New Narratives Driving User Growth in Web3

Written by: Loki, New Fire Technology

Source: SevenUp DAO

Part I What Are We Talking About When We Talk About Cycles

1.1 Determinants of Market Cycles The switching between bull and bear markets in the crypto market has always been very evident. So what are the decisive factors for bull and bear markets? There is a well-known assertion in the real estate sector - "Long-term looks at population, medium-term looks at land, short-term looks at finance," which implies that population, land, and finance play roles in the supply and demand of real estate over different time cycles.

The underlying logic of cryptocurrency is similar; more specifically, it is long-term focused on development fundamentals; medium-term focused on monetary cycles; and short-term focused on event-driven & market sentiment.

Looking at the longer cycle, BTC has always been a winding upward trend, and no matter how high the position, there will be a day when it can be released. This is driven by fundamentals, which is reflected in the chart as a continuously rising bottom line.

Figure: Bitcoin Rainbow Chart (2012-2022) However, in the medium and short term, many events can impact the small cycles of the market, creating numerous local tops and bottoms. These include:

Ø Monetary policy: The Federal Reserve's ultra-loose policy after the pandemic; the interest rate hike cycle starting in 2022

Ø External markets: March 12, 2020; U.S. stocks from April to June 2022; net buying brought by Grayscale

Ø Regulatory policies: 2013 notice on preventing Bitcoin risks; 2017's 94; October 24, 2019, Central Political Bureau collective study; September 24, 2021

Ø Black swans: Mengtougang; 3AC; LUNA; FTX

The cycles we usually discuss are actually medium-scale cycles, largely driven by monetary factors and the resonance formed by industry development narratives leading to the switching of bull and bear cycles.

1.2 Cycle Progress from the Perspective of Supply and Demand of Money Based on this analytical framework, we can make a basic judgment about the current cycle's progress. One point that needs to be clarified is that the fundamental driving force behind this round of bull and bear markets is the global monetary easing after the pandemic, and the biggest driving force of the bear market is also the Federal Reserve entering the interest rate hike cycle. Therefore, understanding the key to this cycle is to understand the supply and demand of money.

On the supply side, the most direct observation object is the Federal Reserve, and all actions of the Federal Reserve revolve around one policy goal: [full employment and price stability]. From the employment rate in the U.S. over the past decade, we can see that the unemployment rate has been gradually decreasing since the 2008 financial crisis, but due to the impact of the pandemic, both the employment rate and inflation rate fell into a big pit, leading to the initiation of quantitative easing and the bull market. However, starting in the second half of 2021, inflation began to rise, necessitating interest rate hikes to control it.

The purpose of interest rate hikes and balance sheet reduction is to curb inflation, and this process has a certain lag. It can be divided into several stages: first, in the first half of 2022, inflation continued to rise, so interest rates needed to keep increasing, and the pace of hikes accelerated. The second stage is when inflation begins to decrease; at this point, the frequency and intensity of interest rate hikes can be gradually reduced, but hikes still need to continue until close to the policy target. The third stage is to stop raising rates or even slowly cut rates.

According to current data, it is clear that we have entered the second stage, meaning the most intense rate hikes are over, but they will continue. From the statements of several key figures, it can also be seen that a 50 basis point hike is very likely in December, with another 50 or even 25 basis points next year. However, it is important to note that the Federal Reserve's strategy is "emphasizing a longer duration rather than a higher rate." The Federal Reserve can still push the terminal rate to a very high level through many 50 basis point or even 25 basis point hikes, and the expected terminal rate of 5%-5.5% may be overly optimistic.

Table: Judgments from Some Policy Influencers

Federal Reserve's Bullard: The Federal Reserve needs to raise rates to the range of 5%-7%, continuing to hike into 2023.

Federal Reserve's Williams: It is expected that by the end of 2023, the U.S. unemployment rate will rise from 3.7% to 4.5%-5.0%; by the end of 2022, the inflation rate is expected to drop to 5.0%-5.5%, and by the end of 2023, it will drop to 3.0%-3.5%; economic growth is expected to be moderate in 2022 and 2023.

