Core Web3 trends - 2022

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The next bull market will be catalyzed by a trend or technology that’s already being built. Three of the seven trends analyzed were applications, and each scored well against the qualitative framework established to measure a trend’s ability to spark the next bull market.

Key Insights

The seven core trends and theses emerging are:

  • Revenge of the Apps
  • Decentralized Social
  • Web3 Gaming
  • Upstart Layer-1s
  • Modularity
  • Zk-rollups
  • Web3 Infrastructure

Introduction

  • Each trend can be evaluated with a framework that considers novelty, relative value (10x value), total addressable market (TAM), value capture, and competition.
  • Decentralized Social scored the highest in the framework due to high novelty and TAM.
  • Application protocols have made significant improvements to their competitive positioning against network protocols.
  • Web3 Gaming has historically out-earned DeFi but faces a competitive road towards sustainable mass adoption.

Trend Evaluation Framework

  1. Novelty
    • The trends behind the next narrative need to dazzle the imaginations of exit liquidity retail participants enough for them to envision a new technotopia.
    • Historically, trends with this strength have come in the form of a distinctly new use case or token distribution model such as ICOs or DeFi’s liquidity mining. * Since crypto is distinctly retail-driven, the novelty must reside in something tangible to the average person.
    • Faster, cheaper, more efficient technology in and of itself isn’t tangible enough to catalyze a bull run.
    • The novelty must reside at the application layer, or at least enable a new application, in order to paint vivid enough pictures of future wealth.
  2. 10x Value
    • The new product needs to offer 10x more value to the user to earn their business.
  3. Total Addressable Market (TAM)
    • Only a trend with a sufficiently large TAM can capture the imaginations of retail and wash away the foul taste of soured bull markets past.
  4. Value Capture
    • While bull markets can be sparked by trends with weak value capture, they can only be sustained by large investors if there is sufficient value capture.
  5. Competition
    • Any protocol hoping to start the next bull run is going to have to compete for attention and users against incumbent products and other new products.
    • If a trend is highly competitive, it’s hard for one protocol to attract enough traction to garner the speculative attention a trend needs. In the past, there has been a clear leading protocol or technology that encapsulated the vision of a trend.

Revenge of the Apps: 3.5 / 5

  • In the past, network protocol tokens potentially achieved a monetary premium status similar to Ethereum.
  • The competitive dynamics have subtly shifted. Many of the emerging Layer-1s and Layer-2 rollups are Ethereum Virtual Machine (EVM) compatible. Application protocols are able to easily spin up an instance on a new chain with little overhead.
    • Aave and Uniswap launched an instance of their protocols on various emerging networks and came to dominate volumes and Total Value Locked (TVL).
    • Now, as more EVM rollups launch over the coming months, the EVM is becoming increasingly commoditized (excluding Ethereum due to the vast liquidity).
  • Effectively, application protocols like Aave, Uniswap, and others have established a dominant position relative to the network layer while their valuations against the network layer are near all-time-lows.

Framework Analysis

  • There’s not much novelty in this sector, especially considering that the recent product enhancements don’t offer users 10x more value.
  • Subtle shifts in competitive positioning and business model optimizations won’t reinvigorate a market that has already learned the promise of DeFi.
  • That said, the TAM for DeFi remains massive.
    • According to the Business Research Company, the traditional financial services industry is valued at nearly $26 trillion. Stablecoin models in particular have the largest TAM and defensibility as liquidity cannot be forked away in the same way proprietary code can. Additionally, stablecoin models can capture sizable value.

Tailwinds and Headwinds

  • The two major headwinds for DeFi protocols are regulatory risk and the overall approachability of crypto — both of which are largely outside the control of the protocols themselves. Regulatory risk is the more existential of the two.

Overall

  • Due to the lack of novelty, app protocols may not spark a bull run. App protocols, however, have significantly improved positioning and business models, making them likely to accrue value in the wake of the next major trend.

