Blockworks: L1 will be the best risk trade of the next decade

Source: Blockworks

Compiled by: Shenchao TechFlow

"Most technologies tend to have workers perform mundane tasks. However, what’s different about blockchain is that its automation is decentralized. Blockchain hasn’t made taxi drivers unemployed; it has made Uber obsolete, allowing taxi drivers to work directly with customers."

-- Vitalik

How to Explain Everything About Cryptocurrency

If you’ve worked in the crypto space long enough, you’ll understand how painful it is to try to explain what crypto is to newcomers.

After working full-time in the crypto field for six years, I still feel flustered when my parents ask me to describe it.

Typically, I default to a Bitcoin-centric answer.

I first describe the problem: central banks print too much money, which is why Bitcoin was created as a digital currency that cannot be devalued by a central entity.

But I’ve started to find this answer unsatisfactory; while it’s an objective fact, today’s cryptocurrency is actually much broader than this answer suggests.

Nowadays, many people in the cryptocurrency industry don’t interact with Bitcoin and don’t care about solving money-related issues.

The development of cryptocurrency is so rapid that it’s difficult to describe what the industry is and why it’s important with a single overarching theory.

I’ve struggled with this for a while, and now I finally think I have a theory that can unify the question of what cryptocurrency is.

The Innovation of Cryptocurrency: Creating a New Commodity

The fundamental innovation of cryptocurrency is the creation of a new commodity: block space.

To overly simplify the definition, block space is storage that exists in cyberspace where any developer can run code or store data.

What makes block space unique as software is that it does not belong to a centralized owner of hardware.

Centralization is the current state of all our software. Companies like Google create extremely valuable software that we all use: Google Search, Gmail, Chrome, etc.

But if Google wanted to, they could unilaterally change anything. However, it turns out that such organizations have many advantages.

As a centralized organization, Google can quickly patch vulnerabilities. They can hire top talent and leverage economies of scale.

However, some software applications are not suitable for being occupied by a single party, especially those that are of high social trust and importance.

For example, while we trust Google, we wouldn’t trust them to manage our money. Why? Because they could change the amounts at any time without oversight. No matter how much we trust Google, we all know that the incentive to cheat is too strong.

These high-trust applications that are unsuitable for traditional software are precisely where block space is very useful. Because it is independently verified by a large number of independent participants globally, it effectively disrupts the existing rules, making hardware operators subordinate to software. This is why I think many people in Silicon Valley don’t understand crypto. It is fundamentally contrary to their business model.

Different Styles of Block Space

It turns out that, like any commodity, there are many different ways to refine block space. For example, Bitcoin’s block space has many unique characteristics that make it suitable for monetary use. Ironically, the properties of Bitcoin’s block space make it particularly well-suited for monetary purposes, but its performance is limited.

The Bitcoin network produces a block approximately every 10 minutes, with a maximum capacity of 4 megabytes. These limitations (and many others) prevent Bitcoin from entering many use cases—high-frequency trading, gaming, etc. However, for monetary purposes, these limitations are actually an advantage, as they force the network to avoid the complexities required to accommodate these applications.

Other block space producers (like Ethereum) have chosen a different set of trade-offs. Ethereum’s block space is general-purpose and better suited for a wider range of applications. This decision has made Ethereum face a broader consumer base for the block space it produces. However, the complexity it must deal with as a network reduces its monetary properties.

I could discuss different styles of block space (dedicated applications vs. general-purpose, block space that is subordinate to another blockchain sequence, such as Rollups, etc.) in multiple paragraphs.

The key point to remember here is that we are in the early stages of experimenting with and refining block space. In the future, I expect there will be a large and diverse market of block space producers and consumers, suitable for different use cases.

Why Do We Care That Block Space is a Commodity?

If you’re considering investing in the associated tokens, it’s important to understand the nature of block space.

This is an important point about understanding commodities. While there are many commodity investors, almost all are traders. No one buys and holds commodities for 20 years because commodities are designed by society to remain stable, or ideally, to decline. (Note: When I say "decline," I mean that actual purchasing power will decrease.)

The reason is obvious—commodities are things we use daily! If oil prices rise too much, policymakers will ultimately do everything they can to bring it back down. The same goes for other important commodities like steel, food, etc.

This is fundamentally the opposite of stocks, which are designed to rise. If the stock market declines for an extended period, policymakers will start looking for ways to make it rise again.

Of course, this statement is simplified, and there are other reasons for stock prices to rise (compounding, etc.), but that’s the high-level reason.

But I Was Told to Hold Cryptocurrency

This means that almost every newsletter reader will strongly dislike this point.

If L1 block space is a commodity, then all the assets we discuss at Blockworks (Bitcoin, Ethereum, Solana, Atom, etc.) are not long-term investments. From the perspective we just outlined, these are short-term trades rather than long-term investments.

But wait, you might say, the data doesn’t support this theory!

I acknowledge the Fat Protocol theory.