Former New York Fed President Dudley: The Federal Reserve's strategy is "emphasizing a longer duration rather than a higher rate," conducting a series of smaller rate hikes, with the peak rate expected to be in the 5-5.5% range. After rates reach 5.25% or 5.5%, the Federal Reserve will observe how restrictive monetary policy measures slow the economy.

Overall, the situation regarding interest rate hikes is relatively clear, just that the pace of hikes has slowed. Analogous to driving a car, we are now just easing off the gas, and next, we need to completely release the gas, then hit the brakes, stop, and then start reversing. Therefore, there is no possibility of any so-called policy shift in the short term. The possible scenarios for the future are as follows:

Ø Best case: Inflation decreases as expected, unemployment remains within a controllable range, achieving a soft landing, with the rate of hikes gradually decreasing in 2023, and the terminal rate staying at 5%-7%, stopping hikes in H2.

Ø Bad case: Inflation decreases less than expected or even rebounds, with the rate and frequency of hikes in 2023 higher than expected, and the terminal rate exceeding 5%-7%.

Ø Worse case: Inflation decreases less than expected or even rebounds, with a recession occurring simultaneously.

On the demand side, VC investment conditions are a good observation indicator. Last year, we proposed the VC Happiness Index, calculated by dividing the current cycle's cryptocurrency market cap growth by the total financing amount of the blockchain industry in the previous cycle. The logic behind this indicator is simple: the purpose of VC investment is to generate profits, so their investments need to be realized through the market cap growth in the next cycle. The higher this indicator, the greater the probability of VCs earning high returns.

This will also form a cycle theory similar to the Merrill Lynch clock. The speculative nature of cryptocurrency market cap is largely driven by external factors. If there is little investment for a period, the next cycle is likely to create a wealth effect, forging a bull market, which in turn brings FOMO sentiment and financing convenience, leading to over-investment. Over-investment makes it impossible to realize gains in the next cycle, forming a bear market, which again leads to insufficient investment, creating a repeating cycle of bull and bear markets.

Figure: Primary Investment Cycle Process in Cryptocurrency Based on the observation of the VC Happiness Index, we made trend forecasts for the primary market at the end of 2021 and the end of 2022:

December 2021 view: In the past two years, VC returns and comfort levels have been very high, but the $30 billion investment in 2021 needs to be realized from the total cryptocurrency market cap in 2022, which means that if VCs want to maintain a happiness index of 253 in 2022, the total cryptocurrency market cap needs to grow by $76 billion, equivalent to five times the current total market cap, which is almost impossible.

December 2022 view: Due to the double top at the end of 2021 leading to excessive optimism and the lag in institutional publicity, VC investment did not start to decline until Q2 of 2022, resulting in an expected total investment of over $20 billion for the entire year of 2022, which means that the VC Happiness Index for 2023 will not be very high, and over-investment will lead to a decline in returns, making a widespread bull market difficult to appear.

More directly, a rebound or small bull market may occur in 2023, but a widespread bull market is almost impossible, because if the VC Happiness Index wants to return to a high level, the required market cap growth is too large, making it difficult to have a universally profitable market. Only when institutions experience real pain and the investment enthusiasm in the primary market reaches the bottom will the market truly find its bottom.

1.3 Atypical Bull Markets Lead to Atypical Bear Markets History will repeat itself, but it will not replicate 100%. This round of bear market cycles has shown many different characteristics, for example, the double top in H2 2021, the failure of BTC market share change rate, and the slower collapse of Alts. In addition to macro factors, there are also some industry-specific factors, the most important of which is that the form of leverage in this cycle has also changed.

First, it is clear that only profitable venues can attract more people, so every bull market is accompanied by a process of increasing leverage, specifically through some form to carry the bubble. For example, ICOs, IEOs, halving bull markets, liquidity mining, NFTs, and GameFi. This creates a false prosperity where everyone is making money, and these altcoins have high market caps. However, in this cycle, many institutional investors and operators participated, resulting in the slower collapse of altcoins. But this also brings a downside, because only by thoroughly liquidating the leverage can the market find its bottom, which is the so-called "as long as the bulls do not die, the decline will not stop." From this perspective, the collapse of malicious institutions is helpful for the market to find its bottom.

