Yesterday, we saw a very neat crypto business model through Axie Infinity and we understood how value was captured by various stakeholders. Today we look at generalizing that thinking to understand how value can be captured in different layers of the web3 stack. This would further help understand some non-obvious crypto-native use cases as and when we encounter them. Let’s get right into it!
What’s in the stack?
Blockchains are computers that can make commitments. The bitcoin network for example makes a number of commitments including the fact that there will only ever be 21 million bitcoins.
Traditional computers are ultimately controlled by people, either directly in the case of personal computers or indirectly through organizations. Blockchains invert this power relationship, putting the code in charge
-Chris Dixon
If blockchains are computers, then they need some kind of hardware to operate on. This would be the hardware layer, let’s call it layer 0. This includes miners and validators. As we have seen, blockchains are also ecosystems. This means that there is a need for a peer to peer communication protocol that lets the network reach a consensus on its state at a given point of time. State could mean anything from the amount of bitcoin / NFTs or any other kind of assets users might hold. This is the consensus layer which we will call layer 1. Once there is a consensus on what the state of the system is, there comes a need to compute on top of it in an agreeable way for various purposes. We can think of this compute layer as layer 1.5 and together these three layers form the blockchain computer. So developers can build their applications and run programs on this computer.
The programs themselves that make the commitment and automatically execute, control or document the relevant terms of the ‘contract’ are the smart contracts forming layer 2 of this stack. Finally layer 3 consists of the user interface that brings these programs to life for regular users and consists of wallets and other kinds of code running on web browsers.
Layers 0 and 3 are on the periphery of the whole scene and we will keep them aside for now as we focus on the heart of this stack - layers 1 and 2. This seems to be where most of the value is captured. Well, how exactly is this value captured? enter multi-sided platforms.
Multi-sided platforms
A multi-sided platform is exactly what it sounds like - a platform that generates value through the interaction between different kinds of participants of a network. Like Uber is a multi-sided platform that connects drivers and riders. Let’s dive into how value can be captured in layer 1.
Let’s say someone comes up with a cool idea / protocol like Axie Infinity with a team of developers and maybe support from investors to generate some initial token value (Axies, SLPs, AXS tokens etc.). This then incentivizes miners and validators to allocate computational resources to provide this network with the necessary security and functionality. This further attracts other developers to build useful applications on top of this protocol that deliver some kind of utility to end users. Based on the meaningfulness of that utility, we now have a community that reinforces the original vision, effectively creating this positive feedback loop. Notice how the protocol itself is a multi-sided platform with five sides - the founding team, the investors, miners, 3rd party developers and the end users.
Given that everything we saw above is open-sourced, it raises the obvious question of how defensible this models is. Like there’s no specific moat like intellectual property or control over resources as seen in traditional businesses. This brings us to network effects - the phenomenon of the network being more useful the more users it has. WhatsApp for instance is an example of a same-side network effect. What’s at play here is a cross-side network effect as seen in the case of Uber - the more drivers there are the more valuable the network becomes to its riders. Each of the five sides of this network exhibit a cross-side network effect with one another in addition to the same side network effects within developers (benefiting from other existing smart contracts in the existing network, say Ethereum) and end users.
This creates a strong ecosystem that is built around these tokens within the internet which is hard to replicate.
Moving on to layer 2 which is the smart contract layer has the following predominant business model:
There is a supply side which offers some kind of service to the demand side which in return pays for that service. A large share of that payment goes to the service providers with a small portion of it going to the governance token holders who could potentially be the founding team / investors who provided the initial capital to build said smart contract. Maker, Compound and Uniswap are all examples of this kind of value capture.
What are we trying out today?
After the original Bitcoin and Ethereum whitepapers, the Maker DAO whitepaper is often recommended for reading and is considered to be one of the most innovative ideas of web3. So today we will be checking out the Maker DAO whitepaper. This is the perfect example of a layer 2 business model. Maker is basically a protocol that facilitates collateral-backed loans without an intermediary. It is a five-sided platform between the lenders, borrowers, a stablecoin called Dai, Keepers (network guardians) and the Maker governance token holders. These governance token holders can also be thought of as vectors to bring in external financial capital into the system. This has been a lot to precess to put this together and given that we are still crypto noobs, we’d love to hear your thoughts on today’s piece. See you at the After Party!