State of the Market

Overview

This last double bull cycle of 2020 and 2021 was marked by the dominance of “narrative”. The merit of a new token project took a backseat to the quality of their marketing and memes. Trading firms turned VCs in the first part and anon influencers in the second part took power where traditionally VCs had sway in 2017. We saw the narrative shift from DeFi, to NFTs, to DAOs (briefly), to L2 (briefly), to Play-to-Earn, to Metaverse, to Web3, and then back to NFTs, with L1 wars spanning the last 5 co-narratives. The crypto space was grasping at new narratives to justify deployment of new capital, to satiate investor appetite for enormous returns; returns which may have been fundamentally possible early on but now only possible from roping in progressively less sophisticated capital to function as exit liquidity for each preceding bagholder. Many years ago, I would have considered this such a shame; misallocated capital without productive value, predatorily extracting stimulus checks from TikTok users who dream of getting rich to escape the drudgery of their paycheck-to-paycheck existence. There’s bottom-feeders in every industry. Today, my thoughts are very different. I see every bull cycle as an incarnation of the natural cycle of life in the animal kingdom where we have a food chain of the greedy being eaten by the slightly smarter but equally as greedy version of themselves. Ugly but unavoidable. I believe now in crypto accelerationism. For a number of years now, we have not been able to make progress in the industry from logic, reasoning, or any form of verbal dialectics. We have only been able to learn by witnessing the outcomes of mostly fated-to-fail experiments (though some do succeed, at least for now). Arguments of small block vs big block, PoW vs PoS, this PoS vs that PoS, this L1 vs that L1, L1 vs L2, (3,3) vs (-3,-3), Punks vs Apes, DOGE vs SHIB, CLOBs vs AMMs, etc, cannot be resolved without actually seeing how they play out in reality. No amount of theorizing on mechanism design, drawing boxes and arrows, using analogies in history, or hardcore wordceling will convince one tribe to abandon their holy cow to join the other side. We as an industry must viscerally experience the good and the bad, what works and what doesn’t, until it is burned into our zeitgeist, forming our collective memory, and only then can we move forward.

The introduction of jargon has been an interesting development in the culture of crypto. In traditional protected and supply-restricted fields like medicine and law, jargon has twofold use. First, it saves time when both communicating parties share a corpus of understanding. Second, it prevents outsiders from easily extracting value which “rightfully” belongs to the insiders. In crypto, this is no different. As we become a wealthier industry, we further couch ourselves in ingroup lingo such that no dirty outsiders can come and eat our lunch. This should give rise to more M&A activity as non-crypto firms without internal expertise look to penetrate this highly lucrative yet highly impenetrable space. I make no normative judgements here good or bad; it’s just natural.

Capital allocation has always lagged the advent of new and useful innovations. Over the course of a bull cycle, ever greater sums of capital chase lower and lower quality projects. Entrepreneurs and grifters alike are all too happy to embark on new half-baked ideas, creating supply to meet the oncoming demand of fresh fiat entering the space. And it is precisely when counter-narrative is maximally self-censored by those who see the naked emperor but fear the backlash from a hornet’s nest of shillers and bag holders, that narrative reaches maximum upward reflexivity. At the height of mania, people buy only things they think can be flipped to the next marginal buyer; valuations grow absurd and common sense is drowned out by a tidal wave of tribal chants and rain dances to make the price go up. If it were not for the macro environment turning, we likely could have gone to even greater absurd heights. Mania had not yet reached its natural crest. With the turning of the tide, “narrative” weakened, both in crypto and beyond our shores, and many projects were revealed to be, at best, grifts; at worst, outright scams. When madness is the rule, nuanced takes and careful considerations are branded as heresy. It is only after “narrative” has weakened that these thoughts can even be published without being policed for wrongthink.

Currently, the market seems fairly priced for majors with maybe alts still a bit too rich. Fed rate hike talk was initially disregarded as not entirely believable, but now is mostly believed and priced in. New developments on further hawkish Fed sentiment caused a small dip which was quickly bought up. It looks like 4–5 rate hikes this year, no more and no less, at least in current expectation. There has been some pullback from speculative alts to majors like BTC and ETH but less severely than in 2018. Most of the gargantuan third or fourth funds raised by crypto VCs will likely go where they always have; to new projects rather than old ones. New projects could still 10x or 100x from this capital backing if macro improves but old projects will likely not have the same order of growth from here.

