Playing the Game: The Nature of Competition among Blockchain Networks
This presentation was created in April 2018 and details how competition amongst blockchain protocols may shape the way projects deploy resources to acquire social, human, and financial capital.
stages of defining, building, and implementing protocols, but this time, billions of dollars of value are at stake at the protocol layer instead of the application layer THE INTERNET Innovation in Information Transfer Network: ISPs Killer App: Email Application Universe: Streaming video and music, data sharing, cloud computing Protocols: TCP/IP, HTTP, DNS, FTP THE BLOCKCHAIN Innovation in Value Transfer Network: Miners, Nodes, Staking, etc. Killer App: Bitcoin Application Universe: Smart contracts, distributed computing, tokenization Protocols: Bitcoin, Ethereum, IPFS, ZCash, Blockstack @Melt_Dem 5
independent applications that have VC $ or users 100s Dozens ? ? ”Ecosystem” # of funds dedicated to ecosystem Dozens 2-3 1 1 Network Cost Annual ”mining” reward or cost to maintain network $6B $120M $0 $0 Nodes in Network # public nodes in network 10K 18K ? 156 Node Concentration # entities with >50% of voting power 3 3 1 1 Distribution of Tokens % supply held by top 100 accounts 19% 35% 97% 62% Development # client codebases that account for >90% of nodes 1 2 1 1 MEASURE METRIC Source: arewedecentralizedyet.com, OnChainFX, BitInfoCharts.com, Blockdaemon research, my back of the envelope math @Melt_Dem 6
MANAGE Speculation Utilization Specification A BRIEF ANALYSIS OF POPULAR CRYPTOASSETS (ASSET | LIFESPAN | MARKETCAP ON JULY 5 2018) BITCOIN | 9.5 YEARS | $112B ETHEREUM | 2.9 YEARS | $47B RIPPLE ($XRP token) | 4.9 YEARS | $19B ZCASH | 1.7 YEARS | $0.8B TRON | 0.8 YEARS | $2.5B EOS | 1.0 YEARS | $7.9B Source: OnChainFX, personal assessment of lifecycle state @Melt_Dem 7
DISTRIBUTION Projects are focusing on product creation and distribution as the end of a process, when really it is just the beginning of a years, if not decades, long obligation to manage the lifecycle of these assets NASCENT (NON EXISTENT) LIFECYCLE MANAGEMENT PRACTICES Most cryptoassets are traded on pure speculation, and have little or no emergent utility. Many projects have not yet launched their networks. Limited information is available about how projects intend to manage assets once networks are live and assets freely tradeable. NO PROJECT HAS REACHED “END OF LIFE” YET Given the fundamental uncoupling of assets from the protocols and projects which they’re supposed to be associated with, many tokens with no value keep trading in perpetuity, with no clear plans as to how these assets get wound down or removed from circulation.
