Yunjiu Capital Niu Fengxuan: We are still on the eve of the Web 3.0 explosion

Author: Niu Fengxuan, Sky9 Capital

Recently, Niu Fengxuan, a partner at Sky9 Capital, attended the "Investment and Entrepreneurial Opportunities in Web3" salon organized by NetEase Technology and Digital Planet in collaboration with Investment Network. Together with Wang Tianfan, partner at BAI Capital, Zhang Fang, partner at Qingsong Fund, and Yang Linyuan, founder of Web3 Scenario Lab, they discussed the development of the Web3 industry from the investors' perspective, investment strategies, and observations on the entrepreneurial ecosystem. Below is a summary of the shared content:

1. Development of the Web3 Industry from an Entrepreneur's Perspective I would like to start by sharing my understanding of the development of the Web3 industry from an entrepreneur's perspective, as I personally identify more as an entrepreneur than an investor. I began my entrepreneurial journey at the end of 2014. My first venture was in the traditional Web2 industry, creating a SaaS tool, but it was not very successful, and I closed the company after two years in 2017. In the same year, I started my second entrepreneurial endeavor in the Web3 industry by founding the data company DappReview.

Over the four years from 2017 to 2021, I have gained a lot of insights. When I first entered Web3 in 2017, we were essentially pioneers. At that time, besides Ethereum, there were a few other chains and development tools, but even the basic infrastructure for developers, such as wallets, was not well established, let alone applications. Although people were already envisioning various scenarios, including finance, gaming, identity, and social interactions, the industry was largely barren.

After four years, we can see the gradual improvement of infrastructure, which I describe as a transformation from "muddy paths" to "asphalt roads"—roads that can accommodate vehicles but not yet airplanes. Four years ago, it was very difficult to walk this path as a developer or entrepreneur; many things were simply not feasible. In contrast, if we compare it to Web2 entrepreneurship, mobile app developers do not have to worry about issues like network, storage, or computing performance; in most cases, entrepreneurs only need to clarify how to build the product, what user needs to address, and whether the product development can keep pace. However, in the Web3 industry, there are many limitations in infrastructure, and we need to know what can and cannot be done. Over the past four years, I have also witnessed the explosion of middleware and protocol layers from 0 to 1, and the application layer has experienced its first explosion against the backdrop of improving infrastructure, achieving a transition from 0 to 1, and today is progressing from 1 to 100 and even from 100 to 1000.

Other sectors, including gaming, NFTs, and the metaverse, are still in the early stages, in my opinion. At the same time, the previous cycle gave rise to many leading projects today, such as OpenSea, Sandbox, Uniswap, Aave, and Axie, which were established during the late stages of the last bull market and the early stages of the bear market, rather than all being born in the bull markets of last year and the year before.

These companies have gone through a lot. When I was working on DappReview in 2017 and 2018, I met members from Sandbox and Axie. The bear market was particularly tough, and they struggled to secure enough funding. By the end of 2019, both Axie and Sandbox were raising funds, and their valuations were around $15 million, raising only $1.5 million to $2 million. Now, Web3 projects often start with valuations ranging from $20 million to $50 million.

During this market cycle, I have witnessed many interesting things as an entrepreneur, and I will share some of them.

2. What Value Does Blockchain Technology Bring? Over the past four years, I have continually asked myself: What value can Web3, built on blockchain technology as its underlying infrastructure, truly bring? This is a question many people ponder. I started DappReview in 2017, and by the end of 2019, it was acquired by an exchange. After that, I engaged in personal investments for a while, and later joined Sky9 Capital to invest in Web3. Throughout these four years, I have repeatedly reflected on this question through my entrepreneurial practice and investment experience. I believe there are two key answers:

First, composability, or interoperability. Composability essentially refers to the ability to combine and call code without permission at the code level. For example, if code is written on the blockchain using smart contracts, others can call that code and interface without permission, allowing new things to be built within that ecosystem. Additionally, digital assets (whether fungible or non-fungible) can interoperate across applications and natively. In many Web2 payment applications, money in one application cannot be used in another; or items and equipment in one game cannot be used in another game. However, the characteristic of building applications on blockchain technology as the foundation is that assets can be called in real-time across applications. This is something that was previously very difficult to achieve. Furthermore, due to the composability of code (which we refer to as Lego logic), it is akin to stacking blocks; I create a block, and others can build on my Lego blocks, which accelerates the development of the entire industry. Throughout 2020, the entire DeFi development explored countless possibilities in just two to three months. On top of the foundational applications like lending and trading, we built various aggregators and other interesting products.

The second point is a unified database. A unified database refers to the ability to connect all the data behind the vast number of Web2 applications. For example, if a user’s data across five applications is read and written in the same place, and they can log into each application with just one address, then the value of that database will be immense.

Today, most leading projects were nurtured during the bear market, and the underlying infrastructure is crucial. Without roads, cars cannot drive; without airports, planes cannot take off.

