The window of opportunity for infrastructure has passed, and the future belongs to applications?
Brand and user experience are the sustainable moats of the application.Author: Adrian
Compiled by: Luffy, Foresight News
Historically, the most lucrative investment returns in every crypto cycle have been achieved by early bets on new underlying infrastructure primitives (PoW, smart contracts, PoS, high throughput, modularity, etc.). If we look at the top 25 tokens on CoinGecko, we find that only two are not native L1 blockchain tokens (excluding pegged assets): Uniswap and Shiba Inu. This phenomenon was first theorized by Joel Monegro in 2016, who proposed the "Fat Protocol Theory". Monegro argued that the biggest difference in value accumulation between Web3 and Web2 is that the value accumulated at the cryptocurrency base layer is greater than the sum of the value captured by the applications built on top of it, and this value comes from:
Blockchains have a shared data layer where transactions are settled, facilitating positive-sum competition and enabling permissionless composability.
Token appreciation -> introduction of speculative participants -> initial speculators convert to users -> users + token appreciation attract developers and more users, etc. This path forms a positive flywheel.
Fast forward to 2024, the initial argument has undergone countless industry debates, while the industry dynamics have also experienced several structural changes that challenge the original claims of the Fat Protocol Theory:
- Commoditization of Block Space: In the context of Ethereum block space premiums, competitive L1s have risen and become asset class definers. Competitive L1s are often valued in the billions, and builders and investors are attracted to competitive L1s in almost every cycle, with new blockchains emerging each cycle that "bring differentiation," exciting investors and users, but ultimately becoming "ghost chains" (like Cardano). While there are exceptions, this has generally led to an oversupply of block space in the market without enough users or applications to support it.
- Modularization of the Base Layer: As the number of dedicated modular components increases, the definition of "base layer" becomes increasingly complex, not to mention the value generated by deconstructing each layer of the stack. However, what can be said for certain is:
The value in modular blockchains is decentralized across the entire stack, and for a single component (e.g., Celestia) to achieve a valuation higher than that of an integrated base layer, its component (e.g., DA) must become the most valuable component in the stack and build "applications" on top of it, thus having more usage and fee revenue than the integrated system;
Competition between modular solutions drives cheaper execution/data availability solutions, further reducing costs for users.
- Towards a Future of "Chain Abstraction": Modularization inherently causes fragmentation in the ecosystem, leading to cumbersome user experiences. For developers, this means too many choices about where to deploy applications; for users, this means overcoming numerous hurdles to move from application A on chain X to application B on chain Y. Fortunately, many smart people are building a new future where users can interact with crypto applications without knowing the underlying chains. This vision is referred to as "chain abstraction." The current question is, where will value accumulate in the future of chain abstraction?
I believe that crypto applications are the primary beneficiaries of our shift in how we build infrastructure. Specifically, intention-centered transaction supply chains, with order flow exclusivity and intangible assets like user experience and branding, will increasingly become a moat for killer applications, enabling them to commercialize more effectively than they do now.
Order Flow Exclusivity
Since the Ethereum merge and the introduction of Flashbots and MEV-Boost, the MEV landscape has undergone significant changes. What was once a dark forest dominated by searchers has now evolved into a partially commoditized order flow market, where the current MEV supply chain is primarily dominated by validators, who capture about 90% of MEV in the form of bids from each participant in the supply chain.
Ethereum's MEV Supply Chain
Validators extract most of the extractable value from order flow, leaving most participants in the transaction supply chain dissatisfied. Users want to be compensated for generating order flow, applications want to retain value from users' order flow, and searchers and builders want to maximize profits. As a result, value-seeking participants have adapted to this change, experimenting with various strategies to extract alpha, one of which is the searcher-builder integration. The idea is that the higher the certainty of a searcher packing a block, the higher the profit. A wealth of data and literature suggests that exclusivity is key to capturing value in competitive markets, and applications with the most valuable traffic will have pricing power.
This is similar to Robinhood's business model. Robinhood sells order flow to market makers and receives rebates, maintaining a "zero-fee" trading model. Market makers like Citadel are willing to pay for order flow because they can profit through arbitrage and information asymmetry.