Bitcoin and other L1 tokens (like Ethereum) are the best-performing assets in cryptocurrency, far exceeding the equity of the most successful companies like Coinbase. But I don’t think this situation will last forever, and the reason is simple: the incentives of block space are similar to commodities. If Bitcoin is to become a successful currency, it cannot continue to grow at 100% per year. Similarly, for blockchains that produce block space for applications to consume (like Ethereum, Solana, etc.), the long-term incentive is for prices to peak at some point.

Some people will point out that the block space market and the token market are not 1:1. I understand this, but they are related because block space is priced in tokens, so they have an intrinsic connection.

I believe the best analogy for cryptocurrency over the past decade is a traditional commodity boom.

You can look at some examples from modern history, but I think the most relevant is the commodity boom of the 1970s.

Due to similar economic and geopolitical climates, I feel the comparison to the 1970s is most appropriate. The commodity boom was initially triggered by the Arab-Israeli conflict, but the underlying inflationary climate exacerbated the situation.

During the same period, Nixon suspended the gold convertibility window, leading to rapid expansion of the monetary base and skyrocketing gold prices.

Now, the point I want to make is not that the 1970s and today are exactly the same; currency devaluation and inflation are factors driving cryptocurrency prices up (though this is part of it).

My point is that throughout history, there have been various periods that misled investors into believing that commodities could maintain stock-like returns over long periods.

An interesting comparison that would make crypto OGs laugh is that in the 1970s and 2000s, people also began to say we were experiencing a commodity supercycle (shoutout to Su Zhu).

My view of the current period is that it is the first phase of a digital commodity boom in the world. Block space is a novel commodity that can be used for an extremely wide range of applications, which is why it is expanding so rapidly.

However, just like all previous commodity booms, financial gravity will eventually take effect. Over time, your favorite L1 will start trading like corn, steel, or soybeans.

The last comparison between the 1970s commodity boom and the 2010s digital commodity boom is their psychological impact on market participants.

There is a very interesting comparison between gold standard advocates and today’s cryptocurrency proponents.

To me, what’s interesting about gold standard advocates is that after the incredible price increases of the 1970s, gold’s performance lagged behind all other assets in the world. Yet, 40 years later, this community is more fervent than ever. If you really think about it, that’s quite incredible.

I believe the same situation exists in cryptocurrency. When an asset you own increases by 10x or 100x, the brain chemistry of most people changes, and it’s hard to forget.

In the cryptocurrency space, I think there are also two other underappreciated dynamics fueling the prevailing tribalism.

The loneliness of the network age. Young people are increasingly seeking community in an isolated world, and large cryptocurrency communities (like Bitcoin, Solana, Ethereum) can provide that service.

Layer-1 needs large communities to come together to create roadmaps that have very meaningful technical trade-offs, but only a small number of engineers truly understand them. Therefore, the strategy is to create narratives around these trade-offs to garner public support (as seen in the block size wars).

So, my prediction for the foreseeable future is that tribalism will increase, not decrease, during this cryptocurrency commodity boom.

Conclusion

For some, this prediction may sound pessimistic. It doesn’t for me.

I believe we are still in the early stages of experimentation and expansion of L1 blockchains. So the good news is that I think we are far from the end of this block space commodity boom. I expect there are still 5 to 10 years to go.

So if you still like Ethereum, Solana, Celestia, or others, you still have plenty of time; I guess existing and new L1s will be the best risk trades of the decade (this is not investment advice). But ultimately, I expect the market to adjust based on the style of block space it requires and become commoditized.

For some, I would understand that this sounds bearish, but I disagree. I think it’s a good thing. My long-term view on cryptocurrency is that it is a foundational layer that enables previously impossible new use cases and businesses. To build waves of businesses for generations to come, we need rich, cheap, and useful block space. And that is exactly what is being built today.

If you’ve read this far, here’s a brief summary of the article:

• The fundamental innovation of cryptocurrency is the innovation of a new commodity: block space;

• The cryptocurrency of the past decade is a block space commodity boom that may continue for the next 5-10 years;

• But ultimately, block space will become commoditized, and Layer-1 will begin to trade horizontally;

• This will pave the way for the first generation of businesses built on block space, which will cross the chasm into the mainstream;

• The equity of these businesses supporting block space will begin to surpass the underlying Layer-1;

One exception to this theory may be blockchains like Bitcoin, whose use case is not to build businesses on it but to serve as currency.

I think this is a valid exception, although as I pointed out earlier, if Bitcoin is to serve as currency, its volatility and returns will decrease over time.

Thus, I ultimately believe the outcomes will be very similar. (As a side note: I think this exception is understood by the crypto community, which is why Ethereum is trying to rebrand itself as "ultrasound money.")

In summary, this is very exciting for me. In the next decade, I look forward to seeing the Cambrian explosion of block space continue. Both investors and users will do well (non-financial advice). Personally, I am excited about what will happen next, which is the wave of businesses built on this block space.

I think when we look back in ten years, we will be amazed at the tremendous changes and everything we have built.

As Bill Gates famously said: "We overestimate what we can do in a year and underestimate what we can do in ten years."