Analyze the upstream and downstream of the cryptocurrency industry to explore the value of downstream front-end applications

Original source: Richard Yuen X account

Author: Richard Yuen

Compiled by: Shenchao TechFlow

The downstream front-end application layer will become one of the largest components of the on-chain economy.

Many people are calling for more applications, but the reasons are misguided—this is not about venture capital firms trying to inflate their infrastructure assets or looking for the next 100x speculative story.

Here are some thoughts.

1. Value Chain - Upstream, Midstream, and Downstream

To understand the potential developments in the crypto/blockchain space, we can draw parallels from the evolution of mature industries (like the internet).

In the mature internet industry, its value chain can be divided into upstream, midstream, and downstream.

• Upstream: The foundational technologies and infrastructure that enable the internet; including hardware, connectivity, networks, core software, and protocols.
• Midstream: Platforms built on top of the underlying infrastructure; including data storage, cloud computing, hosting services, search engines, etc.
• Downstream: Platforms supported by midstream infrastructure that interact with end users and consumers; including social media, streaming, e-commerce, blogs, forums, and other applications.

The upstream value chain involves the development of foundational technologies, including the core protocols and software that midstream platforms rely on. Midstream platforms serve as a critical link, ensuring compatibility, optimization, and seamless integration between upstream infrastructure and technology providers and downstream consumer-facing platforms. Downstream platforms are the primary interface and delivery channel for end users, allowing consumers to access and use the products and services offered by these platforms.

The infrastructure provided by upstream and midstream platforms enables downstream applications to offer diverse products and infinite iterations to meet the needs of end users.

Upstream and midstream infrastructures typically have strong technological moats, with product homogenization and limited differentiation, often becoming commoditized, yet still able to achieve high profits (e.g., Amazon AWS), and some have become public goods.

Downstream applications have lower technological moats, but their product offerings are differentiated, with clear value propositions to attract users, focusing on user retention and creating strong network effects as their moat. Many applications will horizontally expand to offer a broader range of products, and some may even vertically integrate the entire value chain as they scale.

• Upstream and midstream platforms: B2B
• Downstream applications: B2C

As the blockchain/crypto industry develops, I expect the value chain to eventually form the following three main flows:

• Upstream: Foundational technologies and infrastructure that enable blockchain adoption; including protocols and networks (L1/L2), RPC/node infrastructure, execution and consensus clients, execution environments, consensus mechanisms, data storage, zkVM, data availability, etc.
• Midstream: Platforms built on top of the underlying blockchain infrastructure; including economic security, automated market makers (AMM), yield derivatives, intent solvers, oracles, as a service (RaaS), staking and re-staking, shared sequencers, interoperability, decentralized identity (DID), lending markets, chain abstraction, data indexing, etc.
• Downstream: Applications supported by upstream infrastructure; including centralized exchanges (CEX), decentralized exchange aggregators, order book decentralized exchanges, trading bots, games, centralized and decentralized finance (Ce-DeFi), entry and exit services, wallets, decentralized physical infrastructure (DePIN), social, gambling/betting, stablecoins, etc.

2. Key Observations and Thoughts:

Upstream crypto infrastructure is becoming homogenized. Infrastructure projects are almost all built on the same standardized mechanisms—such as proof of stake (PoS), EVM compatibility, etc. While certain projects may offer some degree of specialization or unique features, the overall functionalities provided by upstream participants are largely comparable.

The homogenization of upstream products will ultimately lead to price competition, with these projects striving to differentiate themselves in terms of pricing, performance, and developer relationship management (e.g., the commoditization of block space). Creating brands and network effects is becoming more important than ever for upstream participants to remain relevant in the competition.

It seems somewhat strange that upstream infrastructure (like L1/L2) bears most of the ordinary customer acquisition work, as their business models are primarily B2B. It appears very inefficient to indiscriminately airdrop billions of dollars to users of various downstream applications. Imagine if Amazon AWS spent billions helping its downstream customers (like ordinary traders on Robinhood or viewers of Netflix) with user onboarding—due to unfamiliarity with the product, user behavior/segmentation, engagement metrics, etc., it becomes difficult to devise the right user onboarding and retention incentive strategies. Consequently, billions end up being wasted on attracting airdrop farmers and hired users who will churn after the incentives end.