Next are two investment themes that we consider important and interesting:

The first is the investment theme of data. As mentioned earlier, one of the values brought by blockchain is a standardized unified database. In this database, we believe that on-chain data is actually a "gold mine": everyone has an address, which is your unique identifier. If you use that address across multiple applications, all your related data will be recorded on your data dashboard, in the transaction flow under that address. We can label the address with various tags for analysis. Data is no longer an island. In the past, we left data in various apps like WeChat, and that data would only exist in each company's own database, creating data silos, as large companies would not share data with others. However, now, all data on Ethereum is publicly visible; although it is anonymous and we cannot know the owner of an address, the historical behavior of the address, the DeFi products used, and the types of transactions made can all be seamlessly captured, allowing for more comprehensive and efficient data analysis and mining. Based on this logic, we can clean, analyze, and index data from the underlying data source, and then move up to various protocol layer projects based on this data and content, as well as many ToB data tools, ToC dashboards, and data applications.

In the three layers listed above, unicorn-level companies have already emerged in each layer, and they have actual revenue, so we are very optimistic about this sector. The difference now in data processing compared to the past is that we can see all the data behaviors under an address more comprehensively, and these data behaviors are verifiable. We have invested in some companies, such as Galxe (formerly Project Galaxy) and CyberConnect, which are working on social graphs on-chain and user data aggregation.

I have observed an interesting point: when hiring in the industry now, people are asked which applications they have used. Although resumes may list products they have used or researched, that may not be true. However, as long as we have the address they provide, we can see whether that address has truly engaged in the behaviors they claim, such as participating in DeFi projects or purchasing NFTs, allowing us to verify all their past on-chain behaviors and operations against their claims.

The second part is the application layer. We believe that the next cycle, in the next three to four years, will be a phase of large-scale explosion in the application layer. In the last cycle, the application layer in DeFi had already completed the accumulation of users and value from 0 to 1, retaining some very basic DeFi applications that would still have users even in a bear market. However, looking at other sectors, whether gaming, social, or NFTs, although they experienced some speculation and bubbles in the last bull market, they lost users when the bear market arrived, indicating that they have not fundamentally found their way forward and are still in the early exploratory stage. The killer application of Web3 is not simply layering a wallet login on top of existing Web2 applications, but rather leveraging the underlying characteristics of blockchain, namely composability and a standardized unified database, to unlock new user interaction methods through innovative mechanisms and gameplay in specific scenarios, thereby creating actual value. DeFi has similar examples. Many early DeFi projects, such as Swap, did not use the current AMM (automated market maker) mechanism, but rather an order book mechanism. Since people thought centralized exchanges used order books, with sellers and buyers posting orders to trade, many attempted to create order book-based trading. However, it ultimately proved that this model was not suitable for on-chain applications and on-chain DeFi, and the AMM mechanism for swaps ultimately triumphed. Lending also initially started as P2P lending, which ultimately did not hold up. The original model of Aave was Ethlend, which was essentially P2P lending but did not succeed; the eventual compound model achieved the current scale of DeFi lending protocols through a pool-based approach. From this, we conclude that there will be entirely new gameplay in specific scenarios. This new mechanism will certainly differ from current models and will open up new interaction methods. The sectors we are optimistic about in the next cycle will definitely feature new mechanisms, scenarios, and gameplay, which is also a key focus for us when evaluating new projects. If a project merely changes the existing model or rigidly applies Web2 products with wallet logins, we believe it will be very difficult to succeed. Only by finding entirely new gameplay can one stand out.

3. What Can Entrepreneurs Do? Finally, regarding what entrepreneurs can do. As an entrepreneur myself, I have also endured a bear market in the last cycle. In my view, first, it is necessary to reserve enough funds to cope with the bear market. A bear market may last two, three years, or even longer; it could also be short, with a bull market starting next year. However, I personally suggest that every team prepare at least 2-3 years of funds to survive until the bull market erupts.

During a bear market, teams need to genuinely find real product needs and target users, rather than blindly chasing the hotspots of the bull market, overly focusing on price or illusory users under false prosperity, thus neglecting the essence of the product. In the last cycle, projects like Axie and Sandbox were products and teams that survived the bear market with great difficulty. At that time, there were at least 20 teams with similar products, whether they were Axie-like products or metaverse products like Sandbox. The difference was that other teams did not endure; many announced the cessation of operations by the end of 2019 or early 2020. Therefore, being able to persist longer than other entrepreneurs and survive the bear market is inherently very important.

For aspiring entrepreneurs, I hope you first become believers, then become builders. The industry can be very daunting during a bear market. In 2018, many entrepreneurs entered the industry, but after a year without positive feedback, some could not hold on and left. After another year, in 2020, especially on March 12, 2020, which is a historic day for the industry, the prices across the board plummeted significantly, leading many long-time industry participants to waver and doubt. Therefore, if one does not have a strong belief and genuine love for the industry, it is very difficult to persist during a bear market.

