Dividing the four quadrants of cryptocurrency by fraud and utopianism

Author: Kevin Zhou, galois.capital

Compiled by: Chole, Chain Teahouse

Overview

During the dual bull market cycles of 2020 and 2021, "narrative" dominated, where the level of marketing and meme propagation for a token project became more important than the merits of the project itself. Trading firms transformed into venture capital funds (VC), and anonymous influencers gained the power that once belonged to venture capital firms in 2017.

We saw the narrative shift from DeFi to NFTs, to DAOs, L2s, Play-to-Earn, and even to the Metaverse and Web3, then back to NFTs. The war of L1s has crossed five common narratives, and the cryptocurrency space is gradually deriving new claims to justify the deployment of new capitalism, catering to investors' appetite for massive returns. Returns that were once achievable early on can now only be guaranteed for all holders by introducing less complex capital. Years ago, I would have considered this a disgrace; misallocated capital produced no value and only preyed on TikTok users eager to get rich, allowing these newcomers to lose money for nothing.

Every industry has its underlying workers, but today, my thoughts are very different. To me, each bull market cycle resembles an embodiment of the natural lifecycle in the animal kingdom. In the animal kingdom, we have a food chain where the greedy are consumed by those who are slightly smarter, yet still greedy—ugly but inevitable.

I now believe in crypto accelerationism. For so many years, we have been unable to achieve success in this industry through logical reasoning or any form of dialectic. We can only achieve success by witnessing the majority of doomed experiments and learning from them (though some experiments have indeed succeeded, at least for now).

Discussions about Small Block vs. Big Block, PoW vs. PoS, this PoS vs. that PoS, this L1 vs. that L1, L1 vs. L2, (3,3) vs. (-3,-3), Punks vs. Apes, DOGE vs. SHIB, CLOBs vs. AMMs, cannot be resolved without observing how these things play out in reality. Theoretical research in mechanism design, flowcharts with block arrows, historical anecdotes used as analogies, and rigid textual descriptions are insufficient to persuade a tribe to abandon their sacred cow and join the other side. As an industry, before it is branded into our era's trends and becomes part of our collective memory, we must all experience the good and bad of things with intention; only then can we move forward.

The introduction of terminology is a rather interesting development in crypto culture. In traditional protected and restricted fields like medicine and law, terminology serves a dual purpose. First, it saves time when both parties in communication understand a subject. Second, it prevents outsiders from easily accessing the value that belongs to insiders, and this applies to crypto technology as well.

As we become an industry with a bright future, we will further indulge in internal jargon, preventing dirty outsiders from taking a bite of our pie. However, this will also trigger many market mergers and acquisitions, as non-crypto companies lacking internal expertise also want to enter this lucrative yet hard-to-penetrate field. I make no normative judgments here; whether good or bad, this is a natural phenomenon.

Capital allocation always lags behind useful innovations. During bull markets, more and more funds flow into low-quality projects, and many entrepreneurs and scammers are eager to launch their novel yet immature ideas to create supply to meet the demand for entering the field. Only when they face a backlash from a swarm of people do they maximize their self-censorship mechanisms.

At the peak of frenzy, people only buy what they believe they can resell to the next buyer, leading to absurd valuations. The wave of projects driving prices up has drowned out common sense. If it weren't for the macro environment's shift, we might have reached even more absurd heights. However, this crazy market phenomenon has not peaked yet. With the change in trends, whether in the crypto space or outside the U.S., the "narrative" has been completely weakened, and many projects have been exposed as, at best, fraudulent, and at worst, outright scams.

When madness evolves into rules, meticulous ideas and cautious considerations are labeled as heretical. Only after the "narrative" is weakened can these thoughts be expressed without being regulated by the public's erroneous beliefs.

Currently, the market seems to price professional assets reasonably, but the prices of alts may still be a bit high. The Fed's statements were initially deemed completely unbelievable, but now most people believe them, and prices reflect this, with slight declines quickly bought up. This year, there will be 4-5 rate hikes, neither more nor less, at least that is the current expectation.

