Scale, on-chain reputation, and payments: How do the three killer capabilities of cryptocurrency build emerging markets?

Original Title: 《 Crypto and Net-New Marketplaces》

Author: Li Jin, Variant

Compiled by: Baihua Blockchain

The largest companies on Earth are all built on market networks that leverage network effects. Companies like Amazon (market cap $1.9 trillion), Meta (market cap $1.2 trillion), and Tencent (market cap $4.59 trillion) have aggregated market supply and demand; the more supply and demand they control, the higher their network value.

The same is true in the cryptocurrency space. High-value networks like Bitcoin (market cap $1.4 trillion), Solana (market cap $79 billion), and Ethereum (market cap $460 billion) are all multi-sided networks composed of developers, users, and network operators that become more valuable as they scale.

However, when I look at the landscape of Web2 and Web3 markets, I see not only existing markets but also markets that do not yet exist.

In my years of market venture capital, I have learned that there are markets that should exist, which can help both supply and demand sides find each other and provide significant utility to both, but these markets currently do not exist due to the limitations of the systems they are built upon. I have also witnessed how new technologies create opportunities for new markets to emerge and thrive.

Markets represent the most exciting opportunities in the cryptocurrency space. By leveraging the killer capabilities of cryptocurrency—namely, token-based incentives for scaling and on-chain composability—entrepreneurs can create new markets to serve unmet demand groups. This is an opportunity for leapfrog innovation, not just incremental innovation.

1. Systemic Barriers to Market Innovation in Web2

I have previously written about the era of service markets, specifically how internet markets evolved from the listing era of the 1990s (represented by Craigslist) to the "Uber for X" era of on-demand applications (2009-2015), and then to the era of managed markets (mid-2010s).

Source: a16z, Li Jin and Andrew Chen

The development of each era is a response to new technologies or emerging market demands. In the listing era, the internet enabled individuals to post and find listings online. The "Uber for X" era, which coincided with the rise of smartphones, provided instant access to various services and leveraged users' real-time location information. Managed markets emerged in response to the decreasing market opportunities to meet the higher trust demands in complex markets.

However, each era also brought challenges that limited innovation. In the listing era, a lack of trust and standardization constrained growth. In the on-demand era, scaling the market to provide near-real-time services required massive capital investment. Managed markets faced high operational costs associated with establishing transaction trust, impacting their viability.

Many of these challenges still exist in Web2 markets, hindering the progress of innovation. In particular, two issues—scalability and trust—have impeded progress, while cryptocurrency has unique advantages in addressing these issues.

2. The Scalability Issue

Traditional Web2 markets often require massive funding to establish and scale, especially before the market achieves utility at scale. This capital requirement sets a barrier to entry for new participants. It also means that entire market categories may fail to establish due to prohibitively high costs to achieve the necessary scale, thus failing to provide utility.

For example, consider dating applications. In a dating network, a good match requires both sides to have a large number of users. Traditionally, this means the platform must spend heavily to attract a large user base before the app is useful to any individual user. Dating apps also face low user retention issues, as users tend to leave once the app is successful, further hindering scalability. As a result, there are few breakthrough winners in the dating category.

3. The Trust Issue

The second persistent challenge in Web2 markets is trust. Certain industry verticals require a high level of trust between market participants to transact. For example, matching with the right provider/service carries high risks in certain categories (e.g., childcare or elder care). Other areas involve high order values (e.g., luxury goods, art, real estate).

To establish the necessary trust, managed markets have built additional services and operational layers. For instance, childcare markets conduct extensive vetting of providers before they can transact on the market, including real-life interviews, background checks, and building software tools for real-time visibility and location. In real estate, some managed markets have taken on the responsibility for the entire end-to-end process, from repairs to acting as market makers for homes ("iBuyers"). These additional operations come with significant overhead. Moreover, other markets wishing to list suppliers/providers must repeat this effort, leading to inefficiencies in the market.

