In this episode, Chris Burniske and Ryan Watkins join us to explore the evolving relationship between applications and infrastructure in the cryptocurrency space.
Compiled & Edited by: Shenchao TechFlow
Guests: Ryan Watkins, Co-founder of Syncracy Capital; Chris Burniske, Partner at Placeholder VC
Host: Michael Ippolito
Podcast source: Expansion
Original title: L1 Valuations and the Rise of Apps | Chris Burniske & Ryan Watkins
Broadcast date: November 6, 2024
Background information
In this episode, Chris Burniske and Ryan Watkins join us to explore the evolving relationship between applications and infrastructure in the cryptocurrency space. They delve into the current infrastructure premium situation, examine how ETFs are changing market dynamics, and discuss new opportunities arising from the fusion of decentralized finance (DeFi) and artificial intelligence (AI). Thank you for listening!
Syncracy Capital is an investment firm focused on cryptocurrency and blockchain technology. The firm typically implements its investment strategy by investing in blockchain projects, cryptocurrency assets, and related technology companies. Syncracy Capital aims to leverage its deep understanding of blockchain technology and market insights to provide investors with high-return investment opportunities.
Placeholder VC is a venture capital firm focused on investing in blockchain and cryptocurrency startups. The firm was founded by Chris Burniske and Joel Monegro, aiming to support and promote the development of decentralized technologies. Placeholder VC helps early-stage projects and companies achieve growth by providing funding, resources, and expertise. The firm typically invests in blockchain projects and cryptocurrency-related businesses with innovative potential and long-term development prospects.
Comparison of applications and blockchain
Ryan mentioned that a perspective often arises after the market enters a bear phase, claiming that all assets except Bitcoin are worthless. This is not unfamiliar for long-term practitioners, as people tend to lose confidence when prices fall.
However, Ryan emphasized that internal data shows many applications have actually achieved record high revenues, with annual incomes reaching fifty million, one hundred million, or even three hundred million dollars, and growing rapidly. The revenues of these applications sometimes even exceed those of many infrastructure projects, despite the latter having much higher valuations.
Ryan further analyzed applications on Ethereum and Solana, finding that their total revenue might be comparable to Ethereum's revenue. This trend indicates that applications are beginning to capture an increasingly larger share of the overall fee pool in the blockchain, and their revenues are gradually surpassing those of infrastructure.
Chris supplemented this by discussing the valuation differences between infrastructure and applications. He pointed out that infrastructure valuations are typically several orders of magnitude higher than those of applications, a situation partially influenced by market perceptions of 'currency' affecting infrastructure valuations. He believes that currently in the crypto space, only Bitcoin, Ethereum, and Solana are viewed as credible currencies, and the valuations of these currencies are not based on cash flow, but on market perceptions of them as currencies.
Chris further explained that in the future, there may be some cryptocurrencies that continue to maintain high valuations, while most infrastructure projects may become commoditized, with valuations falling closer to their actual utility levels.
Capital inflow and infrastructure valuation
Michael expressed a view similar to Chris's, believing that the main capital driver for cryptocurrency is currency devaluation. He pointed out that people flee depreciating fiat currencies in search of more stable commodity currencies.
Michael also mentioned that while it is difficult to perform discounted cash flow (DCF) analysis on the US, other proxy indicators can be sought to understand global investor demand. He likened Ethereum and Solana to US Treasury bonds, suggesting that they have high liquidity as currency assets, although future revenue growth may slow.
Ryan then discussed the historical context of Ethereum, noting that Ethereum was initially seen as a programmable commodity currency rather than a stock-like asset. With Ethereum's launch, many competitors emerged, and the market began comparing them with Ethereum, leading to inflated valuations of these infrastructures. Ryan believes that investors may not realize the driving factors behind these valuations, leading to misunderstandings about infrastructure.
Ryan emphasized that infrastructure valuations should not simply be compared to Bitcoin and Ethereum, as many infrastructure projects are actually more like businesses than currencies. He pointed out that projects like bridges and middleware do not possess currency properties and therefore should not be valued by the same standards. Chris also agreed with this view, predicting that future infrastructure valuations may collapse, especially for non-currency infrastructure.
Future asset classes and values
Chris further discussed the concept of Ethereum and Solana as new forms of national debt, suggesting that they possess characteristics of both currency and cash-flow assets to some extent. He mentioned that Bitcoin, as a commodity currency, shares similarities with gold, and emphasized the importance of understanding the fundamental workings of Bitcoin.
Ryan concluded by summarizing that the complexity of valuing these assets lies in their diversity, akin to blind men touching an elephant; different perspectives may lead to differing understandings. He noted that due to a lack of clear comparative standards, intelligent individuals may reach different conclusions regarding the valuation of these assets, reflecting varying market perceptions and understandings of them.
Challenges in infrastructure and application development
Michael mentioned that one of the challenges in the cryptocurrency space is recognizing the uniqueness of these new entities. He pointed out that Bitcoin, as a completely new asset, has return characteristics similar to other assets but is fundamentally different. Many entering the crypto space try to impose their existing worldview on it, leading to different understandings of 'currency' and 'application'. He mentioned that Bitcoin supporters often view applications as useless, while traditional venture capitalists tend to adopt cash flow discount models, overlooking the uniqueness of currency.
