Diversity and Multicellular Organisms
Previously in this series ‘On the Origin of Blockchains’, I have explained that the notion of a niche within the natural world is a useful reference point to help understand how blockchain networks can evolve to colonise financial, technological and commercial niches in the digital world.
Bitcoin is establishing itself in the money niche. Smart contract platforms, with their added complexity, are opening up new niches. In this sixth piece in the series, I will investigate how mutated blockchain elements (genes) and cryptoassets (metabolites) in “second layer” protocols are improving the fitness of networks (species) and expanding their reach.
Second layer protocols are exploding with complexity, bringing with them an exciting wave of innovation.
The appearance of “second layer” protocols has resulted in specialisation providing an ability for decentralised networks to colonise new fundamental niches.
The compartmentalisation provided by organelles is what allows eukaryotic cells to function efficiently, and with such diverse function (think of all the different cell types within the human body). Many of their most important roles involve metabolism, supporting health and growth. Similarly, second layer protocols drive functionality and generate their own secondary metabolites in the form of cryptoassets.
The natural world provides clues as to the types of characteristics that second layer protocols can imbue upon their base layer which will accrue significant value.
- Stable coins: Being able to convert value from metabolites that have a highly volatile market price into metabolites with more stable value for long term storage.
- Governance protocols: Responsiveness to threats and challenges to the environment with the ability to adapt should a quorum be reached throughout all network participants.
- Decentralised exchanges: The ability to exchange secondary metabolites between individuals of the same species to access organelle functionality without necessarily contributing to the network.
- Decentralised oracles: A way to monitor the external environment and have smart contracts react to signals, events and data from the real world.
- Scaling solutions: Modifying the potential output of the network so that a species can increase the carrying capacity, throughput and latency of processing transactions in order to enable colonisation of new niches.
I shall now dig a little deeper into a few of these examples to describe why they may be so important to the base layer organisms, and ultimately the success of their decentralised networks.
Decentralised Exchanges - Provisioning Metabolite Exchange
This effectively allows members of the same species to swap cryptoassets. Circumstances will arise where network participants have an abundance of cryptoassets surplus to their requirements. Second layer protocols have emerged that provide the ability to “trade” metabolites between network participants with several types available; order book models, automated market making models and Dutch auctions — each with their own incentive designs.
This allows access to metabolites that ordinarily would only be awarded for contributing work towards the network. By providing organisms this ability to rapidly, and in a decentralised fashion, transfer metabolites between one another, it makes that species more adaptable, better able to colonise niches and therefore more likely to prosper.
Stablecoins - Creating Price Stable Cryptoassets
“Metabolites” can be pegged to real world assets such as the US Dollar. These allow network participants to transact, while insulating them from volatility. Stablecoins are unlike conventional cryptoassets which suffer from extraordinary volatility. Usually cryptoassets have a known monetary policy, such as a limited supply or fixed schedule. Instead, stablecoins are disbursed based on market conditions and economics, using intricate incentive mechanisms.
Stablecoins can be backed by collateral (e.g. ETH) and aim to safeguard investors from a crash in the markets; a form of capital preservation. Stablecoins are poised to fulfil the original promise of cryptocurrencies by becoming a medium of exchange and a unit of account.
This is evidence that novel decentralised instruments are emerging to enable new types of business and enterprise.
Decentralised Oracles - Responding to the External Environment
Organisms need a way to monitor events or data from the real world. A well-recognised problem facing smart contract-enabled blockchains is the “oracle problem” — how to receive information from the real world and act on it. Solutions are emerging to tackle this, including prediction markets, where the crowd reports the outcome of an event to resolve all bets that were predicated on it. Each solution has a unique incentive design.
Organisms have the ability to colonise completely new fundamental niches if they can receive signals from the environment. They can also detect changes in the environment that may challenge the network and anticipate or respond to those changes in order to increase survivability.
Decentralised oracles allow a species to respond to opportunities and adapt to challenges in the environment.
Scaling Solutions - Improving Baseline Characteristics
Providing mechanisms for adaptation allow the host organism to better realise fundamental niches. For example, base layer protocols may have limitations as to how many transactions they can incorporate into their blockchains and this can perturb the growth of the network. Altering the blockchain elements in the base layer to solve this could compromise decentralisation.
With second layer solutions, improvements to scalability can be achieved that improve capacity, throughput and latency of the network..
Therefore, second layer protocols (organelles) can increase the output and capacity of an organism, which will increase a network’s ability to transact in novel and interesting ways.
Emergence of Multicellular Organisms
We are witnessing the emergence of multicellular organisms where many network participants cooperate together for a greater purpose. For example, a decentralised exchange, which is composed of various groups of stakeholders that include:
- Participants posting orders on the buy or sell side (order book).
- Participants executing market orders at spot (trading activity).
The DEX is a fully autonomous decentralised instrument. Another example may be a prediction market where network participants can bet on the outcome of events such as sports matches or political votes.
Network participants of second layer “organelles” are incentivised to coordinate their activities, creating decentralised instruments, markets and much more.
In the case of a decentralised exchange, market makers could receive a liquidity reward that is proportional to the protocol fees generated from their orders, as well as their stake of secondary metabolites. In the case of a prediction market, reporters settle the outcome of a particular event for which there was a market and are awarded according to the number of secondary metabolites they have staked.
Informing ID Theory’s Investment Themes
Those species with organelles that improve general fitness (e.g. scaling) or the ability to colonise new niches (e.g. prediction markets) are more likely to achieve greater network effects.
ID Theory analyse and test the incentive mechanisms of similar “organelle” types to determine best in class.
If an organelle exists within a base protocol that is poorly adapted to its niche, then no matter how good the organelle is, it is unlikely to prosper as well as a potentially worse organelle housed within a better base protocol.
Those species that have the best array of organelles are likely to be the most adaptive and therefore colonise myriad niches.
Continuing ‘On the Origin of Blockchains’
Having published the first six parts of ‘On the Origin of Blockchains’, it is worth taking a moment to reflect on what has been covered so far.
The natural world provides many examples of species evolving to colonise fundamental niches as their genetic makeup has mutated. By its nature, open source software evolves into networks that are more decentralised and resilient in a way that mirrors biological evolution. Therefore, we can draw clear parallels between the evolution of biological systems and artificial ones, in particular open source blockchain protocols and networks.
Blockchain elements, which are analogous to genes, become crucially important in the process of evolution that makes various blockchain networks fitter and more capable of colonising specific fundamental niches. Bitcoin’s niche is money and, more specifically, the store of value niche within it. Smart contract platforms have added complexity to the DNA of protocols and opened up more niches for colonisation. This is an evolving and exciting area that we are very much in the midst of.
In future parts of this series, I will delve deeper into this ‘Cambrian Explosion’ of blockchain life and the exciting industry trends that underpin it.
ID Theory may hold positions in some of the assets discussed in this post. This post is strictly for informational and educational purposes only and does not in any way constitute an offer or solicitation of an offer to buy or sell any investment or cryptoassets discussed herein. Always perform your own research and conduct independent due diligence prior to making any investment decisions.