Blockchain: Down the Rabbit Hole
Blockchain is eating the world. It was in 2011, that Marc Andreseen prophetically stated that software was eating the world. To date, blockchain adoption has been faster than that of the internet.
When trying to understand the magnitude of the shift that is occurring, there is a temptation to resort to traditional market sizing techniques.
Healthcare + blockchain. Finance + blockchain. Music + blockchain. The list goes on…
At Aura Ventures, we have found this to be unhelpful as blockchain will change every industry in some capacity as well as create new ones. Instead, we chose to focus on the different layers of the blockchain onion and the use cases that peel off at each layer. This approach is far more ecosystem centric and clearly separates enterprise adoption against startup activity.
Our market map looks this:
Where is the opportunity in this labyrinth of use cases?
Before we explore that, we need to understand some key terms and the structure of the ecosystem.
Private and public blockchains are very different. Public blockchains that we know and love, include Bitcoin, Ethereum and basically any protocol that you can buy and sell on an exchange. Many people around the world own the network — it is decentralised by design. Contrast this to a private blockchain in which the infrastructure is owned by a central authority and only authorised participants can add to the blockchain.
Private blockchains
Private blockchains get little attention, but we believe they are generating considerable real-world value. Whilst the promise of offering maximal efficiency for large enterprises as a fundamentally new data structure is not appealing to the public, it is world changing. Not in its promise of a new system but in making the existing one incrementally more efficient.
There are a few use cases across industries that the private blockchain excels in — registry, supply chain tracking, royalties, secure data storage and for some types of transactions.
For example, the Danish shipping conglomerate — A.P Moller-Maersk is digitising the world’s supply chain information for container ships. With the help of IBM’s private blockchain, they have already onboarded roughly 50% of container ships in the world. Imagine if you could trace where each part of the car you bought came from — tyres from Denmark, steel from Germany and leather from Italy.
Carrefour, a French supermarket, is doing exactly that for food by tracing more than 30 of it’s product lines on a private blockchain. Consumers can track produce such as eggs from farm to plate. These use cases leverage all the promises of blockchain without being restricted by the scalability issues of a public blockchain.
Closer to home, our portfolio company, Lygon, uses a private blockchain to digitise bank guarantees bringing both speed and trust to an archaic process that wastes 4 million pieces of paper per year.
In 2019, analysts found that private blockchains accounted for nearly half of the value capture in the blockchain market. While the pendulum has no doubt shifted to public blockchains, we believe it will shift back.
Private blockchains with enterprise adoption do not face the chicken and egg problem common to most two-sided platforms. Large enterprises can onboard one side rapidly to the platform and instantly benefit from the advantages of the new technology without the limitations of scalability and speed. Just look at Walmart ‘requesting’ its thousands of suppliers to start using its private blockchain to track the supply chain.
Public blockchains
For all their limitations, public blockchains are magical.
A public blockchain is an immutable ledger that each node has a copy of in a decentralised network. It allows computers that do not trust each other to work together to form a powerful super computer that is trustworthy and reliable.
There are four fundamental layers to the public blockchain ecosystem.
Layer one (L1) is the underlying blockchain itself. Think Bitcoin, Ethereum & Cardona.
Layer two (L2), is a third-party integration/network designed to improve the performance of the underlying blockchain. Think Starkware, Immutable & the Lightening Network.
Layer three (L3) are smart contracts that run on top of these networks & protocols (called decentralised applications or Dapps). Think Compound, Uniswap & Synthetix.
Finally, Layer four (L4), is how people connect and interact with these Dapps and blockchains (the user interface layer). Think Coinbase, Binance & Metamask.
For a long time, most of the value has been concentrated around Layer 1 blockchains. Speculation has made it very profitable to be the holder of a cryptocurrency that goes to the moon.
Most of these coins are trading at multiples that exceed their underlying revenue generated by transaction fees.
Cosmos made $9k in the last twelve months from protocol revenue, it’s market cap is USD 8.5B as of late 2021. Now some might argue that it is a good sign if a L1 protocol generates such little revenue for the protocol as it is not meant to be a profit seeking company but a public utility.
So that begs the question, where does genuine, non-speculative value come from in crypto land?
As the system matures, we believe greater value will be generated from L2 & L3.
This has already been seen with L2 scaling solutions raising some very large rounds.
Some exciting things are happening in L3 Dapps, with Defi being the most mature part of the ecosystem.
Take the Aussie company, Synthetix as an example. It allows you to trade derivatives of currencies & even equities in a completely decentralised matter. You could trade Gold for Apple without any need for a book maker as the protocol relies on a peer to peer liquidity pool.
Blockchain is taking it’s first bite of the multi trillion dollar derivatives market.
It’s little surprise that over USD 100 billion is locked in Defi applications as of late 2021. The financial sector has been a great on ramp for the technology. Early adopters are technologically savvy and enjoy the many creative financial products on offer. From a technology perspective, executable smart contracts lend themselves perfectly to the financial industry, a historically opaque industry with lots of complex financial products based on programmable rules is ripe is perfect for disruption.
But there is more going on outside of Defi. The ecosystem of Dapps being built on top of Solana is some of the most exciting in the space. Audius is a music streaming platform that is built on the blockchain and offers far higher royalties for artists and better quality music for listeners. It currently has artists such as Deadmaus and Rezz on the platform. The protocol is such that 90% of the platform’s revenue goes to artists.
There are even Web 3.0 dating apps built on Solana. The app provides a token incentive for matches on the platform. Wild.
Where to from here?
The adage is as old as time, in a gold rush sell pick axes. Every investor initially wants to support the infrastructure layer of the ecosystem as opposed to more speculative crypto consumer companies (Soldate is one of them). Much of the early work supporting protocols and L2 scaling solutions has been done and means there is still more infrastructure to be built on top of that.
At Aura Ventures, we believe in products that people love. As an investment thesis, this translates to understanding where the advantages of blockchain are indisputable and investing in companies that provide a 10x better consumer experience — infrastructure layer or not. Many crypto consumer companies are more focused on the technology than the customer.
But sometimes companies like Audius come along with a value proposition that is too strong the market can’t refuse. Higher quality music with 90% of royalties going to the artist.
These are the types of companies we are excited about and hope to partner with one’s like them in the future.