Midstream crypto infrastructure may face the same fate, becoming homogenized and ultimately commoditized.

DeFi applications like Uniswap, Aave, and Pendle—I intentionally classify them as midstream because the differences between participants in the same sub-industry are limited, and they will require more intuitive downstream applications (e.g., front-end aggregators/CeDeFi platforms) to provide better user experiences and scale. Currently, the user experience they offer often caters only to crypto natives (to be honest: setting up and funding hot wallets, navigating to DeFi applications, selecting the right products/trading pairs, choosing the right chain, confirming transactions, etc., is truly a nightmare for most non-native users).

Many midstream infrastructures are still in the iterative stage (especially intent layers/solver networks, co-processors, shared sequencing, chain abstraction)—as technology matures, this area will be able to provide better functionalities for downstream applications—faster, cheaper, more precise execution and computation, better interoperability, smoother user experiences…

The downstream crypto application space has a long way to go before reaching maturity. I expect the scale of the downstream space to surpass that of the upstream space—similar to the market structure in mature industries.

The two main categories of downstream applications: centralized and decentralized. Centralized applications (CEX, CeDeFi platforms, entry and exit services) provide more intuitive user interfaces/user experiences, similar to Web2 platforms, with less user onboarding friction, usually comply with regulatory requirements, and most have found some product-market fit. Decentralized applications leverage and aggregate upstream infrastructure as their support while providing smoother front-end interfaces to reduce user friction. This area will be at the forefront of accelerating the mass adoption of blockchain technology and cryptocurrencies.

Vertical integration—there is a trend where downstream applications that have found product-market fit begin to vertically integrate across the entire value chain and horizontally expand to offer a broader range of services. This phenomenon is not uncommon—Amazon's online bookstore (downstream) built its own logistics/fulfillment network (midstream) and cloud-based infrastructure (upstream) to support its e-commerce and other internal operations, and horizontally expanded its e-commerce products into every ordinary category. In the crypto space—consider centralized exchanges like Binance and Coinbase (downstream) launching BNB Chain and Base (upstream), incentivizing the building of midstream infrastructure on them, and horizontally expanding to offer a broader range of products—wallets, staking services, entry and exit services, custody, etc.; or consider the game Axie Infinity (downstream) launching the Ronin Chain (upstream), along with all midstream applications/infrastructure—Ronin Wallet, Katana (DEX), Mavis Market (NFT marketplace), Ronin Launchpad, Mavis ID (decentralized identity), Ronin RPC, etc.

I expect the burden of customer acquisition to shift back from upstream infrastructure to downstream applications. This will be catalyzed by:

1) L1/L2 ecosystems directly airdropping to applications, enabling them to design incentive programs based on their respective roadmaps, product designs, and business models;

2) Venture capital firms, L1/L2, and ordinary capital reassessing downstream applications and funding growth in this space.

3. Downstream Applications in the Value Chain Will Accumulate the Most Value

Regarding value creation: Upstream infrastructure creates value by pioneering technological innovations and improving the performance, efficiency, and reliability of foundational systems. Midstream platforms create value by packaging upstream technological products into applications, platforms, or ecosystems that are convenient for developers to use, meeting specific market demands. Downstream participants create value by enhancing the usability, accessibility, and personalization of products, relying on midstream and upstream infrastructure.

Current state: Upstream and midstream infrastructures have undergone 2-3 technological iteration cycles, and much of the value created by technological advancements has been reflected in the market capitalization growth of these areas. Innovation has stabilized, and technology has become homogenized. Meanwhile, downstream applications may experience unprecedented growth in the upcoming cycle as they begin to leverage increasingly mature upstream infrastructure to create value.

