DePINs are three-sided markets — an evaluation guide for investors to access decentralized physical infrastructure networks
Decentralized physical infrastructure networks (DePINs) build different types of infrastructure serving markets ranging from energy over mobility to weather. They are a new vertical in the web3 that holds the promise of driving real-world demand by entering and extending established markets, hence solving one of the web3’s main problems and enabling in this way a new wave of crypto adoption.
Recently I got asked how I would evaluate a DePIN project.
Given the potential of DePINs, I believe this question is quite relevant. In what follows, I will explain my answer, which at its core is based on the observation that DePINs are actually three-sided markets and that web3 offers novel tools for incentivizing and managing such large and complex systems that must be carefully used and implemented by system designers.
Introduction to 3-sided markets
The concept of a three-sided market to explain the special characteristics of web3 systems was introduced earlier and is independent of DePIN [1].
This three-sided market framework consists of a supply side, a demand side and a service side, as shown in the figure below.
In DePIN systems, the supply side provides the infrastructure that is used by users via a service provided by a platform.
Different players can sit on each side of this triangle: In the case of onocoy [2], for example, the supply side makes RTK data streams from an infrastructure network of so-called base stations available through a platform maintained by a validation community to customers who want to improve their positioning accuracy achieved with GNSS (e.g., GPS).
The special nature of DePIN can result in each of these three sides being very different.
Supply side
Pioneered by Helium that successfully demonstrated the possibility of building a global and dense infrastructure network [3] using success mechanisms from web3 (such as token incentives and decentralized governance, see below), the supply side is where most DePIN projects start from/ focus on.
The type of decentralized infrastructure that is build as a supply can vary greatly depending on the DePIN System. For a comprehensive overview, please consult who loves burrito?.
In general, a DePIN system can be defined as any system that incentivizes the placement of physical hardware devices as a decentralized infrastructure with blockchain-based cyrptoeconomic incentives in the form of tokens [4]. This fundamentally changes the way how infrastructure networks are created when compared to the past [4].
The main difference in which these physical hardware devices and their placement differ are the openness of the utilized hardware system, the placing rules of the hardware devices [4] and their cost [5] :
- Hardware ecosystem: Some projects use a closed/licensed hardware ecosystem (e.g. Helium or GEODNET), others an open hardware ecosystem (e.g. onocoy or WiHi). While the former approach offers more control over network deployment and thus simplifies platform construction, the latter promises faster scaling because it can rely on existing supply chains and an installed base of infrastructure devices. For example, for the RTK base stations needed for onocoy, it is estimated that 10–30 thousand stations are already out there ready to be connected.
- Placement of devices: The other attribute where the infrastructure networks can vary is if the single devices of the network are required to have a spacing in between them. For instance, an oversupply of devices in a particular region is not desired for systems such as Helium, onocoy, or WiHi, whereas systems such as Render Network which builds a GPU infrastructure do not require a spacing between the devices.
- Device affordability: The initial investment in major equipment or supplies to start operations. Lower prices usually simplify the process of bootstrapping. In particular, low barriers to entry facilitate better crowdsourcing.
Demand side
Following the classic web3 approach of building a large supply base first, the demand side is often neglected in DePIN systems at the beginning.
Nevertheless, by tapping into real world, real industries, and real needs, DePIN systems, unlike other Web3 verticals, promise to generate early revenue because they can serve the requirements of an existing market that they tap into and potentially expand.
In my opinion, this possibility of (early) demand is the biggest advantage of DePIN systems compared to other web3 verticals.
Due to the diversity of infrastructures currently built and markets potentially served, there is no known general classification of the demand side for DePIN systems. In general, it can be said that existing markets are mostly web3 agnostic and therefore often risk averse when it comes to web3 solutions.
Service side
The service side consists of i) the platform that connects the supply and demand sides, and ii) those who build, maintain, and support the platform. There are various approaches to this, differing mainly in the degree of decentralization and the use of cryptoeconomic primitives.
Different layouts can be found here for the different components of the service side [4][7]:
- Distributed ledger: Some systems utilize an own distribute ledger as Helium did in the past. For instance, GEODNET is planning to utilize an own distributed ledger. Nevertheless, the majority of DePIN systems avoid the complexity of maintaining an own distributed ledger and use a L1 instead to which they usually deploy smart contracts. Solana and Polygon are two general-purpose L1 that are very suitable for DePIN [6]. IoTeX and peaq are two L1s that provide great value to DePIN systems by having a specific focus on them.