4. Solutions: The Killer Capabilities of Cryptocurrency

From the perspective of these challenges, cryptocurrency has three killer capabilities that open up new potential directions for market innovation: scalability, on-chain reputation, and payments.

1) Scalability

If there is one thing cryptocurrency excels at, it is scalability. Cryptocurrency incentives (in the form of tokens) have proven to be a very powerful tool for driving growth.

Compared to Web2 markets, cryptocurrency enables markets to grow sequentially through token-based financial incentives, starting from the supply side and then expanding demand. For example, decentralized physical infrastructure networks (DePINs) like Helium and Hivemapper kickstarted their supply side by providing token incentives to participants, while the revenue from the underlying network later caught up.

You can apply token incentives to many types of markets that do not exist due to high startup costs. Imagine a hyper-local social network that requires a large number of users to be densely active (similar to Citizen but more broadly applicable to information or real-time events), or a new dating application. In the AI space, we have already seen developers apply token incentives to create new markets that have no precedent in the Web2 world. For example, networks like Vana and Rainfall enable users to contribute data for AI training and earn token rewards. Aggregating long-tail, private, hard-to-access datasets would be nearly impossible without smart incentives to mobilize large-scale user contributions.

2) On-Chain Reputation and History

One challenge mentioned above in Web2 markets is that isolated markets need to repeat efforts to establish trust. For example, Uber conducts background checks on all new drivers, but when the same driver downloads the Lyft app, that app also conducts a background check because these platforms are isolated.

One application of cryptocurrency is as a portable reputation system. What if this information were stored on-chain and moved as drivers joined any market, rather than requiring each application to conduct separate background checks? Furthermore, other information about provider history, such as reliability and quality, could be represented on-chain, allowing markets to aggregate and leverage a global trust repository. Such a system could eliminate the need for different managed markets to implement their own capital-intensive processes. In Web2, many managed markets provide excellent user experiences, but due to high operational costs, they ultimately become unviable as business models. A global on-chain reputation could fundamentally change their cost structures.

You can find a microcosm of this idea in the Farcaster ecosystem. This social media protocol stores posts, likes, follows, and profiles in a decentralized central network. When users install different applications built on this protocol, their social data moves with them. We are already seeing borderless markets emerge on Farcaster. One example is Bountycaster, where users can post and discover bounties on any Farcaster client, leveraging the rich reputation data on the Farcaster network. With this portable social data, you can imagine various new markets emerging in the Farcaster ecosystem, from smart contract auditing markets to expert markets leveraging Farcaster's connection graph and reputation.

3) Payments

Facilitating payments is a core component of modern markets, but in Web2, supporting cross-border payments requires internationalization across various local systems. This is particularly important for digital markets, as customers and suppliers are often far apart. For example, over 80% of YouTube users are located outside the United States. To support local currency payments in each geographic region, platforms must integrate with international payment gateways. This often results in some marginal areas being underserved, especially for resource-limited, nascent markets or platforms that cannot internationalize.

Cryptocurrency can operate internationally from the outset, enabling transactions between anyone with a crypto wallet. This allows resource-limited markets to have a global impact from the beginning. For example, I recently purchased an NFT in a blockchain data community called bytexplorers, which allowed me to pose data-related questions to an analyst community. Analysts who answered correctly received token rewards, enabling seamless payments and global participation.

5. Opportunities for Next-Generation Markets

If I have learned anything from my years in market venture capital, it is that the best opportunities arise when builders leverage new technologies to create significant improvements for end users. Each generation of market builders has utilized new technologies to unlock new markets that previously could not exist.

Cryptocurrency represents the next stage of this evolution. By leveraging token incentives for scaling, new markets can grow in a more capital-efficient manner. On-chain reputation and history can reduce the overhead for any given market operator. Cryptocurrency-based payment methods allow markets to operate seamlessly across borders from the outset. All of this will not only improve existing markets but also give rise to new markets that can only exist under new cost structures and scaling strategies.