A red ocean for smart contract protocols

Last year was about endless cryptoanarchic possibilities. This year is about limited access to scarce resources (e.g. developers, end-users). Last year was blue sky. This year is red ocean.

Purely based on logic, many predicted fierce competition in crypto. Low barriers to entry coupled with large financial incentives leads to many competitors and weak competitive moats. Over the last six months, we’ve seen this play out, most notably in smart contract protocols.

In addition to the high profile, high capitalization projects coming to market this year (e.g. Tezos, Dfinity, EOS, Rchain, Hashgraph, Ontology, Cosmos, Wanchain¹), we’ve seen dozens of brand new smart contract protocols successfully raise tens of millions of dollars (e.g. Harmony, Quarkchain, Gochain, Holochain, Oasis). Some already trade at billion dollar network values.

Yet, actual traction is virtually non-existent. While some non-Ethereum protocols have succeeded in arranging a set of “launch titles²,” we’ve not seen sustained development beyond the initial hype. Why?

Look to paid marketing for some clues. In paid marketing, a company tries to attract valuable customers through paid channels (like search advertisements). This works if the lifetime value of the customer (LTV) is greater than the cost of acquisition (CAC).

Andrew Chen, a partner at a16z and an expert on growth, calls paid marketing one of the greatest causes of startup implosions.

There’s a few scenarios where paid marketing is justified, but it’s situational. If your product has network effects that kick in after an activation point and really scale, you can use paid to help bootstrap that.

There are many reasons with the LTV might be low. Perhaps the unit economics are unfavorable and the products and services don’t lead to sufficiently high spend. Or maybe the customers are never activating or prematurely leaving the service (“churning”). Activating paid channels with low LTV is one of the most dangerous mistakes a company can make. The company wants a thriving ecosystem but ends up with a hole in its pocket.

We’re seeing a version of this story play out with smart contract protocols. The protocols want a burgeoning developer community reaching millions of end users. Instead, they pay for an initial batch of developers that either fail to reach end-users or churn off their protocol. Developers complain that there are no users on this new protocol and new developer inflows halt. And until the “LTV” for new developers is higher, ecosystem funds are just a way to enrich mercenary developers.

These observations would suggest that protocols should slow down their ecosystem efforts until they figure out how to reach end-users. Unfortunately, they’re operating in a game theoretical hell due to pressures from their token investors. Their tokens are traded 24/7 so they are doing investor relations 24/7 whether they like it or not. If competitors are pouring money into signaling an existent developer community, they have to as well, or face the wrath of speculators scorned.

End-users solve this, so many protocol are trying to hack this problem by pouring money into game development³. Blockchain games can be developed to behave just like normal games. Thus, blockchain games are our best shot at mainstream adoption.

While the first viral hit will likely benefit the protocol it’s built on (a new wave of speculative + developer interest), I’m skeptical this will lead to lasting value. Successful distribution will have little to do with the smart contract protocol itself⁴. Most likely, the first viral hit will be distributed through traditional channels (e.g. App Store, Play Store, WeChat) and the “crypto” part will be functionally invisible.

Still, the first evidence of mainstream adoption will signal a possible improvement to the LTV of new dApp developers. Heartened by a viral success, protocols will redouble their ecosystem efforts. The fight continues.

Tho’ Crypto, red in tooth and claw.

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