Future of layer-1 protocols: The tectonic shifts

Web3 has become an abused industry term over the past two years. Many centralized players classified themselves as Web3 and rode the euphoria and narrative around the buzzword. 2021 saw an unprecedented change with macroeconomic headwinds, geopolitical risks, hacks on DeFi, the blow-up of Terra and one of the biggest frauds committed by FTX — all creating headwinds for price action and beginning the great cleansing event for the industry loosely called Web3.

Based on many conversations with enterprises, developers, venture capitalists and existing ecosystem players, a few tectonic shifts are underway. Web3 is being altered at a fundamental level and the next bull run could be poised to have a different signature.

Here are points to consider. These are all based on data, facts, anecdotes and my own analysis. While these may not be set in stone, I still believe they are directionally correct.

Market correction

Liquidity and risk appetite have boundaries. Equity markets across the world have a market cap of approximately $100 trillion spread across around 58,000 companies. The cryptocurrency or token economy has a market cap of only approximately $800 billion at the time of writing, spread across approximately 22,000 tokens — a significant portion of that total market cap is Bitcoin. The imbalance is clear. Markets are on a correction trajectory with many of the altcoins outside the top 20 in market cap — unfortunately, likely to suffer or not maintain their market position. 

Investor posture

A large part of the bull run was fueled by printed money finding its way into tokens via venture capitalists (VCs). Multiple VCs who invested in LUNA, FTX, etc., have gone through their maturity curve and are not likely to embark on these risky bets without adequate due diligence or finding fundamental value in these projects as a “business” that can yield equity returns. It will be hard to justify valuations based on liquid tokens in the business with no real or hard-to-execute value drivers.

Based on my direct conversations with them, multiple VCs have also mentioned that they are now looking more at new and promising Web3 projects which can drive value creation and technology adoption. There is lesser interest in add-on rounds of older projects. There is also a shift with scrutiny on founders, CEOs and executive teams. Many investors are not likely to invest in inexperienced players or crypto bunnies. Ethical disclosures and background checks on key executives will likely unfold as a part of the maturity process.

Business model changes

Layer-1 protocols absorbed a lot of funding and liquidity based on promises of ecosystems, adoption and becoming a chain of choice. The world doesn’t need this many layer-1 (L1) protocols, many could not drive even meaningful development, let alone sustainable ecosystems. Most L1s have deployed their large funding rounds in propaganda marketing or throwing money and grants at developers or builders — i.e., paying them to build on their chain. This is a race to the bottom with developers stopping building and stopping activity as token prices dwindle.

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Technology adoption

The era is shifting quickly from speculators chasing 100x to the adoption of technology at scale. Token growth will likely only be a byproduct of adoption — potentially becoming the foundational element of the next bull cycle. Meaningful enterprise and consumer use cases, experiences and implementations will need to drive real-world usage be it loyalty points, gaming, social media, security, settlements, etc. Tokens will need to carry real utility in unlocking new business models for brands and enterprises. There are many good examples at play such as with Starbucks, Nike, Adidas, etc. 

Winners, losers and floaters

The layer-1 protocols are the lynchpin in this space. They attracted the bulk of the retail and institutional capital in the past three years. A lot of token-based value projects are launched on these blockchains.

Many wanted to become alternatives to Ethereum and investors wanted to spread their risks, making room for some of these chains. Many layer-1s could not drive developer adoption or network effects as they promised earlier.

There are serious headwinds for layer-1 survivability and growth now as VCs refused to infuse more capital into poorly adopted chains. The bear market has trailed off retail investors and user activity is at a low as many developers seem to have moved on. The developer and community momentum once lost could be nearly impossible to reboot and revive. As cycles change, many chains could find themselves irrelevant by then.

EVM chains have also seen a dip in active weekly developers. Ethereum has weathered prior bear markets and is likely to grow with Polygon, its L2 scaling solution. Some other chains with promise with communities are Avalanche and Hedera for enterprise adoption while Solana (still adopted at scale, despite the FTX FUD) and Flow position themselves as the consumer chains.

Some blockchains may need to reevaluate their existential plays first. They’ll need to recalibrate and think about where they need to go. The risk of a slow death is real for many of them now.

Concluding thoughts

The great cleansing in Web3 is here and it starts with the key shifts in market-driven correction, changes in VC investments’ posture and technology adoption. The tectonic shifts around these three core drivers will shape the next bull run. Layer-1 protocols were overpriced, under-delivered and crowded the scarcely adopted market — sometimes through token throws and other times through cult creation. That era is now over.

No more easy money for existing L1s, hence a lot less available to throw as VCs go after protocols with newer technologies rather than fuel old, flawed and broken business models threatening a race to the bottom. There are winners, some struggling for survival and the vast majority dead in the water. The new bull run with new technology, new vectors of adoption and new players could deliver the promises of Web3 in a redefined manner.

Nitin Kumar is a growth CEO and co-founder at zblocks. He is a recognized leader, author, former consulting partner and VC investor.

This article was published through Cointelegraph Innovation Circle, a vetted organization of senior executives and experts in the blockchain technology industry who are building the future through the power of connections, collaboration and thought leadership. Opinions expressed do not necessarily reflect those of Cointelegraph.

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