Welcome to all the new subscribers from the Balaji Bump! I haven’t quite gone full-web3 here at doranalytics but I continue to bridge the gap with my Paul Revere-esque prognostications. I do believe it is inevitable, so you should all feel right at home..
When I first started this newsletter I didn’t know the path it was going to take, but I knew the end result that I desired: fame, admiration, and a flywheel that kickstarts a web3 micro-fund that propels me and all of my LPs into a level of shadowy influence typically reserved for the Peter Thiels of the world. OK, maybe that’s 2 lies and a half-truth. In all seriousness, I will settle for a nano-fund that returns just enough to pay off my student debt and a Loro Piana shopping spree with Chamath. But it is actually another brilliant man of Asian descent that has me believing that this place where I write half-baked insights on macro movements peppered with homemade gifs and memes could actually be a thing. We’ll see. In the meantime, Balaji and I are buddies now as you can see from this extremely intimate Twitter DM he sent me.
So I guess it’s time we get crackin’ on those startup societies my friends.. but first, why has the debate for web3 use cases suddenly turned into some sort of made-up partisan divide?
As we all know, the markets have been sucked of their liquidity and the most degenerate of assets (yes that is you Crypto) have taken the biggest fall. That’s not to say they won’t bounce the quickest off the bottom, but it’s a reality that simply has to be accepted by even the most fervent [Insertcoinhere] Stan. 65-75-85 percent dips are not only common, but have essentially been normalized by anyone who has seen a few bear market cycles in Crypto. TradFi veterans however, have most certainly NOT normalized such retracements off their precious QQQs and SPYs. Can you imagine if the volatility of the Crypto market was commonplace in the equity markets? Warren Buffet would choke on his daily McGriddle!
(I don’t know about you all, but I can NOT STOP giving Dall-E funny prompts)
All of that is to say, the “I told you so” boys are out in full effect. It’s like All Hallow’s Eve for Crypto-skeptics. Grown adults, giddy off the sugar-high of their own righteousness, prancing around the neighborhood knocking on every web3 project’s door screaming, “THAT’S your use case?!?!” and running off into the night in a fit of laughter.
Some more cold hard facts: they aren’t that wrong. Crypto-fanatics get too caught up in the world of what could be, and often overlook some simple diligence like, “does this project need to be on a blockchain?” I was having dinner with a friend a few weeks ago and when I started talking a little bit about my newsletter, she jumped in with some insight about what one of her friends “who was really into web3” was telling her, which was that every physical object would someday be an NFT. “This table, and this lamp, they would all be NFTs..”, she gestured vaguely. I obviously did not want to ruin a nice dinner by saying that was preposterous and launch into a diatribe on the problem of oracles, but this is the state of affairs that the hype-train has generated. There are a large amount of people who live in a fantasyland when it comes to their expectations of the future, and like politics, the craziest ones are the loudest.
(side note - I am well aware that me and my boy Balaji may also be seen as such fantasists by many, but I would argue there are millions of miles of metaverse between a full fledged Network State and the NFT-ification of the physical world)
It’s no wonder that such hype has been promulgated into all reaches of the internet and real life. The entire Global Cryptocurrency Market Cap went from nothing to almost $3 Trillion in just a short decade. That’s like 1 Apple, 2 Amazons, or 3 Teslas worth of capitalization generated out of thin air. Many, many millionaires were minted as a result, which we all knowww, but continues to be the driving compulsion for the proletariat. People fricking love get-rich-quick schemes. Crypto was (and is) the Wild West of financial investments. You can strike gold, oil, or you can die of dysentery. The excitement is warranted.
“The fact that there is a permanent frontier, and the fact that the permanent frontier is permanently risky, is obscuring the fact that the frontier actually is moving.” - Vitalik
Some wise words denoting that, yes the space is permanently risky, but a lot of the things that we considered risky last year have actually been de-risked. You don’t go from $0 to $3T without institutional investors, and those guys (for the most part) aren’t generally interested in throwing their money into a black hole. That being said, it’s not even the fungible tokens that are drawing the most users to the space anymore, it is the non-fungible ones.
NFTs several months ago passed Cryptocurrencies as the most common first use case for new web3 users. Said another way, if there was an attribution model that determined the source by which web2 users came into the web3 ecosystem, NFTs would be where you spend your money on customer acquisition. The reasons for this are plentiful: art attracts a much larger swath of the populace than just finance nerds, the promise of unending royalties, the power of provenance, the relatively low price barrier to entry, the community aspect, the simple user interface of the trading marketplace, the sheer tangibility of the asset, and the gosh-darn cuteness of things like CryptoKitties. Now, there are also some negative reasons for the NFT bubble, such as the predatory nature of these drops, essentially using what I consider to be Juul pod marketing tactics to entice kids into buying stuff. It’s honestly pretty disgusting some of the hype around these projects. You have literal PhD students teaming up with beautiful models to create enough buzz to sell 10,000 units of a drop, froth up the waters to create a trading frenzy, and dip out to do it all over again before the bag holders realize what happened. And that’s all done in broad daylight. You also have to contend with the conspiratorial Gary V “round up all my millionaire friends to purchase Bored Apes” kind of market manipulation, or straight up front-running the actual smart contract with insider trading. Of course not all NFT drops are so malintent, and there is very real community adoption, but now that the dust is settling I can’t help but think that the fraud has turned off for good a bunch of people who would have otherwise stayed in as early adopters.
