A New Framework For Identifying Moats In Crypto Markets
Author: Robbie Petersen, Delphi Digital Analyst
Translated by: Ismay, BlockBeats
In the current competitive crypto market, the concept of a moat is no longer limited to traditional liquidity and TVL. With the rapid development of DeFi applications, relying solely on liquidity advantages is no longer enough to maintain a sustainable competitive edge. This article delves into how crypto applications can establish truly defensive moats through differentiation in branding, user experience, and continuous rollout of new features. Through the analysis of cases such as Uniswap and Hyperliquid, we reveal that continuous innovation is the key to resisting competition and capturing value in this uncertain industry.
The success of every company—whether a tech giant or a century-old establishment—can be attributed to its moat. Whether it’s network effects, user migration costs, or economies of scale, the moat ultimately allows companies to evade the natural laws of competition and sustainably capture value.
While defensiveness is usually a factor considered after the fact for crypto investors, I believe that in the current market context, the concept of a moat is even more important. This is because there are three unique structural differences in crypto applications:
– Forkability: The forkability of applications means that the barriers to entry in the crypto market are lower.
– Composability: Due to interoperability of applications and protocols, the user switching costs are inherently lower.
– Token-based user acquisition: Using token incentives as an effective user acquisition tool means that the customer acquisition cost (CAC) for crypto projects is structurally lower.
These unique attributes collectively accelerate the competitive dynamics of crypto applications. Once an application opens the “charging switch,” not only will there be numerous other indistinguishable applications offering similar but cheaper user experiences, but there may even be some applications subsidizing users through tokens and points.
Logically, in the absence of a moat, 99% of applications will inevitably be drawn into a “price war,” leading to the inevitable commodification of the product.
While we have many precedents and inspirations for understanding moats in traditional markets, we lack a corresponding framework to explain these structural differences. This article aims to fill this gap, delving into the fundamental elements that constitute a sustainable moat and thereby identifying a few applications that are able to sustainably capture value.
A New Framework for Evaluating Application Defensiveness
The “Oracle of Omaha” Warren Buffett has a simple but effective method for identifying companies with defensiveness. He asks himself, “If I had $1 billion and started a competing business with this company, could I capture a large market share?” By making some adjustments to this framework, we can apply the same logic in the crypto market, taking into account the aforementioned structural differences: “If I fork this application and invest $50 million in token subsidies, could I capture and maintain market share?”
By answering this question, you are essentially simulating the laws of competition. If the answer is “yes,” it is likely only a matter of time before a new fork or undifferentiated competitor erodes the market share of that application. Conversely, if the answer is “no,” then this application likely possesses what I believe are the common traits of all defensible crypto applications.
Characteristics of “Non-Forkable” and “Non-Subsidizable”
To better understand my point, let’s take Aave as an example. If I were to fork Aave today, no one would use my forked version because it would not have enough liquidity for users to borrow and not enough users to borrow that liquidity. Therefore, in markets like Aave’s lending market, TVL and bilateral network effects are “non-forkable” characteristics.
However, while TVL does provide a certain degree of defensiveness for the lending market, the key lies in whether these characteristics are also immune to subsidies. Imagine a well-funded team not only forking Aave but also designing a $50 million incentive program to acquire Aave’s users. If the competitor can reach a competitive liquidity threshold, users may not have much incentive to switch back to Aave, as the lending market is essentially undifferentiated.
It is worth clarifying that I do not believe any team will be successful in draining Aave in the near future, as subsidizing $12 billion in TVL is no small task. However, for other lending markets that have not yet reached this scale, they are at risk of losing significant market share. Kamino recently provided a precedent in the Solana ecosystem.
Additionally, it is worth noting that while large lending markets like Aave may be able to resist threats from emerging competitors, they may not necessarily be completely immune to horizontal integration from adjacent applications. For example, since the launch of MakerDAO’s lending division Spark as a fork of Aave in August 2023, it has taken away over 18% of the market share from Aave. Given Maker’s market position, they are able to effectively attract and retain users as a natural extension of the Maker protocol.
Therefore, if lacking other characteristics that cannot be easily subsidized (such as collateralized debt positions embedded in the DeFi market structure), the structural defensiveness of a lending protocol may not be as strong as one might imagine. Once again, asking the question—”If I fork this application and invest $50 million in token subsidies, could I capture and maintain market share?”—I believe that for most lending markets, the answer is actually yes.