It is important to note that cryptocurrencies themselves are at the end of liquidity transmission. When the money supply increases, it first enters traditional financial markets, consumer markets, and commodity markets, and only then transmits to the crypto market. Within the crypto market, funds first enter BTC, then transmit to ETH and mainstream projects, and finally to new projects and altcoins, and lastly to MEME coins and shitcoins. Conversely, when liquidity retreats, funds gradually concentrate on mainstream coins/BTC, then convert to stablecoins or cash out into fiat currency. BTC has played a role as a safe haven and exit for funds in past bear markets, so BTC.D shows a significant increase during bear markets.

Figure: Changes in BTC\ETH\Stablecoin Market Shares From the market share shown in the above figure, although BTC's market share has not changed significantly in the past few quarters, if calculated based on the combined market cap of BTC/ETH/stablecoins, the combined market share has shown a significant increase, currently maintaining around 70%. Especially after entering December 2022, the market shares of BTC and stablecoins have shown a clear upward trend, which is a good sign.

If the market continues to decline, the next possible scenario is that the market share of stablecoins further increases, BTC's market share slightly increases or remains stable, ETH's market share declines, while the total amount of stablecoins shows a significant decrease. These signs represent the last bulls giving up resistance (e.g., ETH bulls), and funds flowing out of the crypto market, at which point the real bottom is likely to appear.

1.4 Black Swans Accelerate the De-leveraging Process Another characteristic of this bear market is the frequent occurrence of black swans. The collapses of LUNA, 3AC, and FTX have caused the BTC price to show several "large steps," with each shock pushing the market into the next stage. This attribute can also be attributed to the differences in the causes of the bull market in this cycle compared to previous ones. The institution-led bubble ultimately needs to be completed through institutional collapses to achieve the de-leveraging process. This also brings some characteristics to the impact of black swan events:

(1) The impact of black swans is relatively concentrated.

As shown in the figure below, in the month following the FTX collapse, the tokens that experienced significant declines were primarily those led by investment institutions. This differentiation is very reasonable. First, during the 2021-2022 period, the resilience of these institution-led tokens was not in line with market rules; SOL was almost pinned at $38. Second, VCs also began to feel pain and needed to liquidate, and they only had these tokens.

Figure: Mainstream Token Trends Show Differentiation After FTX Collapse (2) Continuous shocks require each subsequent shock to be larger than the previous one.

After FTX, many people are discussing whether there will be another shock. We need to clarify that in a bull market, after a positive development, to sustain the rally, a larger positive development is needed. The same goes for bear market shocks; if there is to be a continuous impact, a larger shock is required. The scale of FTX was already very high, with direct losses of only tens of billions of dollars, but the indirect impact is many times greater.

The table below lists some other entities that the market is currently worried about:

It can be seen that after FTX, many entities are still at risk. Among them: (1) The yellow area lists entities with relatively high risks, such as USDD/MakerDAO and other over-collateralized stablecoins that face de-pegging risks, MicroStrategy and DCG face certain bankruptcy risks; ETH has accumulated a large number of staked tokens waiting to be unlocked after transitioning to POS. However, the likelihood of these projects collapsing and the consequences of such collapses have been somewhat overestimated. For example, many media and KOLs' sensationalism about the DCG collapse issue completely ignores the separation between DCG and Greyscale, the underlying assets being custodied by Coinbase, and the regulatory restrictions on the conversion of trust funds; while ETH FUDers overlook that even if ETH completes the Shanghai upgrade, the unlocking of staked tokens will be limited and will not result in a massive one-time unlocking of tokens. It is undeniable that these projects have the potential to face issues, but even if they do, it is unlikely to bring about another shock on the level of FTX/LUNA.

(2) The green area still includes some very large entities, such as stablecoin issuers, Binance, custodians, all of which are in the hundreds of billions scale, theoretically capable of causing a "larger shock," but there are currently not enough signs indicating that they will face problems.

