by Daniel Liebau, Chief Investment Officer of the Modular Blockchain Fund
The buy-anything approach to picking blockchains, either to build on or invest in, will not survive the new market reality. As the tide of liquidity went out over the past few months, it became clearer that users and investors must conduct a more thorough analysis of blockchain platforms to distinguish winners from losers.
We are off to a great start: Will Cong, Professor at Cornell University, and his co-authors have explained the impossibility trilemma of decentralization, consensus and scalability. And researchers, including Weiyi Zhao at Tsinghua University, empirically investigated what drove token prices in a separate paper.
But there is something more fundamental to the analysis: we need to consider sustainability characteristics. These characteristics will determine which platforms succeed on their path to broad adoption. The current high correlations between token prices of sustainable and not-so-sustainable platforms suggest that market participants do not yet fully price in the importance of sustainability.
Sustainability will drive adoption
A blockchain is not a firm, so we must depart from corporate analysis approaches and develop crypto-native frameworks to assess its sustainability. Previously, I shared how technology, mechanism design and community are vital components to frame our analysis. Today, I expand on this idea by discussing several examples. The basic premise here is that, in the future, consumers will only use a blockchain if it is stable, fair and provides a cost-effective process for transaction settlement. This is true regardless of the use case, whether it is decentralized finance, NFTs or the Metaverse.
Solana has quickly established a loyal following among investors and developers thanks to its high transaction throughput – up to 65,000 transactions per second. But Solana has also suffered multiple severe outages. These outages are a genuine concern. Imagine the consequences for users of a DeFi options vault if an outage occurs on the options expiry date where trading volumes are typically much higher than usual.
It is difficult to say definitively whether this stability factor contributed to the relative decline of Solana’s market capitalisation from 5th to 9th ranking over 2022, but the related issues have been clear to anyone looking carefully. The Solana community is working on three technical changes to address the stability issues.
Ethereum is the largest smart contract platform and has a very active community of developers and users. Its adoption is thus far unmatched. But in combination with decentralized exchanges, the price discovery process for transaction fees on the Ethereum network has given rise to a phenomenon known as MEV, or maximum extractable value. In it, miners can re-order regular users’ transactions and inject their own into the next block. They “front-run” and thus exploit other users unfairly. Bizarrely, miners are the very actors who are in charge of the integrity of the distributed ledger. Related exploitation is by no means a small matter. Miners have extracted an estimated 672m USD on Ethereum thus far. Platforms that make MEV impossible or specifically complicate it, like Tezos’ Timelock, will be adopted more widely in the future. After all, which entrepreneur, Web3 user, corporation, or even investor will choose a platform where validators unfairly exploit others?
Ethereum has also become a victim of its popularity with its unpredictably high transaction costs. For example, the network was overwhelmed during the highly anticipated sale of virtual land by Yuga Labs, the developer of the Bored Ape Yacht Club, on May 1. Due to intense bidding to have transactions prioritized, several users paid between US$6,500 to $14,000 in gas fees, bringing the average daily fee across the entire network to US$475. The co-founder of Ethereum, Vitalik Buterin, recently said that transaction costs need to average $0.05 to be “truly acceptable”.
Even Ethereum’s highly-anticipated transition to proof-of-stake, dubbed “the Merge”, will not fully resolve its unpredictable and often high gas fees. Key on the road ahead will be predictably low prices for transactions to support a variety of use-cases, including enabling access to more comprehensive financial services to the underbanked. Platforms like NEAR and Hedera Hashgraph have developed promising approaches in this space.
Differentiation through design
The examples above demonstrate the significance of stability, fairness, and cost-efficiency on the path to broad adoption. The characteristics I discuss in this piece are mostly hardwired into each platform at inception. Of course, nothing is cast in stone in crypto and each platform is unique: While one may excel in one area, it is weaker in another. In aggregate, however, assessing sustainability will be essential for developers and corporations as they decide where to build their products and services for Web3.0. Regulatory scrutiny and disclosure requirements may further support this trend.
I am confident that blockchains will become the future decentralized operating systems for economic activity – far beyond today’s mostly speculative activity. The difference between sustainable and non-sustainable ecosystems will become increasingly apparent as the industry matures. For investors, entrepreneurs and established businesses, including 81 of the world’s 100 largest corporations using blockchain technology, this means engaging in thorough due diligence of blockchain platforms based on crypto-native sustainability metrics. Tokens powering more sustainable ecosystems should outperform the market over the long term.
The views and opinions expressed above are those of the author, are not intended to constitute investment advice and do not necessarily represent the views and opinions of Modular Asset Management or its employees.