Most networks focus on controlling supply, as this is more squarely in control of a project § Supply is subject to artificial scarcity – projects will limit tokens issued and change inflation rate (slope) to shift demand from S to S1 § Demand is largely speculative today, and projects focus on manufacturing added demand from D to D1 by funding “network development” or paying projects to use tokens § Timelines matter - specificity in the use case of a network may limit short term demand but increase long term demand Economics 101 Manufactured Demand & Artificial Scarcity Source: Machinations of my brain at 5 am, Econ 101 classes D1 S S1 @Melt_Dem 9 Understanding twin engines of supply and demand is critical to engineering incentives
NETWORKS DEVELOP? § Initially driven by financial incentives including speculative demand and artificial scarcity § Some networks are driven by mission and vision, but this is rare HOW DO NETWORKS GROW § Continued management of financial incentives § Development of real use cases and applications HOW DO NETWORKS MAINTAIN AND EXTEND USAGE § Traditional business practices like customer experience, design, and marketing § Increasing network value due to variety of applications uniquely and specifically enabled
SCORE BEWARE THE ROBBER § Strategically choose position to increase access to resources § Beware of neighboring projects who could block access to resources or impede expansion § If you don’t have the resources you need, collude. Form alliances or partnerships. § Know what winning means and maximize routes to a “win” § Understand the resources you’ll need now and later to win § Compromise short term wins to ensure long term success § Even when no one is keeping score, everyone is keeping score § Understand risks that could keep you from playing the game and mitigate exposure § Minimize conflict with others to reduce the risk of getting “robbed” § Don’t engage in. battles you don’t need to fight @Melt_Dem 14
OF NEED § Money (both VC and ICO) § Tokens § Ability to preserve capital § Notable participants / social signal § Reputation & credibility § Press coverage & mentions § Agility & speed § Talent and skill § Execution capability low low medium high medium medium medium high high short term long term long term long term long term short term short term long term long term Most project evolve rapidly from concept to implementation, which may shift priorities @Melt_Dem 15
XRP BCH LTC EOS ADA XLM NEO XMR IOTA DASH USDT NEM TRON ETC BNB VEN QTUM XVG Billions Market Cap by Network Data retrieved 4/4/18 Source: Coinmarketcap.com 80% of all market value Why Clear Goals Matter § If the power law holds true, projects should aim to avoid the “long tail” in order to capture the distribution of value creation § Natural selection implies that the most widely accepted, supported, and adopted chains will survive while weaker ones will die out § Protocols want to be ”the one” that wins the entire category for a specific type of utility or application § As the dynamics of the market landscape change, network growth and expansion will require frequent adjustments to the winning strategy @Melt_Dem 16
STRATEGY § Price sensitivity & volatility § Regulatory overhang § Tax burden § Notable participants / social signal § Reputational risk § Stay relevant § Unable to recruit top talent § Lack of diversity & perspective in team § Inability to execute & deliver § Long term capital management § Hire great lawyers! Call them often The goal of risk management is to reduce interruptions to your ability to play the game § Set aside an allocation, move abroad § Incentivize / promote signaling § Build world class PR team § Continue to manufacture news @Melt_Dem 17 § Hire on fit with mission and vision § Engage community for feedback § Tie pay and bonus to performance
$12 Funds Raised Value of Funds at Peak LC: Today LC: Peak MC: Today MC: Peak HC: Today HC: Peak Billions Modeling Balance Sheet Strength Data includes ICOs April – Sept 2017 Source: CoinDesk ICO tracker, basic analysis ETH: $1,000 BTC: $15,000 Low Cash Cash: 10% BTC: 30% ETH: 60% Mid Cash Cash: 20% BTC: 40% ETH: 40% High Cash Cash: 50% BTC: 25% ETH: 25% An Excess of Financial Capital The risks of holding too much cash are numerous, and include: § Opportunity cost of capital § Agency cost (engage in empire building) § Inadequate control of spending & internal conflict In traditional corporate finance, an excess of cash can be utilized in only a few ways: - Dividend: give money to shareholders - Buybacks: reduce supply - Invest: invest in networking & applications - Mergers & Acquisition: reduce competition
A DIVIDEND § Illogical to issue a cash dividend given token holders have minimal rights TOKEN BUYBACKS § Unclear how token buybacks would impact market other than potential temporary price inflation. Since supply is native to the protocol, risk would transfer from holder to project. MERGERS & ACQUISITIONS § Given that social and human capital are the rarest resources, M&A seems to be the most effective way to deploy capital INVEST § Strategies for investment are limited, but many suffer from principal – agent conflicts as well as adverse selection bias where low quality projects seek to tap into “easy” funding
§ Accrue value to token holders § Incentivize developers to join project § Incentivize contribution of compute resources § Reduce or subsidize network cost to spread edges § Curate demand for tokens § Incentivize entrepreneurs § Create use case specificity APPLICATION NETWORK PROTOCOL Competitive Strategies Strategies should focus on increasing network value and developing competitive advantage § Investments – High risk venture investing likely a poor strategy to drive demand at the app layer § Merger – Two or more protocols can combine efforts to consolidate demand § Acquisition – One protocol can acquire another, either friendly or hostile § Assassination – Kill a protocol through a coordinated attack. We have yet to see a protocol die – what happens to tokens in this case?