Grift and Utopianism

I’ve recently been thinking of two new dimensions across which we can categorize various cryptos: grift and utopianism. For example, on the grift dimension, I think we can agree that OHM is less grifty than TIME which is less grifty than other OHM forks. Now I’m not making any claim about the absolute griftiness level of each of these projects, only that relatively speaking they could be reasonably ordered this way. Generally, the rule is that copies are griftier than originals. On the utopianism dimension, an example would be that BTC is less utopian than ETH and ETH is less utopian than SOLUNAVAX and other new L1s. Generally, the rule is that new projects try to “solve” the problems inherent in old projects and are thus more utopian. Now that we understand these dimensions, we can talk about the investability, returns, and timing considerations of each of the 4 quadrants: 1) low grift, low utopianism; 2) low grift, high utopianism; 3) high grift, low utopianism; and 4) high grift; high utopianism. Who doesn’t like 2-by-2 thinkboi matrices?

Quadrant 1 (low grift, low utopianism) represents projects which are honest efforts at tractable problems which can be solved without requiring some kind of fundamental scientific or technical breakthrough. Examples would be crypto exchanges (in the past), new crypto infrastructure plays, and possibly some early successful cryptos like BTC. These tend to be good long-term investments which are simultaneously considered short-term unsexy particularly during the mania phase of a bull market.

Quadrant 2 (low grift, high utopianism) represents projects which are honest efforts at building grand designs to usher us into a brave new world. These designs often require at least one but sometimes multiple technological breakthroughs to work. You often find that adherents of these projects will bash and trash projects in Quadrant 1 as insufficient to serve as justification for why their Quadrant 2 project is even necessary in the first place. Utopia is only worthy of pursuit if the world that already exists is deeply flawed. Quadrant 2 projects tend to be good investments at very early stages because founders are earnest and it comes through. This allows for founder myth creation and should sustain long enough to get at least a round or two of fundraising. In the later stages, these projects are good investments only if the breakthroughs happen and utopia is “achieved”. It’s unclear whether these utopian pursuits will succeed but VCs only need a few of them to win to make up for all the losers. Part of the game here is for Quadrant 2 projects to look as much like Quadrant 1 projects as possible. This makes the project seem derisked and makes investors feel better. The true requirements of having a breakthrough are often handwaved away and presented designs are continuously reaffirmed as perfectly viable and completely incentive-compatible from a game theory and mechanism design perspective. These are the higher risk, higher return analogues of Quadrant 1 projects. There’s disagreement on risk but no disagreement on the potential returns.

Quadrant 3 (high grift, low utopianism) represents projects which are poorly-executed money grabs. An example of this would be Bitconnect. It was obvious to everyone in the space that this was a scam. This is precisely why Bitconnect targeted people who were outside of the crypto community and frankly less sophisticated overall. To the less sophisticated, a Quadrant 3 project would seem more utopian which is exactly what these projects want to do, to blend in with Quadrant 2. Ultimately utopianism often serves as a cover for grift. That’s why Quadrant 3 represents the worst of our industry, the true bottom-feeders. Stupid greedy people scamming even stupider people. These blowups are what regulators will use to ultimately justify harsher regs on the entire space. Can you think of any other projects in the crypto space right now which purposely target only people outside of the space? If it quacks like a duck.