In mature industries, downstream platforms and applications typically receive the most user attention, as they are the only interface for user interaction. Users often do not know (and do not care) about the backend tech stack that these downstream applications are built on; what users care about most is the user experience these applications provide.

With strong network effects (user base) and differentiated product offerings, downstream platforms can command higher pricing power and achieve higher valuations.

Take ByteDance (the parent company of TikTok) as an example, which has over 50 million daily active users, generates $120 billion in revenue, and has a valuation of $268 billion; while its relied-upon CDN network Akamai only generates $3.8 billion in revenue, with a transaction value of $16 billion in 2023; the same applies to companies like Meta, Netflix, Google, etc.

Value flows from downstream applications that monetize through a large network of paying customers to midstream, and ultimately to upstream participants. The growth of downstream applications will promote the growth of the upstream technologies they rely on, forming a symbiotic relationship.

We have already seen that the fee income from crypto applications exceeds that of upstream infrastructure—midstream (Raydium, Uniswap, PancakeSwap, Aave, Lido, Jito); downstream (Ethena, Pump). Upstream infrastructures like Avalanche, Near, and Polygon are no longer in focus, generating only $10,000 to $100,000 in fees daily.

Take Uniswap and Ethereum as an example: a user trades $100,000 on Uniswap, paying $1 in network transaction fees to Ethereum, but Uniswap earns over $300 from transaction fees and MEV profits—it's evident which layer accumulates more value.

4. Maximizing Profitability

Downstream applications on L1/L2 are influenced by user activity's gas fees (L1 security fees and/or L2 execution fees), while also being affected by upstream L1/L2 block builders utilizing MEV, leaving a significant amount of funds unutilized.

Intuitively, to maximize revenue sources, many downstream applications are beginning to explore the possibility of reclaiming revenue generation sovereignty.

Downstream applications are expected to further privatize their order flow, building their own private mempool through vertical integration, and some may even become block builders. Some may launch their own application chains to capture more value.

Take the Banana Gun TG bot as an example—it is expected to pay over $100 million in priority fees and miner tips to Ethereum builders and validators. Already, 98% of the order flow goes through private mempools. If Banana Gun expands vertically to block building to capture more value, I wouldn't be surprised.

Some choose to build their own application chains to achieve a more optimized blockchain architecture for specific applications (throughput requirements, consensus algorithms, application-specific data structures, custom gas fees and economic incentives, sovereignty, etc.), allowing them to scale more efficiently than general-purpose blockchains. Value capture will also concentrate on application chains rather than sharing "revenue" with the underlying layer blockchain.

As the solver networks (Fastlane Atlas, Semantic Layer, Uniswap V4 hooks), interoperability and chain abstraction infrastructure, as well as services (RaaS) and aggregation stacks (OP stack, ZK stack, Arbitrum Orbit, etc.) mature and proliferate, the profitability of applications is expected to grow, leading to better value capture in the future.

5. The "Front-End Flip" Meta-Concept

Downstream front-end applications that provide smooth user experiences will lead the entry of millions of non-crypto users. Midstream applications like Curve, Aave, and upstream infrastructure will become the pillars of execution and settlement.

I particularly favor front-end applications that include trading bots and wallets with built-in exchanges that provide chain-abstracted trading experiences, optimizing trade execution and low fees; order books and centralized limit order books (CLOB) that offer a Web2-like trading experience, ensuring fast and low-cost trades; payment super apps with on/offline solutions that provide seamless P2P Venmo-like experiences for stablecoin transfers; and social applications and games that reasonably leverage financialization, asset ownership, and artificial intelligence to create experiences comparable to Web2 applications.

The "front-end flip" is happening.

For example, downstream front-ends like Jupiter and 1inch charge fees comparable to Uniswap and PancakeSwap.

Additionally, front-end applications like TG bots, wallet swaps, and aggregators have already generated about 50% of Ethereum transactions.

Downstream front-ends are capturing market share from midstream back-end applications. As these front-ends become the de facto standard for interacting with DeFi, the market share of back-end applications is expected to decline further.

The flipping of front-end fat applications is inevitable.