Weird shit be happens in web3. That’s par for the course when you have a new technology that outpaces our human understanding of how to use it. That’s usually when capitalism takes over and people race to exploit the system for a cash grab before the regulation comes in. This current version of Cryptocurrencies and NFTs are not representative of the eventual de-risked versions we all envision, but it is important to be intellectually honest about some of the flaws the current era when discussing actual future use cases.
Speaking of being intellectually honest, that seems to be the exact thing missing in the world these days. I try to stay above the fray of the political squabbling, but from my frequent peeks into the policy measures, it seems maybe 20% less zesty than a few years ago (?), but that’s not saying much. As I mentioned last week, I think Balaji’s analysis that the political axis is shifting is spot on. The Left and Right bicker with each other with their hypocritical heels dug into the ground, adamant on asserting their ideals, oblivious to the fact that the ideals actually in contention are merely fringe issues, and that the majority of the country is pretty much aligned on most stuff.
It is this same sort of tribalism and pick-a-side-and-never-change mentality that has waddled its way into the web2 vs web3 debate.
There are a consortium of major players in the TradFi market, amazingly smart humans, who, completely entitled to their own opinion, think that all Cryptocurrencies are a bubble, all NFTs are a joke, and web3 is never going to happen. The fact that web3 is such a provocative term, in that it’s name inherently suggests that the entire internet will be rebuilt in its own image, doesn’t help. Nor does the fact that any explanation of the space by super-advocates results in the sort of hand-wavy articulation that does not generally inspire confidence.
As someone who makes a living off of comprehensive objectivity, I pride myself in being able to see both sides of an issue. If I see myself getting too narrow-minded, dogmatic, or myopic, I go contrarian or zoom out. Strong opinions, loosely held. One of the true tests of intelligence is simply being able to change your mind. That comes from the honesty with yourself that your ideals may not be the best solution, or even feasible, or even good for that matter. Humility over hubris. The great meme account PrayingForExits once said on an interview (in which his voice was modulated so as to maintain his pseudonymity), “Ego is minus-EV”. He is of course talking in the context of VC and startup culture in which the Expected Value of a company is negatively correlated with founder hubris. If you don’t have the ability to change your mind, the market is actively discounting the prospect of your future material success.
Most people don’t have that sort of pressure on them though. In fact, most people have no pressure on them to “be right”, the pressure is simply to “be”. To have an opinion gets you into the arena, by far a better option than being on the sidelines (in some people’s eyes). I don’t need to rehash what has been going on Media for the past decade, but as I careen deeper into the Tech/VC/PE/TradFi/DeFi ecosystems, I see similar lines being drawn around web3 the way the MSM draws lines around Left vs Right. The same problem exists in both debates: people refuse to change their mind.
Which leads us to the topic of Use Cases, and why are they so damn Contentious? It’s not just because the sides of Web3 Always Cool and Web3 Always Stupid have been chosen like teams in 2nd grade gym class. It’s because both sides have points, and those points never seem to get discussed. This blockchain technology space itself is mostly new, as is the space around the space. The Tech/VC/PE/TradFi/DeFi ecosystem has skyrocketed in popularity over the past 2 years as the people with the most Exits (aka success) from the private markets that have become god-like figures in Silicon Valley circles over the past decade have now become god-like figures on Twitter and Spotify. That brings every middling-VC scurrying to the table to start a podcast, and every wannabe-middling-VC to start a Substack (eek). Moderately-above-middling-VC Logan Bartlett who runs the podcast Cartoon Avatars has an interesting take on the situation. He says the Tech media is having a moment that “Hollywood had in the 50s, Sports had in the 90s, and Politics had in the 00s”, in which the players in the game are exalted to levels of celebrity they were previously not entitled to. So it all makes sense: the mad dash to the space to gain recognition, choosing a niche, taking a stance. The pressure is to “be”, not “be right”.
I am not going to use this space to run through a list of web3 use cases and give you my thumbs up or thumbs down like some sort of web3 Commodus. I want to keep things more nuanced here. Like gender and politics before it, web3 is becoming non-binary. It’s OK to be confused. You don’t have to pick sides. You can choose both. Use cases can be great ideas with critical flaws, as well as horrible ideas that are actually plausible. But each use case should be analyzed critically through an open mind, not a predetermined one. The path to riches is paved with utility, and utility requires a use case.
Instead, I am going to go through some of the arguments that web3 finds itself having to constantly defend. The point is to show that each one of these has its own merits, and that each use case will end up being a spectrum of the tradeoffs incurred by such merits. Ultimately, it is up to the consumer to decide if the pros outweigh the cons, and as an investor it important not to conflate “I wouldn’t do that” or even “a rational person wouldn’t do that” with “people will never do that”. People are buying digital rights to digital art with digital coins with little Shiba Inu pictures on them in the magnitude of billions of dollars. I think it is safe to say we don’t always know what the hell people will or won’t do.