Decentralized Social: 4 / 5

  • Decentralized Social (DeSoc) has the potential to be the underlying structure of how people and capital organize as well as exchange value on the internet.
  • DeSoc gives people on-chain reputations, organizations (DAOs), and ownership of their content. Content ownership is key as it introduces a way for people to finally capture the value they create. The result is a re-architected flow of value on the internet.
  • Currently, the DeSoc sector is split into three layers: the front end, the social graph layer, and content storage.
  • The core piece of DeSoc is the social graph layer. Unlike traditional social, the social graph is entirely open and fully extendable.
  • Due to the openness of the data. Additionally, the customizability given to developers allows users to benefit from crypto-specific monetization like Post-to-Earn.
  • To the detriment of the front ends, however, the value is likely to accrue to the social graph and content layers. Once a user’s connections and content are stored in the social graph layer, they can utilize them in another front end.
  • One core challenge facing DeSoc is the scalability of the base networks like Polygon and Etheruem. Polygon’s peak daily active addresses was 1.5 million, but even middle tier social networks like Twitch have over 140 million monthly active users. To reach these levels, protocols will likely have to first adopt performance enhancing scaling solutions like rollups, parallelization, and data availability.

Framework Analysis

  • While the potential of the sector is promising, it is still early innings for DeSoc. Many of the protocols are either currently in a gated launch or have yet to launch entirely.
  • The trend scores high in novelty due to both its newness and tangibility to a retail-driven audience.
  • The overall TAM for social is significant.
    • Facebook earns roughly $120 billion in revenue a year which comes out to about $30 per user. According to the Business Research Company, the entire social industry is worth over $220 billion — and that’s effectively just advertising revenue.
    • Including Business Wire’s 2027 projection of digital entertainment and content, the collective industry is roughly worth $1 trillion in annual revenue. In addition, a sizable amount of service industry work could be run out of DAOs and guilds on social protocols.
  • Value capture is quite high in the traditional social sector as noted by the projected $1 trillion valuation. DeSoc should follow suit albeit to a lesser degree, as more value will likely be shared with content creators than retained within the protocol compared to traditional social.
  • Additionally, the social graph and content storage layers will likely accrue more value compared to the front end layer.
    • Traditionally, users could only access their data from a single front end whereas with the DeSoc architecture, the valuable data gets locked in the social graph and content layers.
  • The combination of novelty, large TAM, and value capture earned DeSoc a 4 out of 5 total trend score which is the highest ranking of the seven trends evaluated.

Tailwinds and Headwinds

  • By far, two of the biggest complaints with Web2 social is the lack of transparency and limited revenue share.
  • DeSoc should positively capture this energy by democratizing data and fairly distributing revenues.
  • In addition to solving Web2 frustrations, users have demonstrated a desire to own content in the rise of NFTs.
    • While there was certainly some unhealthy speculative flair to that trend, a major outcome was the user education around owning digital content which should transition well to DeSoc.
  • One of the largest headwinds faced by DeSoc is crypto’s notoriously clunky mobile experience.
    • While apps like STEPN have started to successfully navigate mobile crypto, Apple has a history of hampering free value flows within apps on the App Store.
    • This results in a limited available user base which is bad business for social apps that rely on user-count-driven network effects.

Web3 Gaming: 3 / 5

  • Web3 Gaming is ultimately about giving players ownership of their in-game digital items and utilizing tokens to create in-game economies.
  • The core thesis is that players with a stake in the game, whether it’s in-game items or quasi-equity (tokens), feel more attached to the game’s success and are more willing to invest time and money.
  • When many players are invested and wish to buy and sell their items (NFTs), an in-game economy emerges that dramatically shifts the traditional gaming business model.
    • Instead of games extracting value from players via Downloadable Content (DLC) and micro-transactions, games earn by simply collecting marketplace fees from players exchanging game items.
    • Users are incentivized to acquire game items either by the expectation of profit or incentivized rewards.
    • This business model has been deemed Play-to-Earn (P2E). While not as popular, other Web3 Gaming monetization models include selling tournament tickets or sponsorships, stake-to-play, selling game items, or merchandise.
  • Axie first popularized P2E in the second half of 2021. The game showed that gaming business models could attract significantly more users and earn more revenue than many other protocols.
    • Axie’s $1.3 billion lifetime protocol revenue is still the largest of any application protocol and is $500 million more than the second highest grossing protocol, OpenSea.
    • However, Web3 Gaming has been set back ever since Axie fell from grace exposing core flaws in the P2E model:
      • Token and Game Mechanics: Too many tokens and game items make it difficult to maintain system stability.
      • New Player Purchases: Requiring first-time players to purchase expensive NFTs both limits the available player universe and creates an unhealthy profit expectation.
      • Susceptible to Bots: Passively played games can be botted and the game economies distorted in the process.
  • The sector is learning from previous missteps and continues to build out new business models and infrastructure.
    • Specifically, there is a focus on skill-based games that require high levels of play or deep knowledge of the game’s meta.
    • If successful, the game business model would shift more towards traditional sports. Monetization happens around the game via selling sponsorships, tournament entries, and purely aesthetic game items.
    • While this approach alleviates many of the mechanism complexities encountered in the P2E models, it does dampen the revenue outlook compared to Axie’s unstable P2E model.
  • Regardless of the business model, Web3 Gaming as a whole is challenged by development timelines and cost.
    • Game development is significantly longer than software due to the art components and additional complexities. The higher the quality of the game, the longer the timeline. When NFT game items and complex token mechanisms are also thrown into the mix, game development is both longer and much harder to change once shipped compared to traditional software products.