Front-Ends Capturing More Value
The popularity of aggregators and forked front-ends has made the defensiveness issue in the DEX market more complex. Historically, if you asked me which model was more defensible—decentralized exchange platforms or aggregators—my answer would clearly be decentralized exchange platforms. Ultimately, the front-end is just a different perspective on viewing the back-end, and the switching costs between aggregators are inherently lower.
In contrast, decentralized exchange platforms have a liquidity layer, and the switching costs from a forked exchange platform with less liquidity are much higher, leading to more slippage and poorer net execution results. Therefore, given that liquidity cannot be forked and is also more difficult to subsidize on a large scale, I have previously believed that DEXs have stronger defensiveness.
Although this view still holds true in the long term, I believe the balance may be shifting towards the front-end, with more and more value being captured by front-ends. My reasoning can be summarized by four reasons:
Liquidity is more like a commodity than you think
Similar to TVL, while liquidity is inherently “non-forkable,” it is not immune to subsidies. There have been numerous precedents in DeFi history that seem to confirm this logic (e.g., SushiSwap’s vampire attack). The structural instability of the perpetual contract market also reflects the fact that liquidity alone cannot be a sustainable moat. Countless emerging perpetual contract DEXs have been able to quickly gain market share, indicating that the barriers to launching liquidity are inherently low.
In less than 10 months, Hyperliquid has become the highest trading volume perpetual contract DEX, surpassing dYdX and GMX, which previously held over 50% of the perpetual market share.
Front-Ends are Evolving
Today, the most popular “aggregators” are intent-based front-ends. These front-ends outsource execution tasks to a network of “solvers” who compete with each other to provide the best execution for users. Importantly, some intent-based DEXs also access off-chain liquidity sources (such as centralized exchange platforms, market makers), allowing these front-ends to bypass the liquidity bootstrapping stage and immediately offer competitive, if not better, execution results. Intuitively, this weakens the role of on-chain liquidity as a defensive moat for existing DEXs.
Front-Ends Control the Relationship with End Users
Front-ends that control user attention have disproportionate bargaining power, enabling them to reach exclusive cooperation agreements, and even achieve vertical integration. Through its intuitive front-end design and control of end users, Jupiter has become the fourth largest perpetual contract DEX on-chain. Additionally, Jupiter has successfully integrated its own launch platform and SOL LST, and plans to establish its own RFQ/solver model. Given Jupiter’s close connection with end users, the premium of JUP is at least to some extent justified, although I expect this gap to eventually narrow.
Furthermore, as the ultimate front-end, no application is closer to end users than a wallet. By connecting retail investors on mobile, wallets have the most valuable order flow—”traffic insensitive to fees.” Given the inherently high switching costs of wallets, wallet providers like MetaMask are able to accumulate over $290 million in fees by strategically selling convenience to retail investors rather than optimal execution.
Additionally, while the MEV supply chain will continue to evolve, one thing will become increasingly clear—value will disproportionately accumulate in the hands of participants closest to the origin of the order flow. In other words, all current initiatives aimed at redistributing MEV—whether at the application layer (considering LVR DEX, etc.) or at a more foundational level (such as encrypted memory pools, trusted execution environments, etc.)—will disproportionately benefit those roles closest to the origin of the order flow. This means that protocols and applications will become increasingly “thin,” while wallets and other front-ends will become increasingly “thick.”
I will further elaborate on this point in a future report titled “The Fat Wallet Theory.”
Building Moats for Applications
In clear terms, I expect network effects in liquidity to bring about inherent winner-takes-all situations in large-scale markets, but we are still far from this future. Therefore, in the short to medium term, relying solely on liquidity may still be an ineffective moat.
Instead, I believe that liquidity and TVL are more like prerequisites, and true defensiveness may come from intangible assets, such as branding, differentiation in user experience (UX), and most importantly—the ability to continuously roll out new features and products. Just as Uniswap was able to overcome Sushi’s vampire attack because they have the ability to “innovate beyond Sushi.” Similarly, the rapid rise of Hyperliquid can be attributed to the team building arguably the most intuitive perpetual contract DEX to date and continuously rolling out new features.
In simple terms, while liquidity and TVL can be subsidized by emerging competitors, a team that continuously launches new products is irreplicable. Therefore, I expect a high correlation between applications that can sustainably capture value and those with innovative teams that never stop. In an industry where moats are almost impossible to exist, this is undoubtedly the strongest source of defense.