Examples Investing in “the ecosystem” theoretically helps: § Curate Demand for Tokens: By funding projects to encourage them to build on your protocol § Incentivize Developers: Many ecosystem funds include allocations for developers to build tools like SDKs and tutorials or grants for R&D § Create Use Case Specificity: This is the most interesting opportunity – incentivizing experimentation with new use cases that could drive competitive advantage and network demand § Buy Social Capital & Credibility: Given the proliferation of ecosystem funds, it’s arguable how much social capital a fund buys at this point Source: Nasdaq Newswire, BTC Magazine, Medium
Scenario Conducting a merger of two network, or as I like to call it, a spoon theoretically would: § Aggregate Demand for Tokens: Instead of splitting activity over two networks, concentrate on one. Too many architectures dilute value. § Incentivize Network Growth: Compute resources and oracles now support one network instead of building across two, simplifies growth § Accrue Value to Token Holders: Consolidate supply and demand, easier to manage price § Consolidate Social & Human Capital: Consolidate engineering talent to focus on one architecture, and own the narrative around prediction markets § Market cap: $270M § Current Supply: 11M circulating at $24 § Total Supply: 11M Source: OnchainFX, back of the envelope math § Market cap: $67M § Current Supply: 1.1M circulating at $60 § Total Supply: 10M GNOGUR Ethereum-based decentralized prediction market § Market cap: $350M § Current Supply: 11M + 3.3M circulating at $24+ § Total Supply: 21M
Source: OnchainFX, back of the envelope math Conducting a network acquisition helps” § Preserve Value for Token Holders: In friendly cases, it may benefit holders of the acquired network’s token to get liquidated for a new token. In hostile cases, value likely isn’t a concern. § Bootstrap Network Growth: Acquiring, younger network can leverage existing network infrastructure from older acquisition target § Consolidate Protocol Engineering: The core team behind Cardano also built much of Ethereum Classic - maintaining two projects is unnecessary § Focus Ecosystem on One Project: Since both projects focus on similar functionality and use case specificity, consolidating efforts is beneficial § Market cap: $4B § 24 hour TX vol: $1B § Actively traded, active community Source: OnchainFX, back of the envelope math § Market cap: $1.4B § 24 hour TX vol: $21M § Thinly traded, largely inactive community § Cardano “acquires” Ethereum Classic network § ETC token holders either receive Cardano in some fixed ratio or are liquidated using cash
In an assassination attempt, one network will expend nearly all of its resources to kill a competing network § Hijack Network: The most successful attack vector is typically encouraging network compute resources to only mine or support one chain § Drive Competitor Value to Zero: There will be blood in the streets. Done in conjunction with a fork, this might be avoided. § Acquire Social & Human Capital Where Possible: Due to short term reputational damaging, there may be short term recruiting and narrative issues § Curate the Ecosystem: An assassination is a great way to weed out the types of users you don’t want § BUT BEWARE THE ROBBER
WAY TOO MUCH FINANCIAL CAPITAL § It’s poorly managed or completely unmanaged in most cases, but it’s waiting for opportunity THE BATTLE IS ON FOR SOCIAL AND HUMAN CAPITAL § There is a fierce competition for attention and talent. Projects who can sustain an inflow of interest and stay relevant will accrue capital more quickly. POWER LAWS DICTATE WINNERS WILL EMERGE § Investors are currently adopting a “spray and pray” strategy when it comes to protocols and tokens. In the future, activist investors will actively collude to make winners. NO STRATEGIES ARE OFF THE TABLE § To date, few novel approaches have been tried. In the coming months and years, no strategy is too crazy to contemplate as networks compete for demand. Get crazier. Be bolder.
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