At present, the market pricing of major stocks seems fair, but some people are still a bit overly affluent. Initially, people thought the Fed's rate hike comments were not entirely credible, but now most believe them, and this is reflected in market prices. New developments regarding the Fed's further hawkish sentiment led to slight declines, but they were quickly bought back.

It seems there will be 4-5 rate hikes this year, neither more nor less, at least that is the current expectation. From speculative allies to major coins like BTC and ETH, there have been some pullbacks, but they are not as severe as in 2018. Most of the massive third-party or fourth-party funds raised by crypto venture capital firms may flow into long-awaited destinations, namely new projects rather than old ones. If the macro situation improves, new projects can still achieve 10x or 100x returns from this capital support, but old projects are unlikely to see the same growth again.

Fraud and Utopianism

I have recently been contemplating two new dimensions through which we can classify various cryptocurrencies: fraud and utopianism. For example, on the fraud dimension, I think we can agree that OHM is more trustworthy than TIME, and TIME is more trustworthy than other OHM forks. I am not claiming that these projects are absolute scams; rather, relatively speaking, we can reasonably compare them using this dimension.

In general, projects that imitate tend to be less valuable than the original projects. On the utopianism dimension, the best example is that BTC is less utopian than ETH, while ETH is less utopian than SOLUNAVAX and other new L1s. In the crypto space, new projects attempt to solve inherent problems in old projects, thus I classify them as more utopian. Now that we understand these dimensions, we can discuss the investability, return, and timing factors of each quadrant: the first quadrant represents low fraud/low utopianism; the second quadrant represents low fraud/high utopianism; the third quadrant represents high fraud/low utopianism; and the fourth quadrant represents high fraud/high utopianism. After all, who doesn't like a 2×2 matrix quadrant?

The first quadrant, low fraud/low utopianism: represents projects that can yield returns with a certain effort on manageable issues without requiring any foundational scientific or technological breakthroughs. For example, past crypto exchanges or some early successful crypto technologies like BTC are often good long-term investments, while being considered unattractive short-term investments, especially during the frenzy of a bull market.

The second quadrant, low fraud/high utopianism: represents projects that strive to build grand mechanisms to fulfill the complete vision of the crypto space, leading us into a brave new world. The designs of these projects typically require a very solid foundation and sometimes multiple technological breakthroughs to work. You will often see followers of these projects criticize and condemn first quadrant projects for not meeting their needs, using this as justification for the necessity of their projects' existence in a world with serious flaws, where utopia becomes a worthy goal to pursue.

The second quadrant is a good investment option in the early stages, as founders are usually serious about developing the project, and the chances of success are high. This allows founders to present everyone with myth-like stories and sustain them long enough to secure at least one or two rounds of fundraising. In later stages, these projects are only good investments if they achieve breakthroughs and truly "realize" utopia. While it remains unclear whether these utopian pursuits will succeed, venture capital only needs a small portion of them to compensate for all the losers, and the game is to make second quadrant projects appear as much like first quadrant projects as possible, making them seem low-risk and giving investors a sense of safety.

The necessary conditions for breakthrough projects are often overlooked, while the designs presented by the projects are continuously confirmed as entirely feasible and fully aligned with incentive mechanisms from the perspectives of game theory and mechanism design. These then lead to the high-risk, high-reward backroad of the first quadrant, where there are divergences in risk but no divergences in potential returns.

The third quadrant, high fraud/low utopianism, represents bad money-scam projects. Bitconnect is an example; it is clearly a scam, which is why Bitconnect targeted people outside the crypto space. Simply put, for those with simple thoughts, third quadrant projects seem more idealistic, which is exactly what these projects aim to do—merge with the second quadrant and ultimately make utopianism synonymous with fraud. This is why the third quadrant represents the worst and truly bottom-dwelling individuals in our industry, even creating a vicious cycle: foolishly greedy people deceive even more foolish people, allowing regulators to use these examples to impose stricter and more reasonable regulations on the entire field.