Overall, the probability of a larger shock than FTX is not high, and various incidents, including FTX, are merely a wave in the process of value regression. The FTX collapse accelerated the de-leveraging process, but did not have a substantial impact on the foundation of the crypto industry. This phenomenon has a positive side, as it will accelerate the bottoming of the VC Happiness Index, helping to reduce over-investment and eliminate bubbles. The downside is that it will continue to weaken the wealth effect in the industry in the future, affecting new capital inflows.

Through the above analysis, we can make a basic judgment about the cycle's progress: the driving factors of the bull market, especially the role of institutions, have been significantly weakened, and we are experiencing a de-bubbling process. Institutional collapses have accelerated this process, but the foundation for the development of the crypto industry has not been shaken; the myth of institutions driving growth in the past has vanished, and industry development is returning to its roots.

Part II The Main Line of Web3 User Growth

Based on the assessment of the current situation, what we can do in 2023 and the latter half of the bear market is very simple: return to technical construction; return to demand-driven; return to user growth. More specifically, it means refocusing on core application scenarios and core application needs. The market will only believe in real data, not ethereal visions. Web3 Product Value Capture Ability = Web3 User Count * Product Penetration Rate * Market Share * Value Capture Efficiency On the positive side, the current Web3 infrastructure has matured significantly compared to the last bear market, and the recognition and awareness of cryptocurrencies have also improved significantly. What we need to do next is to land users, achieve product penetration, and find and meet user needs.

Around the main line of Web3 user growth, there are several directional opportunities worth paying attention to:

2.1 Blockchain Solutions First, blockchain solutions. Large-scale users and applications inevitably require sufficiently robust infrastructure to support them.

2.1.1 L1s & L2s

The golden age of L1s has ended, and only those L1s that can truly bring something new will survive. The competitive landscape facing L1s in 2023 is significantly different from that in 2022, with changes reflected in:

Ø From 2017 to 2021, Ethereum's gas usage increased by 60 times (and it is a concave curve, showing an accelerating upward trend). In the mid to late stages of the bull-bear cycle, demand was significantly present and overflowing, which is why we can see the success of BSC/Solana/AVAX. These public chains essentially absorbed the overflow of funds/users/demand from ETH, with the underlying logic being that "new crypto users can conduct affordable transactions in these environments." However, in 2023, this overflow will visibly disappear. In the past two years, there have been 9 chains with peak TVL exceeding $8 billion: ETH/BSC/Terra/Polygon/AVAX/Solana/Fantom/Tron/Heco, but currently, the second/third-ranked Tron/BSC have only about $4 billion in TVL.

Ø Ethereum will clean up technical debt in the coming years, determine the scale and security of Rollups, and achieve an exponential increase in capacity.

Ø 2022 can be called the year of Layer 2. From the perspective of TVL, Arbitrum and Optimism's TVL reached about $1 billion and $500 million, ranking 4th and 7th respectively. In terms of daily on-chain activity, Arbitrum and Optimism have already surpassed most L1 competitors. In addition, competitive L1 dApps are increasingly being deployed on L2s; for example, Avalanche's Trader Joe recently announced their deployment on Arbitrum. In 2023, L2s and modularization are expected to bring new value stacking to ETH while putting greater pressure on L1 competitors.

Every cycle will produce new winners, but the biggest difference between 2022 and 2023 is that loose liquidity and market demand no longer exist. New L1s like Aptos and Sui have strong teams, funding, and supporter networks, but they must truly bring something new.

2.1.2 zkEVM, Modular Layers & L3

L3, zkEVM, modular layers, and complex middleware have become hot topics in market discussions in 2022. The starting point for alt L1s is the "increasing congestion of ETH and demand overflow," while L2s are expected to solve the current "execution bottleneck." How did this become popular due to Ethereum's increasing congestion and rising transaction costs? Many refer to this as the "execution bottleneck," which L2s temporarily resolved. In the post-merge world, Ethereum will focus on solving the so-called "data availability bottleneck," although this issue has not yet emerged.