Framework Analysis

  • While Axie may have already diminished the overall novelty of the Web3 Gaming trend, the simplicity of the game left onlookers anticipating a true AAA Web3 game.
    • A Web3 game that rivals traditional gaming expectations would garner attention, but getting there will be difficult.
    • Offering 10x the value of traditional game studios and their resources is a massive undertaking and can likely only be accomplished with a crypto-specific game component unduplicatable in traditional markets.
  • The direct gaming industry, according to Accenture, is worth $200 billion.
    • Nearly half of that estimate comes from mobile games, suggesting that gamified experiences like STEPN have the largest current target market. STEPN’s status as the largest Decentralized Exchange (DEX) on Solana proves that the value capture is high.
    • However, not all Web3 games are mobile. Developers are currently working to build skill-based Web3 games, with an emphasis on e-sports components. Although e-sports is a rapidly growing industry, its current size of $1.3 billion dampens the short-term outlook for games that depend on competition.
  • Competition in the sector is high. Web3 games aren’t just competing with each other; they’re competing with traditional high-quality games.
    • In the future, developers and users will likely migrate to Web3 Gaming over time due to the lack of platform fees (iOS charges 30% on revenues) and content ownership.
    • However, the traditional player is already currently enjoying high-quality products. It will likely take some time for Web3 games to develop enough to turn the tables.

Tailwinds and Headwinds

  • Traditional gaming itself is growing over 20% each year and provides a strong tailwind for Web3 Gaming.
  • Much of the traditional growth is attributable to the rise of livestreaming competitive games and e-sports. Dota 2 runs the largest annual e-sports prize pool with nearly $40 million, which, compared to crypto’s incentive funds, is comparatively small.
  • Web3 Gaming’s potential for token rewards allows it to capture the e-sports momentum of the traditional sector.
  • Web3 Gaming’s progress is being impeded by the platform gatekeepers of traditional distribution channels.
    • Apple’s strict policies, for example, potentially limit Web3 Gaming’s ability to encroach on traditional gaming’s largest revenue channel.
    • Looking ahead to trends like AR/VR, the platform providers of those devices could also impose restrictive policies on Web3 games.
    • The restrictiveness of platform operators is a primary reason Solana and others are releasing phones. While it would circumvent many of the restrictions posed by incumbent mobile platforms, it does face the additional challenge of establishing a large enough market to make something as user-heavy as gaming successful.

Wrapping Up

  • The next bull market will be catalyzed by a trend or technology that’s already being built. Three of the seven trends analyzed were applications, and each scored well against the qualitative framework established to measure a trend’s ability to spark the next bull market.
  • Decentralized Social scored the highest amongst all the trends, including the infrastructure trends to be included in Part 2.
    • DeSoc scored the highest due its novelty amongst the general public and its total addressable market size.
  • The Revenge of the Apps scored the second highest due to its significant potential market size and competitive positioning. However, the trend likely won’t kick-start a bull market due to lacking novelty amongst the market.
  • Web3 Gaming was the lowest scoring application trend largely due to its weak competitive position relative to traditional gaming. Over the medium term, there are significant headwinds facing the trend including the platform gatekeepers that could limit distribution. However, there is long-term potential for Web3 Gaming — particularly interoperability infrastructure — once tailwinds such as AR/VR attract consumer attention.