Quadrant 4 (high grift, high utopianism) represents the Rube Goldberg machines and perpetual motion machines of our industry. They are grifts like Quadrant 3 but better executed. Even industry insiders will have a hard time reasoning about these complex contraptions and even the skeptics can only conclude that “it probably doesn’t work but maybe it does because I can’t quite put my finger on what’s wrong”. Does the Gordian Knot have a loose end; can it be unraveled? Quadrant 4 projects try their best to pretend that they are in Quadrant 2. Over time, if the project is short-term successful they might well actually try to turn the grift into a real business and migrate to Quadrant 2. What’s the difference between WeWork and Theranos? The former migrated from Quadrant 4 to Quadrant 2; the latter failed to do so. Overall, Quadrant 4 projects have been great short-term investments for many in the space. Sad but true. Part of the reason for this is that token projects are able to achieve liquidity much quicker than private companies of the past; they are effectively able to “IPO”. With being “public” comes all of the incentives of public companies: short-term orientation toward the next few quarters. Founders can retire before the revelation of whether the product actually works or whether it has true, unsubsidized product market fit, especially when usage can be bought by paying for it with the token itself. Most seemingly successful crypto projects are Quadrant 4 projects because the incentives to flip fast cash are too great for participants to ignore. Founders, employees, investors, traders, exchanges, market makers, OTC desks, SAFT slingers, lawyers, and other third-party service providers all benefit from these Quadrant 4 grifts. The only people who do not benefit are the last bag holders, drunk on Kool-Aid, desperately clinging to a utopian dream sold to them by smarter but shadier characters than themselves.

I find these dimensions of grift and utopianism to have great explanatory power for the phenomena we witness in this space, cycle after cycle. In summary, Quadrant 1 is good long-term but unsexy short-term. Quadrant 2 pretends to be Quadrant 1 and can move to Quadrant 1 if they solve a problem where a solution might not exist. Quadrant 2 is short-term lucrative, with higher risk and higher return in the long-term. Quadrant 3 pretends to be Quadrant 2 but only succeeds in its pretense toward unsophisticated players. Just avoid entirely. Quadrant 4 pretends to be Quadrant 2 and may migrate there if they want to cover their ass and go legit after some initial success. They are by far the best short-term investments if you only care about money. VCs benefit from the greatest amount of access arbitrage here. Quadrants 2 and 4 are where accelerationism is most necessary.

NFTs

We largely stayed away from trading NFTs and NFT-related tokens. We felt that we did not have sufficient competitive advantage to play that game. To the extent that aesthetics mattered, we didn’t have excellent taste. To the extent that mimesis mattered, we didn’t have enough Twitter followers. Plenty of other markets to trade; plenty of fish in the sea.

First, let’s look at the category of art and pfp NFTs. In that they are status/signaling symbols, Veblen/luxury goods, or heirloom/prestige items, we can make the argument that some of them will hold value long-term. In the same way that there are a dozen to two premier fashion houses in the meatspace, we could see a similar number of NFT series which have enough brand value to sustain. That being said, surely there are not 1000s of top fashion houses so most NFT series will likely not have much value. Thus, at best, we have a power law distribution of value where winner takes most. We could also argue that status symbols are only so useful as the reach they have in displaying to others. With meatspace fashion brands, this would be limited to foot traffic in meatspace proximity to the wearer. With NFTs, this would be limited to social media like Twitter and Discord. It is yet hard to say which display space will be greater though it is a reasonable argument to make that the virtual world is far vaster than the physical world, especially as Twitter and Instagram are actively integrating NFT functionality and especially as people spend more and more time on the internet. It is also, no surprise that pfp NFTs have outperformed general art NFTs since they function better as avatars of online identity. Still, be careful investing in NFTs as this sector has the highest concentration of grift of all the recent narratives. The gaming/streaming community largely hates NFTs already. I blame Ice Poseidon.

Second, I do think that vampire attacks similar to LOOKS have some reasonable chance of gaining market share. They are able to directly target the correct demographic which would be perfect users for their platform. That being said, LOOKS price and market cap have been getting decimated recently, most of the volume there is wash volume, and founders have been cashing out. If this turns out to be a complete grift, it would not be surprising given that the team is anonymous and the token price has already achieved a very rich price in a very short time. Nevertheless, the idea of having multiple competing platforms for NFT trading makes good sense since fees are high and there is room for competition. Moreover, orderbook-like liquidity network effects do not exist so challengers have an easier time competing with incumbents. Liquidity network effects for NFT exchanges are weaker than for delta one exchanges which are, in turn, weaker than for options exchanges.

Lastly, when it comes to non-art non-pfp NFTs, the design space is largely unexplored. I find this expedition worthwhile. Most of it, like all new paradigms, will likely be nonsense but I’m optimistic that people will find a handful of good and useful things here.