The fourth quadrant, high fraud/high utopianism, represents the Rube Goldberg machines and perpetual motion machines of our industry. Like the third quadrant, but executed better, even insiders find it difficult to logically reason about these complex devices. Even skeptics can only conclude, "It might not work, but it might work because I’m not quite sure where the problem lies." Can the Gordian Knot be untied? Fourth quadrant projects do their utmost to pretend they are actually in the second quadrant. Over time, if a project achieves short-term success, they may attempt to turn the deception into a genuinely executable project and migrate to the second quadrant.

What is the difference between WeWork and Theranos? The former migrated from the fourth quadrant to the second quadrant; the latter failed to do so. Simply put, fourth quadrant projects are often a good short-term investment for many in the field, albeit sadly, partly because token projects can achieve liquidity faster than past private companies; they can effectively "go public."

Founders can retire before their products prove effective and truly fit the market, especially when the project's tokens can be purchased. Many seemingly successful fourth quadrant projects emerge like mushrooms after rain, with numerous founders, employees, investors, traders, exchanges, market makers, non-mainstream trading markets, SAFT slingers, lawyers, and other third-party service providers benefiting from the fraud of the fourth quadrant. The only ones who do not benefit are the last ones to board, sitting in their clunky cars, sipping their favorite drinks, desperately clinging to a utopian dream sold to them by those smarter and darker than themselves.

I find that whether in fraud or utopianism, the phenomena we see in this environment have great explanatory power, representing one cycle after another. In summary, the first quadrant is for long-term projects, unsuitable for short-term; the second quadrant pretends to be the first quadrant, and if they solve problems that may not have solutions, they can move to the first quadrant. The second quadrant is short-term and profitable, with higher risks and higher returns in the long run. The third quadrant pretends to be the second quadrant, but only works for users unfamiliar with the field. The fourth quadrant pretends to be the second quadrant, and if they successfully cover themselves and achieve some initial success, they may gradually migrate to the second quadrant. If users only care about money, then of course they will be the best short-term investment so far, and venture capital benefits from a large amount of arbitrage entering here.

NFTs

We basically stay away from trading NFTs and tokens related to NFTs because we feel we do not have enough competitive advantage to play this game. Aesthetically, we lack excellent taste, and in terms of the importance of imitation, we do not have enough Twitter followers, fundamentally preventing us from providing a large amount of market trading.

First, we can observe the categories of art and NFT avatars. Since they are status/signal symbols, Veblen effects/luxury goods, or heirloom/prestige items, we can say that some of them will retain value in the long term. However, like top fashion companies in the real world, we can see a similar number of NFTs maintaining value due to sufficient brand equity. The reality is that there are certainly not over a thousand top fashion companies, so most NFT series may not hold much value. Therefore, at best, we have a "power law distribution" where "only one winner can capture the most value." We can also argue that status symbols are only useful when displayed to others, and for those real-world brands, the traffic is generated by what people consume in reality.

NFTs, however, are limited to social media platforms like Twitter and Discord, making it hard to say which has more growth potential. However, as people spend more and more time online, and the virtual world is broader than the physical world, it is a reasonable argument. Twitter and Instagram are also actively integrating NFT features, so it is not surprising that NFT avatars perform better than general art, as they play a better role as avatars of online identity. Nevertheless, one should invest cautiously in NFTs, as the number of scams in this industry is the highest among all recent trends.

Secondly, I do believe that vampire attacks like LOOKS have some reasonable opportunities to gain market share, as they can directly target the right demographics, making them the perfect users for their platform. That said, LOOKS' price and market cap have recently plummeted, with most trading volume merely being wash trading, and the founders have consistently been cashing out. If this is entirely a scam, with an anonymous team and the token price reaching very high levels in a short time, it would not be surprising. Nevertheless, the idea of having multiple NFT trading platforms competing makes sense, as fees are high and there is competitive space. Moreover, there is no liquidity network effect like an order book, making it easier for challengers to compete with existing businesses.