- Middleware: The middleware consists, amongst other, of the the access to the data, computation and routing of information in the system that is not happening on-chain. Various degree of openness and decentralization can exist here. From self-hosting these services on private servers over using cloud services of larger cooperations to applying decentralized solutions (e.g., routing: w3bstream, Streamr; storage: filecoin, siacoin)
- Token(omics) simple one token models to complex multi-token setups (see below) can be utilized. Token distribution and Token design vary greatly among the systems, e.g. a system can pre-mine tokens or condition their creation with performing actions in the system, as often observed in DePIN (e.g. incentivizing the placement of hardware).
- Governance: A great variety in the governance of the overall system, stakeholder-participation and the decentralization of its construction can be observed in DePIN [4], ranging from centralized core-teams to self-organized communities that implement and maintain a DePIN.
Inherent challenges of 3-sided markets
Three main challenges can be identified when instantiating a DePIN system:
- Chicken-egg: Before clients are onboarded in a DePIN system (demand side), a supply has to exist. But with no clients, in particular in times of a bear market, it is difficult to convince actors to invest into the placement of infrastructure (supply side), resp. investors to support a platform development (service side). Nevertheless, all in all, I think one still needs to start from the supply-side, but has the demand-side rigorously evaluated right from the start.
- Different nature of the three sides: The actors sitting on each side of the three sided market place might differ greatly. For instance, on the supply side one can have a veteran crypto whale who searches for another investment opportunity, whereas on the demand side one might find a conservative and large international cooperation or governmental organization that did not have had any exposure to crypto yet, whereas on the service side you might rely on expert groups from both worlds, the progressive web3 and the more risk-averse industry where a DePIN is trying to go in (e.g. for instance, in WiHi data stream validation has to be performed by weather and climate experts, whereas the incentive design for this to be facilitated is performed by people from cryptoeconomics such as using a proof-of-stake type consensus mechanism on data stream quality).
In addition, there may be more than one community on each of the sides having different needs and requirements. It is therefore a challenge to coordinate the different sides and communities so that they work together harmoniously and synergies are used. - Complexity: Due to its size (usually building large-scale networks) and its variety of involved actors on the three sides of its market, constructing a DePIN is hard due to the interdependencies among the various system components. In particular, DePINs are complex systems that can neither be controlled nor steered like a coffee machine [8], but require different governance and control mechanisms that facilitate mechanisms such as self-organization, collective intelligence or digital democracy [9].
Successful web3 mechanisms to instantiate 3-sided markets
Among other, DePIN system utilize two success mechanisms from web3 to instantiate decentralizes infrastructures. These are token incentives and community/ DAO mechanisms.
Token incentives
Blockchain-based tokens are a powerful tool for the self-organization of a complex system by co-ordinating human action (rational and non-rational actors) towards goals set by a community [10],[11] and thus can be utilized for improving systems performance or contribute to its establishment in the first place.
For instance, using tokens as incentives for humans to share data can improve the quality of collected information when compared to scenarios where no tokens are utilized [12]. Or, using tokens as an incentive to place physical infrastructure can result in the creation of a global and dense DePIN network as Helium demonstrated [3].
In general, token incentives in large, global, and interconnected systems are a potential feedback tool for facilitating self-organization that typically trumps top-down control in managing complex systems [9]. In particular, using more than one token as a tool, targeting different stakeholders/community members, has been shown to further improve the performance of a system [12]. In fact, such a multi-dimensional token system comes close to what we observe in natural systems: Multi-dimensional real-time feedback and coordination system are the success principles that steer and manage the human body, Forrest ecosystems or flocks of birds [13].
Providing value to the token is important to make such incentive systems work [14]. Several mechanisms exist to give a token value [7]. One of these mechanism which often is utilized in DePIN is burn-and-mint (BM) which is a supply-management mechanism that ensures that a native cryptocurrency has value [15]: The two-token model is very feasible for DePIN systems, because, following the multi-dimensional token model approach, it allows to crowdsource the construction of an infrastructure network with a tradable and value-appreciating token [15] (targeting the supply and service side of a network by motivating actors to contribute), while having in fiat terms a stable system-internal non-tradeable (hence not a stable coin!) token that targets the risk-averse/ traditional markets in which DePINs are positioned (demand side). Thus using two tokens addressing different stakeholders in the ecosystem.
In some DePIN systems, over time, token models are often extended with either further tokens targeting sub-markets (e.g. IOT or Mobile in Helium) or improving functionality/ increasing further value alignment (e.g. using NFTs or other type of tokens), hence naturally applying the efficient coordination mechanism of multi-dimensional token models.
Community & (DA)Organization
Tokenomics such as burn-and-mint are only one aspect of the cryptoeconomic design of a DePIN system. Another one is the governance/ organization of the system [16].