The second important point is to set aside historical burdens, immerse yourself in the industry for a while, and then think about what to do. The Web3 industry is still in the grassroots entrepreneurial era from the last two cycles, and today, many excellent engineers from large companies have entered the field, bringing outstanding product development, management, and team-building capabilities. However, this industry requires some time for immersion to understand and recognize it, as it has just transitioned from "muddy paths" to "asphalt roads," and there are still many imperfections. Some former Web2 entrepreneurs may come in and feel that everyone’s products are too simple, thinking they can create something very complex, but this is not so easy to achieve. Therefore, it is necessary to immerse oneself in the industry for a while before considering what one can do and what limitations exist, rather than aiming too high. Many talented individuals come in wanting to make a big impact, but the industry’s infrastructure is still insufficient to support such endeavors.

4. Roundtable Discussion Q: What is the biggest difference between investing in Web3 and investing in other industries?

First of all, relatively speaking, I have less experience investing in Web2. In Web3 investments, my intuitive feeling is that it is quite challenging to conduct in-depth due diligence (DD). Some project teams may have members in the US, some in the UK, some in Singapore, etc., and often we have not met the team in person when investing in many projects. Therefore, for some decentralized office projects, there are still challenges from an investment perspective. However, some of these projects still need to be invested in; for example, a few days ago, the CEO of Nansen tweeted that several co-founders met in person for the first time. Nansen is a project valued at nearly $1 billion, with revenues of about tens of millions last year. When I invested in Nansen, I had not met the CEO; I just thought the product was good. Therefore, due diligence and references for the teams and founders of Web3 projects are actually more complex.

At the same time, the investor structure in Web3 investments is more diverse. In traditional industries, a financing round typically involves three or four institutions at most, but in Web3, it is common to see a round involving a dozen or more institutions. Each institution can provide support and value-added services in different regions or fields. Whether an institution can provide this added value is also a threshold for investing in the project. Because there is currently no shortage of money in the market, but rather a shortage of good projects, this is also a result of the current market supply and demand environment.

Q: Which areas of Web3 do you value the most, and what type of entrepreneurs do you prefer?

At this stage, we are more focused on infrastructure and middleware because we believe that the underlying development environment and infrastructure are still not sufficiently完善, so we place great importance on this area. In the application layer, we are optimistic about more innovative gameplay, mechanisms, and designs. Compared to factors like team, sector, and product, we prefer to see creative products. In fact, we have seen many homogeneous products across various sectors, and we believe they are unlikely to succeed. We prefer cases that are innovative and have higher odds.

Regarding teams, aside from some infrastructure and technical directions that have certain thresholds and requirements for the team's hard skills, we still believe that ideas are more important than the team's configuration for protocol layer and application layer projects. Our requirements for teams are relatively lower, focusing more on whether these ideas are creative. The type of entrepreneurs we are optimistic about should first have a high level of attention to the industry, understanding it better than we do in the sector, rather than discussing things that we already know. We prefer talents who venture into unknown areas, as we believe they are more focused on the industry and are not just looking to complete projects. Conversely, entrepreneurs with a "hammer seeking nails" mentality are not the type we particularly favor, as I believe the industry is still early enough to offer opportunities for revolutionary innovation, rather than merely organizing a group of developers to raise funds and build products.

We hope entrepreneurs genuinely believe in this industry, whether in seeking demand or proposing interesting ideas, they should aim to achieve significant goals.

Q: What is the biggest pitfall in this industry? Can you give some advice to new entrepreneurs entering Web3?

I believe a clear issue currently is that many people are full of confidence, determined to enter the industry and make a big impact, only to find that there are no users, or that active users are very few, and these users are primarily there for incentives—if the project cannot provide some incentives, users may leave. I think this is a stage issue in the industry, stemming from multiple factors, including the lack of sound infrastructure and the product itself not meeting users' essential needs. That’s why I mentioned earlier that entrepreneurs should immerse themselves in the industry for a while before deciding what to do, understanding what can be done, and getting a grasp of the industry’s current state before starting their entrepreneurial journey. I think the biggest pitfall is that the actual experience within the industry and the external appearance of the industry are quite different; one cannot know without personally practicing within it. It’s like crossing a river; a small river may seem shallow, but when crossing, one finds the water is deep. This presents a significant challenge for entrepreneurs.

Q: Besides funding, what kind of value and support can you provide to entrepreneurs?

The core competitiveness of funds investing in Web3 lies in bringing additional value to the invested projects. In my view, this can be divided into business and resource aspects. In terms of business, many early Web3 projects particularly need support in business and product development, even requiring deep involvement and strategic input. For example, the white paper for Uniswap V3 was actually published jointly by the Uniswap team and the Paradigm research team, so leading funds often have their own research teams deeply involved in projects, which reflects the value they create for projects. We have been trying to provide more advice on product and direction to our portfolio, sharing ideas with them, and they can reach out to us whenever they need. For some projects in the product development phase and during transitions, we meet with them very frequently, even weekly.

Other forms of assistance, I believe most investors would also provide, such as token economic model design, resource connections, and facilitating collaborations with other projects. However, I think the more important aspect is providing support in business, as inter-industry collaboration is quite open, and resource connections are relatively easy. Another aspect is recruitment. We have helped our portfolio recruit some people, and I believe this is something everyone would do. So the core is that we hope to understand the product direction of the companies we invest in, providing more insights and attention to help them navigate correctly on this path, reaching higher stages and broader markets.