L1s

Since technical merit completely doesn’t matter until it finally rears its head some indeterminate time in the future, we shouldn’t waste time on this. I’d only like to say that it makes perfect sense what kinds of profiles back each of the different L1s. HFT Chicago prop shops prefer SOL. Koreans prefer LUNA. Grad students prefer AVAX (it’s the only professor coin which has played out well after all). Andre disciples prefer FTM. Valley VCs prefer all of them because, hey you only need to be right once to return the entire fund right, and sometimes smaller L1s like NEAR because there’s greater billions to grow when you aren’t already a couple of yards in market cap. ETH maximalists now sit in the same camp as old BTC maximalists as they try to defend against attacks from all sides from the “new”. Generally, they have been unsuccessful in their defense because people like shiny new things. With the new, your grandest hopes and dreams are possible; with things that have launched and chugged along, you only see the callous reality of what actually is. Behind the curtain of utopianism is the barbarism of the real and the ugly truth of human nature. Our nature to yearn for a perfect world and our nature to exploit this yearning in others. In the end, a Girardian scapegoat is needed to satisfy the raging malcontent of true believers turned disenchanted mob and who better to fulfill this role than the prophets who promised what could never be delivered. That’s not to say these L1s will not be successful, only that founders are very aware of the Sword of Damocles which unceasingly hangs over them. Best to win, second best to continuously pivot to ever greater tradeoffs on principles of decentralization because it doesn’t matter until it does and who knows when that will be and if it ever will happen at all. Maybe we are all just afraid of the Boogeyman; maybe not. As we reinvent financial and monetary systems, we start to sympathize with the Fed Chairmans of the past. No Fed Chairman wants the economy to blow up on their watch so why not just pass the buck to the next guy, kick the can down the road. In any case, may the best L1 win. Just useful to consider all the incentives of the participants; that’s all I’m saying. Not everyone is in it for the tech. In fact, not many are.

At this point, having waited over 7 years, I’m afraid to even ask if we really will get PoS on Ethereum delivered this year. What will happen first: ETH 2.0 or the reawakening Hal Finey’s frozen body? Haha, who knows at this point. Just kidding, don’t flame me.

When it comes to cross-chain bridges, the main challenge is to ensure that the synthetic assets on one chain are not arbitrarily inflated without proper backing on the originating chain and that the transporting process is secure. We recently witnessed the wormhole exploit between SOL and ETH which was due to a problem with the former. I’m not particularly concerned with this weakness since it is just a bug which can be fixed. The SOL wormhole exploit was bailed out by Jump though likely it was a lot of their own money, they stood to lose a lot of value on their SOL bags if the bridge was allowed to fail, and I’m sure they took their pound of flesh in the structuring of the bailout. Still, not too concerning. However, what would concern me would be if there were fundamental issues with bridges in general even if the code was written perfectly. Left to be seen. Also, even if bridges today are fairly centralized, as long as there is a way to eventually decentralize without compromising security, it should be fine. We will see. I’ll hold my skepticism in reserve.

DeFi

DeFi 2.0 is like DeFi 1.0 but 2 is greater than 1. Bigger numba better. DeFi 2.0 is marked by the idea of having the protocol, itself, control or own assets. Sometimes it’s called PCV (Protocol Controlled Value) or POL (Protocol Owned Liquidity) or whatever else. The idea is the same, you now have a DeFi protocol that also runs a hedge fund on the side. Good idea or bad idea? Left to the reader to decide. Now that protocols are holding, in treasury, other protocol tokens and participating in each other’s governance votes, we enter into an era of systemic risk. Have a look at this: https://twitter.com/Galois_Capital/status/1486937936054689793?s=20&t=LwBktrRBWNfCxqI9QQJmaA. What’s easier to reason about, this relatively small TIME-MIM-LUNA slice for a larger web of composed products or, say, a CDO-squared from the height of structured products pre-2008 crisis? Scary. Composability is wonderful and allows things which were never before possible but we need to be careful because systemic risk builds up over time and entangled protocols become harder and harder to reason about. Other than that, same shit, bigger number.

