stablecoin pool, there was only an ETH-Token Pool. (Due to correlation, it’s often more profitable than Token-Stablecoin Pool)
This kind of usage gives a liquidity premium for the native coin. In this case, liquidity is the utility. In TradFi, U.S. Dollar is often considered the reserve currency, so the U.S. Dollar value is really powerful and considered as the global standard. Every native coin in every Layer 1 blockchain ecosystem often works like the U.S. Dollar of its own ecosystem.
Capturing values from an equity perspective
Partnering with powerful crypto business
Partnering with powerful crypto businesses is the way to go for layer1 blockchains. In the case of Solana-FTX, and BSC-Binance, two entities (crypto exchange, layer 1) take advantage of each other in many ways.
For a simple example, a popular project on each layer chain is often listed first on their partnered exchange. Even the exchange does the marketing & liquidity provision for layer 1, like making partnered chain’s Defi accessible for CeX users.
And finally, they share the profits. Layer 1 supports powerful crypto businesses with investment, technology, etc. And for that, Powerful crypto businesses share the profit with the L1. For example, Binance does the buyback & burn for BNB with their profit from the trading fees. Bybit does the same with BIT(BitDAO Token), even if it’s not L1.
This kinda approach is really valuable because fills the gap between mass and Web3. Even though crypto-native services like DeXes, Lending protocols, are growing, they are still smaller than centralized crypto service providers like Binance.
Look at the figure below:
20% For the spot market, but for perp or lending (CeFi vsDeFi), is not really worth comparing (obviously CeFi wins.)
So, Layer 1 and centralized crypto service providers are conventionally considered competitors, but surprisingly, not at all. Crypto-native services are flexible, growing fastly, and decentralized but have bad UX, but the opposite for centralized crypto service providers. So, they are the best teammates, not only competitors.
Doing their own business
This is mostly cases of Layer 2 chains, but the logic works the same. Killer DApps like Axie Infinity, DyDx, etc, are often spinning off from their mother chain to have their own chains. This is the exact case of the equity-style approach because the “appchains” hold their own business and the success of appchain is linked directly with the success of their business.
I don’t know the case, but I think there would be a case that layer 1 acquires some powerful DApp into their chain, and link the incentives. It would be fun to watch it.
Otherwise, layer 1 should be aware & have a strategy for this situation. Because layer 1’s value comes from the killer DApps. If the killer DApps want a spin-off and have their own chain, layer 1’s value will eventually go down. So, for layer 1, incentivizing & aligning interests with those Killer DApps will be more important.
Acting as an infrastructure layer of app chains
Multichain & Appchain maxis are building chains like Polkadot (DOT), and Cosmos (ATOM). Those chains are not independent layer 1, but more like a appchain building platform.
For example, Polkadot has a killer feature called parachain. You can consider parachains are subchains for Polkadot. The biggest advantage of using parachain is that each parachain is interoperable with other parachains & Polkadot mainnet. In Polkadot's case, those parachain slots are being auctioned. So, if the demand for parachain increases, the DOT coin’s value will go up.
For the Cosmos ecosystem, we have a similar feature called Cosmos IBC, but the tokenomics was kinda weakly linked with that feature, unlike Polkadot. It was good for expanding the ecosystem rapidly but was not really good for ATOM demand & quality control. So, recently they announced their tokenomics renovation plan.
Conclusion: The fat protocol theory
There is a popular thesis called “fat protocol theory”. The underlying argument of the fat protocol thesis is that blockchain technology can fundamentally flip that dynamic and change it such that the protocol layer accrues more value than the application layer. (I quoted this from this article)
So, if the thesis goes right in the reality, this value-capturing method for layer 1 protocols, can be a big agenda for the next several years. I think this would evolve like the platform revolution (in the sense that they made a whole new value capturing methods), in a more decentralized & flexible way.
Some strong, big, general chains like Ethereum & Bitcoin would have the currency/commodity kinda value. Appchain builders like Polkadot & Cosmos would have the platform value. Chains with strong business partners like BSC, and Solana would have equity-like value.
For the disclaimer: this article is no investment advice. But, these value-capturing methods are especially important when you make investment decisions on layer 1. Web3 is not always about technology.
Behind technology, there is human movement, and behind the human movement, there are incentives. Even if the technology is the game changer, it could lose in Web3 if it doesn’t have a good incentive system.
Aligning tokenomics with the protocol’s success is a hard thing to do, but is has to be done for every L1. At first, Web2 services had no idea about revenue making and value capturing. And they find some killer value-capturing methods like platform advertisement, data monetization, etc.
What do you think is the next platform advertisement and data monetization in layer 1? Let’s Talk in the comments.