Finally, when it comes to non-art, non-NFT avatars, the design space is largely unexplored. However, I think this exploration is worthwhile. Like all innovations, most may be nonsense, but I optimistically believe that people will find something useful here.

L1s (Layer 1 Blockchains)

Since the technical advantages do not hold significance until they eventually appear in the future (at some uncertain time), we should not waste time on this issue. I just want to say that it makes complete sense for different people to support different L1s. HFT prop shops in Chicago like SOL; Koreans like LUNA; graduate students like AVAX (after all, it is the only professor coin that performs well); Andre's followers like FTM; Silicon Valley venture capital firms like everything because if they buy right once, the entire fund has good returns; sometimes they like smaller L1s like NEAR because, if you don't already have a market cap of millions, NEAR can still have tens of billions of larger growth.

In resisting attacks from all sides regarding "new things," ETH maximalists are now in the same camp as the old BTC maximalists. Generally, their defenses are unsuccessful; people are fickle. With something new, you have the potential to achieve the grandest hopes and dreams. As for things that have already launched and are steadily moving forward, you can only see the harsh reality of the actual situation.

Behind utopianism lies the barbarity of the real world and the ugliness of human nature. Humans have a nature that desires a perfect world, but they also exploit others' desires for a perfect world. Ultimately, true believers will become disappointed traitors, needing a Girardian scapegoat to satisfy their anger and dissatisfaction. At that point, who could be more suitable as a scapegoat than those prophets who can never realize the future?

This is not to say that these L1s will not succeed; rather, the founders are very aware of the Damocles sword hanging over their heads. Their best bet is to win, followed by making greater compromises on decentralization principles, as decentralization does not hold significance until it is achieved. Who knows if it can be achieved, and if so, when? Perhaps we fear the specter, or perhaps we do not. When we are reshaping the financial and monetary systems, we begin to sympathize with past Federal Reserve chairs. No Federal Reserve chair would want an economic collapse to occur during their tenure, so why do they all want to push the problem onto the next person, like kicking the can down the road?

Given that all incentives for participants are useful, I hope the best L1s can win in any case. That is what I want to say; not everyone enters the space for the technology. In fact, not many people are in it for the technology. At this point, I have been waiting for over seven years, and I don't even dare to ask whether we will really get Ethereum's PoS this year. Which will come first, the arrival of ETH 2.0 or the revival of Hal Finney's frozen body? Haha, who knows the answer now? I'm just joking, don't flame me.

As for cross-chain bridges, the main difficulty they face is ensuring that synthetic assets on one chain are not artificially inflated without proper backing and ensuring the security of the transportation process. We recently witnessed a vulnerability between SOL and ETH, caused by issues with SOL. I am not particularly concerned about this vulnerability, as it is merely a fixable error. Although the SOL vulnerability was rescued by Jump, it is likely that they paid out of their own pockets.

If cross-chain bridges fail, their SOL wallets will lose significant value. I believe they will also have to cut off a pound of flesh from their rescue architecture. However, this is not overly concerning. What worries me is that even if the code is well-written, cross-chain bridges will have fundamental issues, which remains to be seen. Additionally, even if today's bridges are quite centralized, as long as there is a way to decentralize without compromising security, it should improve. People will wait and see, and I will hold a skeptical view.

DeFi

DeFi 2.0 is similar to DeFi 1.0, but 2 is greater than 1; the bigger the number, the better. The hallmark of DeFi 2.0 is the idea of protocols controlling or owning assets themselves, sometimes referred to as PCV (Protocol Controlled Value) or POL (Protocol Owned Liquidity). The idea is the same: to have a DeFi protocol while simultaneously running a hedge fund. Whether this is a good idea or a bad idea is left for the readers to answer.

Now, some protocols hold tokens of other protocols and participate in each other's governance votes, ushering us into an era of systemic risk. It is easier to reason that this will be used for larger composite product networks or for structured products from before the 2008 financial crisis, which is quite frightening. While composability is great and enables things that were previously impossible, systemic risk will rise over time, and entangled protocols will become increasingly difficult to untangle, so we need to be cautious; otherwise, it will ultimately turn into a larger mess.