Since managing and regulating complex systems in a hierarchical, top-down manner is challenging and often leads to lower overall system sustainability and resilience [17], bottom-up and decentralized mechanisms such as collective intelligence, digital democracy, and self-organization have been shown to more effectively manage such complex systems [18]. They are currently explored by policy makers (e.g. city of Aarau [19]) and also in companies, ranging form self-organized teams within a hierarchy [20][21] to fully decentralized organizations in the form of TEAL organizations [22],[23] .
Decentralized autonomous organizations (DAOs) are blockchain-based organizations that accelerate this observed decentralization trend in society. DAOs combine collective intelligence, digital democracy and self-organization [24], facilitating the shift from hierarchical organizations to democratic and distributed systems [25].
Amongst other, they use bottom-up mechanisms such as Improvement Proposals, quadratic voting and idea markets.
Community is the driving force behind web3 in general and DePIN in particular. A community is made of individuals having relationships with each other and sharing a common identity. The individuals in these communities can have different goals for their participation, e.g., return on investment, salaries or product design.
Communities can sit on all the three sides of a DePIN market and will facilitate its success: On the supply side you could have a community maintaining the infrastructure, on the service side you could have a community facilitating the platform (e.g. a validator community that uses a proof-of-work or proof-of-stake algorithm to guarantee platform security) and on the demand side you could have a community being interested in the infrastructure (e.g., in the GNSS industry, there are different agricultural communities that can be involved, or when it comes to weather, different communities use weather data streams to make predictions (e.g., hobbyists, scientists, farmers)).
From my experience though, the community approach by default is more suitable for the supply, then service and than demand side. In particular, on the demand side, if going into an existing market, one is most likely to be confronted with rational market players that are willing to buy the product if it fulfills their needs, independent if they have a feeling of belonging to a community. This might be different in cases, where no market exists which could be attempted to be build by following a community approach. In order to meaningfully include communities in the overall DePIN system and not to make them reject the constructed technology it is important to consider the values of community members [26]. In particular, value conflicts need to be carefully resolved.
The DAO is what happens when these community members start to collaborate and organize themselves towards a shared vision that satisfies their personal goals. In an ideal scenario, “a sense of community brings trust and wellbeing which enable better organisation. And effective organisation can enable value flows that sustain community.” [27] In this way, communities and DAOs can form natural symbioses, which result in powerful anti-fragile organizations capable of motivating individuals and communities to accomplish the extraordinary [28], like setting up and managing complex systems such as global, dense and decentralized physical infrastructure networks [3].
Evaluation guide for DePIN marketplaces
So, now having some background on DePIN systems, their challenges and success mechanisms, how do we evaluate a concrete DePIN system?
My observation is that DePIN systems are a blend of web2/ traditional industries (e.g. business development, IT infrastructures) and novel web3 concepts (e.g. decentralized consensus, token incentives, communities).
Hence, (traditional) investors can start evaluating DePIN systems starting from their current knowledge of existing best practices and then move (slowly) into evaluating the aspects that are novel when it comes to DePIN/ web3 systems (and where best-practices may still need to emerge).
- They can start from evaluating the core team (experience, domain knowledge, ability to execute, technical capabilities, understanding of the three sides of the market),
- Then analyze the demand side of the three-sided market (Business model, problem-solution fit, product-market fit, early adopters, etc.)
- And then slowly move into the novel parts of DePIN systems. In the service/ platform side traditional evaluation criteria (e.g. technical feasibility) are mixed with DePIN-specific ones (e.g. viability of incentive Design, feasibility of a blockchain-solution, utility of consensus).
- On the supply side, one can check the scalability of the miner build-up, viability of incentive design (e.g., crowding-out of intrinsic motivation or interaction effects [12]), the hardware ecosystem [4], supply chains, return on investment [5], etc.
- Finally, investors need to evaluate if the right values are incorporated in the DePIN system in order to attract and motivate contributors to join the community and facilitate the network effects.
A stakeholder-oriented value-sensitive design analysis as introduced in one of our contributions [29] has shown to be feasible to analyze this value-orientation, e.g. as performed in finance4 [13], onocoy [2] or WiHi. In this context, audience reachability is of particular importance [5].
Also the community (including the core team) and the three sided market need to be organized effectively, such that the system gets functional. Here, investors have to evaluate if a project is able to use the network effects/ collective intelligence of a large and diverse community and facilitate their effectiveness via, for instance, self-organization. Some governance criteria have been introduced in our recent work on a taxonomy for DePIN systems [4] and our democracy-by-design paper [18].
Outlook
I have provided some general background and considerations for evaluating a DePIN system that take into account the special nature of these systems as complex three-sided markets.
I hope you found this elaboration useful. Please let me know! ❤
In following blog posts I will go into some of these aspects in greater detail. Let me know if something is of particular interest to you and I will try to cover it!
Also ping me if you have a question, feedback or want to collaborate :)