The Contentiousness
Why a Blockchain?
By far the quickest way to shut down a web3 use case is by saying “how does blockchain solve this?” And rightfully so, like I and many others have said, blockchains are the slowest and most expensive way to do accounting. Adding a blockchain into a project makes it infinitely more complex (and increasingly polarizing), so you better need a damn good reason to have one.
The two foundational reasons are: immutability (trust) and censorship resistance (privacy). This is why Balaji advises all startup society founders to utilize history when crafting their One Commandment. It is only by displaying objectively what happened in the past that one can formulate consensus around how to protect the future. If you have 100% faith in the American government to not inflate the global reserve currency away, or change the Wikipedia definition of what a Recession is, then you don’t care about trust, and that’s fine. Some people have doubts, even in the most free country in the world. What does that say about the other 194 countries? And even if you don’t have doubts, you have to respect history that there are precedents for all sorts of shady stuff done by governments (America most definitely included). Also, to have that trust you need to maintain that reported history is an accurate representation of the facts, and not some modified version that the winners get to dictate. If you have 100% faith that the American government will not force a social media company turn off your account, or force the social media company change the algorithm to throttle you, or even have the social media company of their own accord through their monopolization, thwart competitors who offer free speech alternatives, then you don’t have a privacy issue, and that’s fine too. But the simple facts are that history is littered with examples of government and corporate overreach, be it tyrannical genocide, regulatory capture, or a nosy HR department reading your personal Slack messages.
Not everything has to be on a blockchain, but local ordinances apply. Laws and morality are different things, and absent freedom to vote with their feet, they can vote with their choice. Just like lots of macroeconomic issues can be traced back to energy supply, lots of the questions about “why blockchains” can be traced back to the fundamentals of trust and privacy. Trust of what, and privacy from whom are valid questions, but the answers are complicated, and not to be frivolously dismissed.
The Oracle Problem
So You Want To Put Your Real World Asset On Chain… congratulations! You now have an oracle problem. This is the nontrivial little issue where blockchains control everything on the blockchain, and nothing else. In order to get something from IRL to OC, you have to have either a centralized protocol connect it, or a human. Either is open to all sorts of data entry errors and manipulation. However, if you want to build something truly monumental say, an on-chain version of Carta, where every LLC in the country could list shares of their company to increase liquidity and expand the total investable market of the US by 4x, you need some crazy diligence to ensure that the smart contract you purchased does indeed entitle you to the shares that you think you are getting. It’s trust again, but in reverse. Is the exponential value unlock worth the uncharted risk? That’s for the market to decide.
Middlemen Bad / De-Centralization Good
Due to the fact that everything on web3 seems to be financialized, we end up looking at everything through a financial lens. There are other things that blockchains can do with trust and immutability like governance and provenance. Balaji shows how putting science and news on chain creates a ledger that eliminates revisionist history and fraud. These are features to some use cases that might appear to be bugs in the financial market. Take the instance of a simple financial transaction. It goes through an intermediary (a bank) who takes a cut for the favor of providing security. If you, as the purchaser, don’t receive the goods or services that you were promised to receive, the bank can just reverse the purchase. You can go on your merry way while the bank does the dirty work of Accounts Receivable. On a decentralized blockchain, there is no such transaction reversal. All sales are final. If you fat finger a 34 character wallet address and it goes to 0xb794f5ea0ba39494ce839613fffba74279579268 instead of 0xb794f5ea0ba39494ce839613fffba74279579269, well sorry, but that’s where that money is staying. Would you like to take legal action to resolve the issue? That’s great, good luck with that. Is this a trade-off the market is willing to make? That depends on the market and how confiscatory the current centralized entity is. In some markets there may be absolutely no reward for that type of risk. In others, there might be so much middleman capture that users flock to the blockchain in droves. Those two instances could be the same market with different consumer risk tolerances or objectives. Another not-oft talked about benefit of a blockchain option is simply having the option for a 0% middleman capture. As wallets and user interfaces get more sophisticated and user experience goes up in quality, trust in the system will organically grow and new customers will accept the risk profile. Off-chain services will have to either lower their prices to compete with on-chain ones, or increase the value they provide to justify the cost. Either way the consumer wins.
My point in all of this is that blockchains don’t solve everything. They are very messy when interacting with the real world, and there is a lot of benefit to maintaining old-school human intervention in a lot of examples. But it’s a spectrum, and this is the Wild West. As the infinite frontier gets pushed out further and further, the Overton Window of acceptable risk moves along with it. The Bears are having a moment, and the Bulls are understandably shook, but let’s not all pretend like each side doesn’t have merits to their arguments. Competition is good for markets, but steadfast tribalism is intellectually dishonest, promotes toxicity, and ultimately leads to slippery political slopes.