Author:
Li Jin
Translation:
Blockchain in Plain Language
The world’s largest companies are built on network effects. Companies like Amazon (worth $1.9 trillion), Meta (worth $1.2 trillion), Tencent (worth $4.59 trillion), and others have amassed market supply and demand. The more supply and demand they control, the higher their network value becomes.
The cryptocurrency space operates in a similar fashion. High-value networks like Bitcoin (worth $1.4 trillion), Solana (worth $790 billion), and Ethereum (worth $460 billion) are composed of developers, users, and network operators. As these networks expand, they become more valuable.
But when I look at the landscape of Web2 and Web3 markets, I not only see existing markets but also envision markets that do not yet exist. Through my years of entrepreneurial investment in the market, I have realized that there are markets that should exist to help connect supply and demand, and provide essential utility to both parties. However, due to limitations in the systems they create, these markets do not currently exist. I have also witnessed firsthand how new technologies provide opportunities for new markets to emerge and thrive.
Markets present the most exciting opportunities in the cryptocurrency space. By leveraging the killer capabilities of cryptocurrencies, such as token-incentivized scale expansion and on-chain composability, entrepreneurs can create new markets to serve underserved groups. This is an opportunity for transformative innovation, not just incremental innovation.
1. Systemic Barriers to Market Innovation in Web2
I have previously written about the era of service markets, where the internet market evolved from the listing era of the 1990s (represented by Craigslist) to the on-demand app era of “Uber for X” (2009-2015), and then to the managed market era of the mid-2010s.
Source: a16z, Li Jin, and Andrew Chen
Each era’s development responds to new technological or emerging market demands. In the listing era, the internet allowed individuals to post and search listings online. The “Uber for X” era provided instant access to various services and utilized users’ real-time location data. The managed market emerged to meet higher trust requirements in complex markets as market opportunities diminished.
However, each era also brought challenges that limit innovation. In the listing era, lack of trust and standardization hindered growth. In the on-demand era, significant capital investment was needed to scale the market to provide almost real-time services. Managed markets faced high operational costs related to establishing transaction trust, affecting the feasibility of these markets.
Many of these challenges still exist in Web2 markets, hindering the progress of innovation. Particularly, two issues, scalability and trust, impede progress, and cryptocurrencies have unique advantages in addressing these issues.
2. Scalability Issue
Traditional Web2 markets may require significant capital to establish and expand, especially on a large scale before the market becomes practical. This demand for capital sets entry barriers for new participants. This also means that due to the high cost of achieving the necessary scale, an entire market category may not be established, thus unable to provide utility.
For example, consider a dating application. In a dating network, a large number of users on both sides are needed to facilitate good matches. Traditionally, this means that platforms must spend a significant amount of money attracting a large number of users before the app is useful to any individual user. Dating applications also face the problem of low user retention rates, as users leave once they find success, further hindering scale expansion. Therefore, breakthrough winners are rarely found in the dating category.
3. Trust Issue
Another persistent challenge in Web2 markets is trust. Certain industry verticals require a high level of trust between market participants to conduct transactions. For example, in some categories, matching with the right provider/service carries high risks (e.g., childcare or elderly care). Other areas have high order values (e.g., luxury goods, art, real estate).
To establish the required trust, managed markets have built additional service and operational layers. For example, the childcare market extensively screens providers before they can transact on the market, including real-life interviews, background checks, and the creation of real-time visibility and location software tools. In real estate, some managed markets have taken on the responsibility of the entire end-to-end process, from repairs to acting as market traders for homes (“iBuyers”). These additional operations come with significant costs. Additionally, other markets wishing to list suppliers/providers on the market must replicate this effort, leading to inefficiencies in the market.
4. Solving Problems: Cryptocurrency’s Killer Capabilities
From the perspective of these challenges, cryptocurrencies have 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 cryptocurrencies excel at, it is scalability. The financial incentives provided by cryptocurrencies (in the form of tokens) have proven to be a powerful tool for driving growth.
Compared to Web2 markets, cryptocurrencies enable markets to grow in an orderly fashion through token-provided financial incentives, starting with the supply side and then expanding demand. For example, decentralized physical infrastructure networks (DePINs) like Helium and Hivemapper kickstart their supply side by providing token incentives to participants, with revenue from the underlying network catching up later.
Token incentives can be applied to many types of markets that do not exist due to the high cost of entry. Imagine a hyper-local social network that requires a large number of users to be heavily engaged (similar to Citizen but more widely applicable for information or real-time events), or a new dating application. In the field of artificial intelligence, we have seen developers apply token incentives to create new markets with no precedent in the Web2 world. Networks like Vana and Rainfall enable users to contribute data for AI training and receive token rewards. Aggregating long-tail, private, and hard-to-access datasets is almost impossible without intelligent incentives to drive large-scale user contributions.
2) On-Chain Reputation and History
One challenge mentioned in Web2 markets is the need for trust-building efforts in isolated markets. Each platform often needs to repeat these efforts. For example, Uber conducts background checks on all new drivers, but when the same driver downloads the Lyft app, the app also conducts a background check because these platforms are isolated.
One application of cryptocurrencies is as a portable reputation system. Instead of each application needing to conduct background checks separately, what if this information is stored on-chain and moves with the driver as they join any market? Furthermore, other information about provider history, such as reliability and quality, can be represented on-chain, enabling markets to combine and leverage a global trust repository. Such a system can eliminate the need for different managed markets to implement their capital-intensive processes. In Web2, many managed markets provide excellent user experiences but are ultimately not feasible as a business model due to high operating costs. Global on-chain reputation can 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 can already see borderless markets emerging on Farcaster. An 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 audit 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 local systems. This is particularly important for digital markets, as customers and suppliers are often geographically distant. For example, over 80% of YouTube users are located outside the US. To support local currency payments in each geographical region, platforms must integrate with international payment gateways. This often leaves some underserved regions, especially for resource-constrained, nascent markets, or platforms unable to internationalize.
Cryptocurrencies can operate globally from the outset, enabling transactions between anyone with a crypto wallet. This allows resource-constrained markets to have global reach from the start. For example, I recently purchased an NFT in an on-chain data community called bytexplorers, which allowed me to ask data-related questions to an analyst community. Analysts who answer correctly receive token rewards, enabling seamless payments and global participation.
5. Opportunities for the Next Generation of Markets
If there’s one thing I’ve learned from years of entrepreneurial investment in the market, it’s that the best opportunities arise when builders use new technologies to create significant improvements for end users. Every generation of market builders leverages new technologies to unlock new markets that were previously impossible.
Cryptocurrencies represent the next stage of this evolution. By leveraging token incentives for expansion, new markets can grow in a more capital-efficient manner. On-chain reputation and history can reduce the expenses of any given market operator. The payment methods based on cryptocurrencies enable markets to operate seamlessly across borders from the start. All of these not only improve existing markets but also give rise to new markets that can only exist under new cost structures and expansion strategies.
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