An increasing amount of trading is conducted through private mempools, further highlighting this trend, which recently reached a historic high of 30% share on Ethereum. Applications realize that the value of all user order flow is being extracted and leaked into the MEV supply chain, while private trading allows for more customization and commercialization around sticky users.
As we enter the era of chain abstraction, I expect this trend to continue. Under an intention-centered execution model, the transaction supply chain may become more decentralized, with applications directing their order flow to solver networks that can provide the most competitive execution, driving competition among solvers to lower profit margins. However, I anticipate that most value capture will shift from the base layer (validators) to the user-facing layer, where middleware components are valuable but have low margins. Frontends and applications that can generate valuable order flow will have pricing power over searchers/solvers.
Possible Future Value Accumulation Methods
Today, we are already seeing this happen, utilizing niche order flow forms from specific applications (e.g., oracle extractable value auctions, Pyth, API 3, UMA Oval), where lending protocols are regaining liquidation bid order flow that would have otherwise flowed to validators.
User Experience and Branding as Sustainable Moats
If we further break down the aforementioned 30% of private trading, most of it comes from frontends like TG Bots, Dexes, and wallets:
While it has often been thought that the attention of crypto-native users is not concentrated, we ultimately see a certain degree of retention. Both branding and user experience can serve as meaningful moats.
User Experience: Introducing entirely new forms of frontend that connect wallets on web applications will undoubtedly capture the attention of users who need specific experiences. A great example is Telegram bots like BananaGun and BONKbot, which have generated $150 million in fees, allowing users to trade Memecoins in the comfort of Telegram chats.
Branding: Well-known brands in the cryptocurrency space can charge more by earning users' trust. It is well-known that the fees for in-app exchanges in wallets are very high, yet it is a killer business model because users are willing to pay for convenience. For example, MetaMask swap generates over $200 million in fees annually. The frontend fees from Uniswap Labs have netted $50 million since launch, and transactions interacting with Uniswap Labs contracts in any way other than through the official frontend do not incur this fee, yet Uniswap Labs' revenue continues to grow.
This indicates that the Lindy effect in applications is consistent with, or even more pronounced than, that in infrastructure. Typically, the adoption of new technologies (including cryptocurrencies) follows some sort of S-curve, and as we transition from early adopters to mainstream users, the next wave of users will be less mature and therefore less price-sensitive, allowing brands that can reach critical scale to profit in creative ways.
The S-Curve of Cryptocurrency
Conclusion
As a cryptocurrency practitioner primarily focused on infrastructure research and investment, this article is not meant to deny the value of infrastructure as an investable asset class in cryptocurrency, but rather to reflect on the shift in mindset when considering a new category of infrastructure. These infrastructure categories enable the next generation of applications to serve users above the S-curve. New infrastructure primitives need to bring entirely new use cases at the application level to attract sufficient attention. At the same time, there is ample evidence that sustainable business models exist at the application level, where user ownership directly guides value accumulation. Unfortunately, we may have already passed the market phase for L1s, where betting on every new shiny L1 would yield exponential returns, although those with meaningful differentiation may still be worth investing in.
Even so, I have spent considerable time thinking about and understanding different "infrastructures":
Artificial Intelligence: The agent economy that automates and improves end-user experiences, the computation and reasoning markets that continuously optimize resource allocation, and the validation stack that expands blockchain virtual machine computing capabilities.
CAKE Stack (https://frontier.tech/the-cake-framework): Many of my points above suggest that I believe we should move towards a future of chain abstraction, while the design choices of most components in the stack remain significant. As infrastructure supports chain abstraction, the design space for applications will naturally grow, potentially blurring the distinction between applications and infrastructure.
DePIN: For some time, I have believed that DePIN is the killer real-world use case for cryptocurrency (second only to stablecoins), and this has never changed. DePIN leverages everything that cryptocurrencies excel at: permissionless coordination of resources through incentives, guiding markets, and decentralized ownership. While each specific type of DePIN network still faces particular challenges that need to be addressed, solutions to validate cold start issues are significant, and I am very pleased to see founders with industry expertise bringing their products into the crypto space.
