Which Web 3 protocols are most likely to succeed? A VC suggests a common thread

Jhe is in class Internet 3 stack is an evolving canvas of composable protocols, each fully open source and susceptible to competing projects forging their code. The ease of building a similar project in the Web 3 space can make it difficult to decipher which protocols will become more valuable in the long run.

Yet it is not strictly the popularity of a protocol that increases its long-term value, but rather a combination of its popularity and its correctness. While popularity is easy to measure, correctness is more complicated, coming in various forms. After evaluating dozens of protocols, I believe the most desirable form of defense is utility that cannot be easily derived by a competitive project.

Parker McKee is a principal at Pillar VC, where he focuses on crypto and Web 3 investments.

I call this quality the “unbreakable usefulness” of a project. The Unforkable utility reflects the hard-to-replicate value for a protocol user.

To make it easier to recognize unforkable utility, I’ve identified its six most common forms and paired them with contextual examples. Interestingly, all six types fall under the broader umbrella of network effects. I am still developing this framework. Here is my thought in the hope that others can critique or build on the ideas.

The 6 types of utilities that cannot be unplugged:

  1. Protocol collateral/liquidity (capital)
  2. Liquidity of the protocol (content)
  3. Critical mass of network participants (application layer)
  4. Scaled value + critical mass of network participants (security)
  5. Acceptance of assets
  6. Liquidity of assets

Collateral/liquidity Capital

The first type of inforkable utility is collateral and liquidity in the form of capital. By capital, I mean the on-chain assets that contribute to the efficient functioning of a market. For example, the lending/borrowing protocol by Aave Front-end functionality and smart contracts can be forked easily, while project collateral and liquidity are much harder to replicate.

The borrowers’ guarantee on the protocol constitutes one side of the market. Liquidity on the supply side is the other side of the market. Collateral capital and liquidity capital are both impassable, and together they create impassable utility for the user.

At the time of writing, Aave, the most well-known lending-borrowing protocol, had the most collateral/liquidity of all loan protocols with $11 billion in total value locked (TVL). As a result, a user who takes out a loan will theoretically use the best and most efficient market to execute large transactions. The effectiveness of scaled collateral/liquidity serves as an unstoppable utility to the protocol.

Read more: The choppy waters of crypto-liquidity

Liquidity of content

Similar to capital liquidity, a protocol can also see liquidity as content. Similar to Aave, LBRY (Web 3 Youtube) is a two-sided marketplace, but instead of borrowers and lenders, LBRY connects content creators and viewers.

Unlike Aave, however, LBRY’s entrenched state is only found on one side of the market with content creators and their content. A mirror copy of the LBRY protocol and GUI could be created, but the new project should convince content creators to publish their content on the new protocol.

History shows that viewers prefer the platforms with the most content and hence the deep content library acts as the go-to utility. There is also a positive loop at play with more content leading to more creators, who produce even more content. Other examples of Web3 content liquidity are Mirror and Audius.

Critical mass of network participants (application layer)

A famous computer engineer named Bob Metcalfe once assumed that the value of a networked device is proportional to the square of the number of its users. Therefore, the more participants there are on a common network, the more valuable network access is for each user.

The best example of this in Web 3 is a hypothetical decentralized email protocol (please someone build it!!). As the number of participants in this protocol increases, the utility for each user also increases. Once a given network reaches critical mass, even if a progressively better protocol is created, the utility delta between the network with all participants and the protocol without participants is so large that a migration to occur.

In the case of the messaging protocol, the unforkable utility is in the collective group of network participants. Another example would be a decentralized payment network.

Critical mass of network participants (consensus/security layer)

Another type of non-forking utility is network security driven by the value of the network at scale and a critical mass of network consensus participants. Whether it’s a Layer 1 proof-of-work (POW) chain like Bitcoin or a proof-of-stake (POS) chain like Algorand, the network becomes more secure as the value increases due to the increasing cost of performing a 51% attack. Additionally, the more consensus participating users there are on the network, the more complicated it becomes for a user or group of users to execute such an attack.

As Kyle Samani pointed out in his article on capturing L1 value, “More [an L1] that is, the easier it becomes for the next marginal user to justify storing their wealth in that chain. The logical inference of this positive loop (more value leads to more users leading to more value) suggests that there should only be a few high-value, exceptionally secure L1 chains.

Acceptance of assets

Similar to the definition of “currency”, an asset can have unparalleled utility if it is “generally accepted at face value as a mode of payment”. In the crypto space, there are many assets like USDC/USDT/etc. that meet this definition. Their project teams and communities have extended their distribution and acceptance to the point where most people will accept the asset without questioning its value.

For example, if someone receives Solana USDC, it is more helpful to the user if they can find an exchange that will take the asset or a trader that will accept it. This challenge is even more acute for new project tokens. In the case of an asset, entrenched utility can be found in its acceptance by other parties, ecosystems and applications.

Liquidity of assets

The more ecosystems and applications in which an asset is liquid, the more useful that asset becomes. By using the Wormhole Solana-Ethereum Bridge As an example, when a user brings an ETH ERC-20 token to SOL using Wormhole, they are given Wormhole Wrapped ETH (weWETH). weWETH is a native Solana asset that represents ETH on Solana. This new weWETH asset is neat, but a key factor in its usefulness is whether or not there is liquidity for it.

If there is little liquidity for the asset, a user is limited in how they can use it. When launching a new asset like weWETH, building liquidity is key in the early days, even if it involves partnerships and incentive rewards. For an asset, the entrenched utility lies in its depth of liquidity and the number of places where this deep liquidity can be found.

I hope the examples above prove that fully open Web 3 protocols can achieve significant long-term value despite frequent fork attempts. Unforkable utility is hard to achieve, but has enormous potential.

Nevertheless, soft forms of defense like community and brand that have often proven effective in generating value are also important to highlight. There are many Web 2 and 3 examples of this phenomenon. I think over the next few years we will see the best projects use these soft forms of defense combined with the more mechanistic forms of defense above to create extremely valuable protocols.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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