Key Directions:

Ø Zero-Knowledge Proofs

Ø Implementation of Decentralized Data Availability and Sorters

Ø DA and execution solutions focusing on vertical development

Ø Tools and developer tools that make L3 easier to deploy.

Ø Cross-chain interoperability protocols (CCIP)

2.2 Web3 Infrastructure The second opportunity is Web3 infrastructure, which is the second layer of infrastructure. The logic is simple: the development of Web3 inevitably requires networks and protocols for computing, storage, bandwidth, finance, and identity. Although the penetration rate of most similar protocols is still very low, as long as users are engaged and penetration rates increase, value capture will be an inevitable event, as ENS has fully demonstrated.

2.2.1 On-chain Infrastructure

In the past cycle, the business model of Web3 Infra has been fundamentally validated. After DeFi Summer, DeFi projects went through a painful de-bubbling process, but afterward, a clear differentiation emerged, with blue-chip DeFi's competitive position further solidified, and more innovative projects began to appear. In the Web3 Infra space, ENS has demonstrated very strong revenue-generating capabilities, while Filecoin, Arweave, The Graph, and Helium have completed verifiable, de-bubbled revenue validation. The upcoming increase in Web3 users, improvement in infrastructure penetration rates, enhancement of charging capabilities, and explosion of application layers will bring predictable growth to Web3 Infra.

Key Directions:

Ø Addressing Basic Needs: Storage, Computing, Indexing

Ø The Cornerstone of DeSoc: DID, Social Graphs, SBTs

Ø SaaS Services: DAO SaaS, Smart Wallet SaaS, Security SaaS, etc.

2.2.2 PoPW Infrastructure

In addition to pure on-chain infrastructure, many protocols are utilizing the physical work proof framework to incentivize suppliers to participate in building hardware networks (like Helium). Multicoin Capital refers to this model as Physical Work Proof (PoPW). PoPW, like DeFi aimed at traditional markets and X2E aimed at third-world countries, represents a penetration from the crypto industry into non-crypto industries. Once the penetration rate reaches a certain level, it will complete a qualitative change from quantitative change, promoting the large-scale realization of Web3.

Key Directions:

Ø Decentralized Mobile Networks

Ø Decentralized Geography & Mapping

Ø Decentralized Environmental Data Collection

Ø Decentralized VPN

2.3 Web3 User Acquisition Almost no one is born a Web3 user; we need to actively cultivate Web3 users. The current scale of Web3 users (Ethereum addresses) is not much different from the scale of internet users in 1995. According to Huobi's estimates, the current global cryptocurrency user count is about 340 million, which is still significantly lower than Facebook's monthly active users (2.9 billion) and the number of Web2 users (5 billion). Better blockchain solutions and more complete Web3 infrastructure create the prerequisites for an explosion of Web3 applications, and the next step is how to achieve large-scale user migration.

2.3.1 Web3 User Education

There are now many products for Web3 education, such as Gameta and Hooked, and many other Web2 companies are also transitioning. The mainstream approach is a three-step process: attracting traffic, conversion, and distribution. Users complete their Web3 learning through practical experiences like creating their first wallet, owning their first token, obtaining their first NFT, and playing their first P2E game. GameFi guilds also have characteristics of user conversion and education products, with specialized products making the business more centralized.

Existing Web3 user education products have strong homogeneity, and potential differentiating factors include:

Ø Customer acquisition methods & conversion methods

Ø Conversion costs and conversion efficiency (differences among traditional vendors)

Ø User identification and user stratification (by region and value)

Ø Coupling degree of related businesses (low-threshold usage environments, infrastructure & information aggregation)

Ø Methods of sedimentation and value capture for users after conversion (value capture methods after conversion)

Key Directions:

Ø Gamified Education

Ø Community-based Education

2.3.2 Web3 User Integration

Currently, cryptocurrencies and NFTs have demonstrated their application potential in many fields and gained recognition in many traditional sectors, but the problem in the current Web3 space is that most developers and end-users find it difficult to interact with Web3 technology. It needs to be more aligned with Web2 usability. Existing Web2 products have massive data, user numbers, and business coordination. Compared to "creating a new Web3 product," "enabling Web2 products to have Web3 features" may be a more practical path.