Play-to-Earn

You work to earn money, and then you spend the money you earn on playing; that has always been the case, right? Work is essentially something you do not want to do, and you are willing to work because it is rewarding. Games are essentially things you want to do because you enjoy them, and you might even be willing to pay for them. So, what the hell is P2E? If you are a farmer in rural China, relying on earning game gold in WoW to make a living, that is work. If you play WoW and enjoy it, you might buy WoW gold on RMT sites, and the gold on RMT sites comes from those rural areas in China; that is gaming.

In P2E, people have again fallen into the trap of using too many terms to make it sound like a cool buzzword, making you feel that P2E is a market mechanism where you can "have your cake and eat it too." In most ordinary games, some people earn money through work, while others play by paying, with almost no overlap between the two groups. In most "P2E" games, while some still earn money through work, the players who pay to play have almost been replaced by a new group—this new group pays to buy the work of workers and ultimately sells it to other paying groups.

In other words, the main difference between most ordinary games and P2E games is that the former has workers and players, while the latter has workers and speculators. It is evident that almost no one genuinely wants to play P2E games. If the P2E industry ever launches a truly interesting game, it will become an ordinary game with workers and players. It only exists at a subtle point of differentiation from ordinary games: it provides on-chain anonymous assets for virtual game assets, allowing for an active secondary market outside the game developer's platform, but the game developers can still easily tax it.

The general consensus among game developers is that the secondary market is detrimental to their revenue because they do not easily take a cut from every transaction in the secondary market, and it cannibalizes the primary market. Now, with cryptocurrencies, although the issue of primary market cannibalization has yet to be resolved, they can easily tax it. In my view, this is still a good thing, as the best games of the past indeed had active secondary markets, and now there is at least a greater incentive for game developers to return to that beautiful era before the anti-secondary market trend. Players can get what they want, and developers can get half of what they want. Therefore, powerful synergies can arise between cryptocurrencies and games, but the current P2E games have not yet achieved this.

Metaverse

If the term Metaverse refers to virtual reality (VR), then we already have it, and it is a growing industry. If the Metaverse means more than just VR, then we must define it precisely to avoid the inflation of ordinary vocabulary due to excessive abstraction. Think about it: when people say artificial intelligence, they mean machine learning; when they say machine learning, they mean statistics; when they say statistics, they mean linear regression.

Money has already inflated enough; let us not allow vocabulary to inflate as well. If the Metaverse refers to virtual communities, then we already have Telegram chat rooms, Discord communities, and even the company formerly known as Facebook. If the Metaverse merely describes a trend where people generally spend more time in the virtual world and less in physical space, then it is a trend that is happening. The Japanese hikikomori are our future; when banks print too much money, half of humanity will have no sex life, becoming shut-ins and basement dwellers, while the general populace turns into corporate zombies, ultimately succumbing to "karoshi" (death from overwork). Believe me, this is true, but the evidence cannot be captured in the blank spaces of this article.

However, from a practical perspective, when we talk about investing in the Metaverse, regardless of its actual meaning, it typically takes two forms: investing in a virtual world or investing in specific virtual land/assets within a small block. For the former, cryptocurrencies bring two innovations that were previously impossible—first, you can allow your users to gain ownership of "a small block" through something akin to Web3-style yield farming, provided you have some anti-Sybil mechanisms; second, you can organize your user base to conduct decentralized payment business activities with each other.

In other words, you can log into places like Decentraland, have your avatar walk into a virtual art gallery, find a punk you like, and then click it to link directly to the auction on OpenSea. One more click, and your Metamask wallet opens, allowing you to buy it from the gallery. Once purchased, you can leave it on display in the gallery or take it down to showcase in your virtual house, or even display it in both places—this is certainly cool.