Play-to-Earn

You work to earn and you spend what you earn on play. Isn’t that how it’s always been? Work is essentially things you would not do out of your own volition and you are compensated for doing these undesirable tasks with payment. Play is essentially things you would do of your own volition because you enjoy it and may even be willing to pay to do so. So what the fuck is P2E then? If you are a rural Chinese peasant who earns a living by farming WoW gold, that’s work. If you play and enjoy WoW, you might buy WoW gold from RMT sites who get it from these rural Chinese. That’s play. In P2E, people are once again using wild nomenclature that makes for a cool sounding buzzword to make it seem like you can have your cake and eat it too. In most games, there are people who are working to earn and people who are paying to play. These two groups have virtually no overlap. In the case of most “P2E” games, you still have people who are working to earn but the second group is mostly replaced by a new group which is the pay to buy the work of the workers to eventually sell it to other people in the paying group. In other words, the difference between most games and P2E, is that you go from workers and players to workers and speculators. The elephant in the room is that virtually nobody actually wants to play the game.

If the P2E sector ever comes out with a game that’s actually fun to play, then you just have a normal game with workers and players. There’s no difference except for one subtle point. Having on-chain bearer assets for virtual game assets allows for an active secondary market which operates outside of the game developer’s platform but which can still be easily taxed by game developers. The general consensus of game developers has been that secondary markets are not good for revenues because they are not easily able to take a cut of every transaction and it cannibalizes the primary market. Now, with crypto, they are able to tax easily though the primary market cannibalization cannot be resolved. In my opinion, this is still a good thing because the best games of the past do have active secondary markets and now there is at least a bigger incentive for game developers to return to the good old days before the anti-secondary trend. Players get what they want and developers get half of what they want. So crypto and gaming could have some strong synergies but the current state of P2E is not it.

Metaverse

To the extent that the term “Metaverse” means VR, we already have it and it’s a growing industry. To the extent that the term “Metaverse” means more than just VR, then we must be precise on its definition lest we start climbing “sky high abstraction ladders” that inflate the value of ordinary words. When people say AI, they mean ML; when people say ML, they mean statistical methods; when people say statistical methods, they mean linear regressions. Money is already inflating away; let’s not inflate away our words too. If “Metaverse” means virtual communities, we already have that with Telegram chats, Discord communities, and even the company formerly known as Facebook. If “Metaverse” merely describes a trend where people will generally spend more and more time in the virtual world and less and less time in the meatspace, then it’s happening and the hikikomori of Japan are our future. When you print too much money, half your people stop having sex and become shut-ins and basement dwellers while the other half become salarymen of giant zombie kiretsus until they inevitably all die of karoshi. Trust me; it’s true, but the proof doesn’t fit in the margin.

Still, from a practical angle, when we talk about investing in the “Metaverse” whatever it actually means, this usually takes two forms: investment in a virtual world or verse or investment in specific virtual land/assets within a verse. For the former, crypto allows two innovations which were not possible before. First, you could have your users take ownership of the “verse” through the equivalent of yield farming in a Web3esque approach so long as you have some anti-Sybil mechanism. Second, you could have your users engage in commerce with each other without reliance on centralized payment rails. In other words, you can log in to, say, Decentraland, have your avatar walk into a virtual art gallery, find a Punk you like, and click on it to link directly to the auction for it on OpenSea. With another click, your Metamask wallet opens and you can just buy it from the gallery. Once it’s bought, you can leave it displayed in the gallery or take it down to display it at your virtual house or display it at both places. Sure, pretty cool. Still, VRChat, as an example, could just integrate this functionality even if their verse is centralized. Does Decentraland have unique advantages and disadvantages versus VRChat? Hard to say but maybe the next topic will shed some light.