Key Directions:

Ø Blockchain Integration for Developers

Ø Asset & Account System Services for Users

Ø SaaS Services for Data/Products

Ø Payment/DID/SBT/Social Graph plugins for existing products (like Twitter)

2.3.3 Web3 for the People

Regions lacking financial infrastructure often also experience widespread poverty, which means that for them, whether participating in DeFi or using payment functions requires them to have "income." The development of Play2Earn and Web3 brings unprecedented opportunities for them, allowing everyone in the world to generate value through participating in Web3 content creation, Play2Earn gold mining, or contributing their attention.

Potential Directions Include:

Ø Micro Income Streams: Aggregators for "micro income"

Ø Micro Income Plugins and Middleware

Ø Asset Management: Gathering, managing, and reinvesting funds

Ø Credit Finance: Credit lending, non-collateralized lending, etc., providing loan services for regions and people lacking financial infrastructure

Ø DAO Ventures/Crowdfunding: Allowing users to participate equally in Ventures, helping to fund more meaningful causes (such as education, healthcare, environmental protection, carbon emissions, etc.)

Ø Improving Cash Reserves: Many countries currently suffer from currency over-issuance and hyperinflation issues, and introducing stablecoins or more highly liquid currencies or asset combinations can help them resist inflation.

Ø Decentralized Charity

Ø APIs, Middleware, and Related Services in the Payment Field

2.4 User-Friendly Wallets

2.4.1 MPC Wallets

Fragmenting private keys is achieved through multi-party computation (MPC) to implement multi-signature off-chain. MPC wallet code is open-source, automatically generating simple passwords after "encapsulating" private keys, and then managing assets through passwords.

Features: No private keys; off-chain signing; semi-custodial; used in multi-party decision-making scenarios.

2.4.2 Smart Contract Wallets

Using contract accounts (CA) as wallet solutions. This is another mature "no mnemonic" solution.

Important Directions:

Ø MPC Custodial Wallets

Ø No Private Key Social Wallets

Ø Privacy Protection Wallets

Ø ZKP + MPC Multi-signature Wallets

Ø Combination of User-Friendly Wallets and Web3 Education

Ø Customized Wallet SaaS Services for Different Terminal Scenarios

Ø Products and Services for Ordinary Users/Small-Scale DAO Organizations

2.5 Small Needs Under the Big Narrative Finally, addressing small needs under the big narrative. In the process of large-scale migration of Web3 users, many small needs will actually arise, and capturing them can yield quite good results. For example, Link only created an oracle, and as a result, it emerged during DeFi summer, now ranking in the top 20 by market cap. Future structural opportunities like this still exist:

2.5.1 General Trading Aggregation

Important Directions:

Ø Token Liquidity Aggregation

Ø NFT Pricing/Oracles/Makers

Ø Extending the Breadth of Custodial Services

Ø Structured Derivatives

2.5.2 Web2 Products' Web3 Plugins

Important Directions:

Ø NFT Minting Tools

Ø Payment/Tipping Tools

Ø Integration of DID/Social Graphs with Web2 Products

Ø Integration of Storage with Web2 Products

2.5.4 ETH Bonding (also known as Liquid Staking Derivatives)

Ø Asset Reuse Stablecoins

Ø DEX Protocols Based on Super Liquid Staking

Ø Bond Discount Protocols

Ø Fixed Income Securities Products & Interest Rate Derivatives

2.5.5 DAO Transparency Tools

Ø DAO Governance Tools & Services

Ø DAO Governance Voting Proxy Protocols

Ø Trustless Products/Technologies

2.5.6 Anti-Regulation and Pro-Regulation Forks

Ø On-chain KYC/Compliant DeFi

Ø Decentralized Validators

Ø Compliant Crypto Brokers

Ø Stablecoins Decoupled from RWA