Written By: Alex Lin
Published Date: Aug 12, 2022
⏱️: ~15 minutes
In a bull market, abundant capital is accompanied by a lack of discipline. A superficial beauty masks a less picture-perfect truth since everyone has skin in the game. The loudest champions promote even the most half-baked and low-quality ideas. The sentiment deviated into speculation in the final 6 months of the last crypto bull run. Capital funneled into experiments with business models only existing in pitch decks. The cycle eventually ran its course and concluded in a particularly dark Q2 2022. Led by the collapse of Terra, the total cryptocurrency market cap fell 53% to $892B in June.
And now, in a bear market, things have taken quite a turn. With baseless hype and mania now dispelled, we, as an industry, have begun to recalibrate. Doubt creeps into the most stalwart believers, only thwarted by a consistent declaration:
“Some of the best companies start during a bear market.”
On the surface, there is plenty of historical evidence supporting this statement. Some of today’s top mobile apps (e.g., Uber, Venmo, Snap, Instagram, etc.) were created during the 2008 financial downturn. In the late 90s, during the dot-com bubble, it was Amazon, Nvidia, Salesforce, Google, Paypal, and Netflix. In web3, some of the most battle-tested DeFi protocols emerged from the last bear cycle. That said, it’s effortless to identify successful companies in retrospect. You can correlate their founding date to a period in time that also happens to be a downturn. In reality, product and financial cycles evolve mostly independently.
Over the last 40 years, financial performance (Nasdaq Index) has had unpredictable fluctuation. Contrarily, the product cycle of a technological era follows a more consistent behavior. According to Chris Dixon, two key phases break up a product cycle: incubation and growth. During incubation, early adopters use products built and ideated by enthusiasts. In the earliest years of such a phase, infrastructure development remains the focus. To transition from incubation to growth, product cycles need applications. Applications play a key role in facilitating infrastructure innovation through expectations of mainstream consumerism and adoption. In web2 for instance, the release of Amazon Redshift resulted in the ability for organizations to handle analytic workloads on big data datasets stored by column-oriented database management systems. AWS customers needed a solution that could handle the big data revolution occurring in the early 2010s that Amazon RDS wasn’t suitable to address.
For the last few years, the incubation phase is all the crypto product cycle has ever known - a digital speedrun of the modern financial system accompanied by infrastructure development. What was once a 300-year process is now undergoing rapid experimentation. Mistakes and failures feed into learnings that inevitably fuel innovation. Early on, failed attempts of governance tokens seeking utility and value populated the market. Now, we've reached a point where tokens reflecting tangible protocol utility exist yet they remain the exception, not the norm. Since our firm’s inception, there have only been a handful of projects in Shima Capital's deal pipeline that had value accruing tokens paired with a clear revenue model for usage (and we invested in most of them!).
NFTs coupled with play-to-earn gaming and Ponzi-based DeFi protocols made a valiant effort run in 2021 where the total crypto market cap almost reached $3T. For a while, these projects achieved early traction but had unsustainable business models. Users making money from the introduction of other users’ capital is the result of a negative-sum game. In the existing market climate, this model fails. Sustainable revenue for a protocol should originate beyond shaky, predatory structures that charge hefty fees. It was clear that capital (i.e., users) cycled from one protocol to another, prompted only by a protocol’s grifty financialization levers. Users chose to use a protocol based on projected APR or APY percentages, not because there was a substantive difference in user experience and value (outside of monetary incentives) of the application itself.
Web3 infrastructure has also come a long way. The earliest known proposal for a blockchain protocol and digital cash goes back to 1982 by David Chaum. For the next two decades, individuals such as Wei Dai (b-money) and Hal Finney (reusable proofs of work) laid the groundwork for Satoshi’s lone publication. The introduction of Ethereum and smart contracts confirmed web3's status in the incubation phase. But what does it all mean if there aren’t any use cases to leverage these foundational underpinnings? At the end of the day, infrastructure is a means to an end: to deliver the best user experience of applications that consumers can derive value from. Despite the focus on infrastructure and middleware projects in these market conditions, arguably, the bigger opportunity lies with what consumers are enabled to do.
The rise of DeFi 1.0 and NFTs incited the previous bull cycle where the first real mainstream adoption of web3 applications occurred. The increased consumer demand further necessitated the need for new infrastructure development. The existing bear market is an invitation for the web3 product cycle to evolve out of incubation and into growth for the ecosystem. With better infrastructure projected to be on the way (e.g., 4th generation layer 1 networks, zero-knowledge proofs, smart contract automation, Ethereum Merge, etc.) and more founders and operators entering the space, disruptive applications prioritizing merit beyond financialization are inevitable.