However, using VRChat as an example, their blocks are centralized, and they can directly integrate this feature. Does Decentraland have unique advantages and disadvantages compared to VRChat? It is hard to say clearly now, but perhaps the next topic will provide us with some insights. What happens when we turn land ownership into anonymity? What if we turn virtual land ownership into anonymity? This indeed is a core distinction between Decentraland and Second Life, creating a certain degree of scarcity for virtual land and providing unforgeable, unchangeable land ownership.

However, there remains a question: how much difference in value exists between land near transportation hubs and land far away? The value of virtual land also benefits from surrounding foot traffic, just like land in physical space. But in the virtual world, people can teleport and fly. If a project restricts users' teleportation or flying, its competitors will not impose such restrictions. Since gravity does not need to be a rule in the virtual world, I can imagine that land there can also be vertically stacked.

Therefore, I do not think the price of virtual land can reflect the same price ratio as the value difference between urban and rural land in the real world. However, certain virtual lands may still be more valuable than others, depending on how much attention they can attract locally. Ultimately, how unpredictable is the ownership of virtual land? What if someone posts something very vulgar or illegal (like bloody pornographic content) on their Decentraland plot? Can Decentraland take it down? True anonymous land ownership means Decentraland has no authority to act in such cases.

Web3

We are different from Gabe Newell's Valve; we have truly managed to reach 3. To avoid the inflation of concepts and vocabulary, we adopt Chris Dixon's definition of Web3 here: Web1 is read; Web2 is read/write; Web3 is read/write/own. Therefore, FCoin essentially invented anti-fee mining, which was later popularized in DeFi as yield farming. So is Web3 yield farming? Just kidding; its mechanism is not up to par.

Web3 is a universal yield farming tool similar to stocks, and securities regulators find it difficult to take enforcement actions against it. This could be good or bad, depending on whether you are a regulator. Imagine if Uber (if you are Chris Dixon, imagine Lyft) issued small amounts of Uber/Lyft stock to passengers and drivers based on every ride recorded on their platform, with no paperwork or intermediary costs, and no expenses arising from regulatory actions. This could actually be very beneficial; it is a great way to establish two-sided or multi-sided markets, solve the "chicken or egg" problem, acquire customers, and generate word-of-mouth. Well, let’s see what happens. When ambitious entrepreneurs mention Web3 in their speeches, just like the past trends of "artificial intelligence" and "sharing economy," you need to be extra cautious.

Conclusion

In summary, the conclusion is that everything in the cryptocurrency space is fine. In the long run, as always, I remain optimistic about the cryptocurrency field. In the short term, there is some work to be done, and some things need to be cleaned up. I know some people will say my article is silly, but I will not comment on them.

So, don’t want to try that method just because your college friend made a few times the return on NFTs. Aside from those successes that can never be achieved, we can all ultimately succeed. Life goes on, and cryptocurrency continues; keep building, keep hodling, and try to do some good for the world, but make sure that the good you do doesn’t drag us all into hell.

We really need to clean up our space; otherwise, at some point, there will be a systemic explosion, and everyone will cry out for regulation, just like the history of mature markets will repeat itself. I can’t believe Gerko banned me on Twitter for speaking the truth; that idiot. You know, when people say they mean no offense, the next thing they say is always offensive. No matter what happened with artforz, I can’t believe they came up with such a smart scam. Once the scammers start dumping and prices drop, their community members will get furious and shout for blood. But what if they can discreetly dump without causing prices to drop, even making prices rise while monetizing? I want to say that they really have found such a group of geniuses.

If you ask me about the next stage of monetization in DeFi 3.0, I want to say that this convoluted machine is super complex, even complex enough to make big shots like Daniel Larimer feel outmatched. Readers who have made it this far must be very curious. Let me give you a bit of Francis Bacon's wisdom: there is nothing new under the sun, as Plato imagined, all knowledge is memory. So Solomon said that all novelties will be forgotten. Barry can gain from closed-end funds as a compromise, but if people just want to buy more cryptocurrencies from it, I think it may only lead to bad outcomes. Nietzsche also said that those who sit and think are nihilists; fortunately, I am a walker. Readers who have made it this far may be perfectionists, achieving true meticulousness.