What happens when we turn land title into bearer instruments? How about when we turn virtual land title into bearer instruments? That’s really the core difference between Decentraland and Second Life. It creates some level of scarcity for the virtual land and unforgeable, unseizable title to the land. Though there is still a question on how much more land is worth near centers of traffic versus far away. Virtual land value also benefits from foot traffic around the area like meatspace land but in virtual reality people can teleport and fly. If you restrict users to not be able to teleport or fly, then your competitor will not impose such a restriction. Because gravity does not need to be a law of the virtual world, I imagine that land can also be stacked vertically. So I don’t see virtual land values reaching the same ratios of urban versus rural land value in meatspace but some virtual land could still be more valuable than other pieces of virtual land depending on how many eyeballs they can capture locally. Lastly, how unseizable is virtual land title anyway? What if someone put up something very vulgar or illegal on their Decentraland plot like some gore or porn? Is Decentraland able to take it down? True bearer land title would suggest not. Is that the case right now?

Web3

Unlike Valve, we actually managed to count up to 3 this time. To avoid concept/word inflation, let’s just go with the Chris Dixon definition of Web3. Web1 is read. Web2 is read/write. Web3 is read/write/own. So basically, FCoin invented trans-fee mining which later got popularized in DeFi as yield farming. So Web3 is yield farming. Just kidding, not paradigm shifting enough. Web3 is generalized yield farming of an equity-like instrument where enforcement action by securities regulators will be difficult. Possibly good, possibly not, depending on if you are a regulator or not. Imagine if Uber (or Lyft if you are Chris Dixon) was able to give out tiny bits of Uber/Lyft stock to both the rider and driver for every ride on their platform, without any overhead from paperwork or middlemen and without any overhead of possibly getting into trouble with regulators. Could have been pretty good actually. Good way to build two-sided or multi-sided markets, good way to solve the chicken-egg problem, and good way to acquire customers turned evangelists. Ok, so let’s see how it goes. Still important to be careful as aspiring entrepreneurs start putting Web3 in every pitch deck, just like what happened with the “AI” and “Uber for X” trends.

Conclusion

So in conclusion, all good in crypto land. I remain optimistic about the crypto space in the long run as I always have. Short-term, there’s some work and some cleanup to do. I know some people are going to call me a midwit for post but to them I present without comment:

So be nice to your neighbors, floss, don’t feel some type of way that one of your college friends flipped a buck on NFTs, wagmi except for those who are ngmi, life goes on, crypto goes on, keep building, keep hodling, try to do something good for the world while making sure you’re not dragging all of us to hell with your good intentions, go outside at least once in a while… we seriously need to clean up our own space or at some point theres going to be a systemic blowup and then everyone is going to cry for regulation and then history repeats just like for the mature markets cant believe gerko blocked my dumbass on twitter for telling the truth its ok though he mad cuz bad i can see why dan doesnt use punctuation its kinda nice and pretty fun no offense but current p2e games are not fun at all and thats coming from someone who has played tens of thousands of hours of games you know when people say no offense the next thing they say is always gonna be offensive sorry not sorry whatever happened to artforz cant believe they came up with such a clever grift i mean normally the problem with rug pulls is that once the grifters dump their community gets mad as the price goes down and pitchforks come out but what if they could stealth dump without causing the price to go down or even make it go up while monetizing i mean how did they even come up with that bunch of geniuses if you ask me next level monetization defi 3.0 that would put even larimer to shame on how intricate some of these rube goldberg machines are are you still reading you must be a very curious person good for you so many dudes riding on the coattails of their autist something something pow a fair seignorage system rotate your mother if you want rotate wen tokyo i guess thats never happening always running into crypto people at the gun range lol makes sense they finally coming out with attack on titan final half season can kisagun still owes me money how are you guys still reading this arent you all at ethdenver high out of your minds that coinbase superbowl ad was great francis bacon solomon saith there is no new thing upon the earth so that as plato had an imagination that all knowledge was but remembrance so solomon giveth his sentence that all novelty is but oblivion barry could just drip yield from the closed end funds as a compromise but i guess all that selling pressure might be bad if folks just going to buy up more crypto from it im just here pacing and stream of consciousness wordceling this shit out nietzche said people who think while sitting are nihilists good thing im a pacer mev is like the olympics of mindsports i don’t understand sports i mean theres only so many ways of putting a ball in a hole starcraft wc3 dota are all just way more strategic and way more interesting to watch having gotten this far you probably an obsessive type real meticulous and on the spectrum so just fyi we are hiring at hiring@galois.capital hr gonna kill me