Subsequently, Michael raised questions about the different strategies of L1 (Layer 1) protocols in infrastructure building, particularly comparing Ethereum and Solana. He pointed out that Ethereum has adopted a more minimalist design philosophy, allowing the market to develop freely, resulting in a rich infrastructure ecosystem. In contrast, Solana is a more integrated protocol that provides many built-in features, reducing reliance on external providers.
Influence of application developers
Chris responded by emphasizing the impact of infrastructure design on application developers. He noted that Placeholder focused on Ethereum investments in 2018 and 2019, while shifting towards Solana during the bear market of 2022 and 2023. He pointed out that Solana's design enables application developers to build efficient applications more quickly, citing the success of the NFT exchange Tensor as an example, emphasizing that Solana's developers were still able to achieve success during challenging times.
Ryan also added that Solana's integrated design allows developers to spend less time on infrastructure issues, enabling them to focus more on user experience and retention strategies. He mentioned that Solana's application development teams typically spend only 20% to 30% of their time on infrastructure, while Ethereum teams may need to spend 50%, and Cosmos teams may need to spend 80%.
Ecosystem fragmentation issues
Ryan further noted that as independent teams build extensively on infrastructure, the issue of ecosystem fragmentation arises. He mentioned the lack of unified standards between different ecosystems, leading to challenges in asset transfer and interoperability. This competition and diverse viewpoints make it difficult to establish consensus.
Chris added that these changes often take a long time to manifest their effects, and market participants should not rush to declare victory. He mentioned that the historical competition and mutual accusations between Bitcoin and Ethereum, as well as performance variations across different market cycles, complicate the understanding of the market.
Relative performance of Ethereum and Solana
Chris discussed the challenges Ethereum faces in relative performance, stating that although he personally still holds and stakes Ethereum, he believes Solana has performed better during this period. He mentioned that market complacency and the accumulation of wealth may lead to laziness, ultimately requiring some setbacks to re-energize. Chris believes Bitcoin has gone through similar cycles and is currently in a revival phase. He speculated that Ethereum may also experience a similar transition by the end of this decade, facing different directional choices, including those of Celestia, Bitcoin, and Solana.
Comparison of design philosophies
Michael then inquired about Ethereum's design philosophy, suggesting that it has adopted a very minimalist design, allowing the free market to address many issues. For example, the sharding problem Ethereum initially sought to solve ultimately allowed the market to develop its own roadmap based on aggregation. He noted that Solana, on the other hand, has taken a different approach, attempting to integrate complexity into its infrastructure design so that application and product developers can build more smoothly.
Unique direction of Celestia
When discussing Celestia, Ryan drew an analogy, suggesting that Celestia's construction direction resembles a Bitcoin with ZK opcodes, aiming to provide low-cost user verification. He emphasized that Celestia offers greater flexibility than Bitcoin, allowing developers to build more complex applications. He explained that Celestia's design allows developers to have more control in an optimized blockchain ecosystem, thus creating the best user experience.
Ryan further provided examples, mentioning that projects like Uniswap can enhance user experience by controlling multiple layers (such as wallets, front ends, protocols, etc.). This flexibility is a core advantage offered by Celestia, allowing applications to better adapt to user needs. He noted that Celestia's design philosophy is to view applications as chains rather than traditional smart contracts, thus offering more possibilities in application development.
Finally, Michael mentioned the short-term challenges Celestia faces, including its recent unlocking events and price volatility, reflecting the market's sensitivity to investor sentiment. His comments illustrate how investors are seeking opportunities and risks in a rapidly changing crypto market within a complex ecosystem.
The ultimate fate of value accumulation
Chris began discussing the current market's focus on crypto assets, especially concerns about significant unlocking events. He mentioned that once market concerns about these unlocks dissipate, unexpected positive reactions may occur. Michael summarized their discussion, mentioning the relationship between infrastructure and applications, and the future of how value will accumulate across different levels.
Overview of the Fat Protocol Theory
Michael mentioned a famous article, the 'Fat Protocol Theory', and invited Chris to summarize its core points. Chris pointed out that the fundamental idea of the Fat Protocol Theory is that the protocol layer of the internet (such as TCP/IP, HTTP, SSL, etc.) has almost no economic value; the real value comes from the applications built on top of these protocols (like Facebook and Google). In the context of blockchain, the situation is different, as the protocol layer (like Bitcoin and Ethereum) possesses significant economic value, while the value of the application layer is relatively low.
Chris further explained that Joel's theory emphasizes that in the early stages of blockchain, the value of the protocol layer is much higher than that of the application layer. However, over time this situation may change, especially as new applications continue to emerge.
Value and challenges of the application layer
Chris also mentioned that while the value of the protocol layer is significant, the application layer also has its own value. The application layer faces some challenges in value accumulation, as the characteristics of blockchain allow user data to be shared across multiple applications, contrasting with the monopolistic lock-in mechanisms seen in Web 2.0. For example, users can use the same data across different applications, increasing competition among them.
He used Coinbase as an example, pointing out that the company bears many regulatory costs and compliance requirements, thereby establishing its own moat in the market. Chris emphasized that the success of investments depends not only on market opportunities but also on the timing of entry and the scale of investment.
Capital flows between infrastructure and applications
Michael agreed with Chris's viewpoint, mentioning that there may currently be excessive capital flowing toward infrastructure, while applications could be the next significant opportunity area. He believes that as the market develops, investors and developers need to reassess the value relationship between infrastructure and applications to find new growth points.
Michael mentioned that many fund managers are confident about the market shift but are uncertain about the specific timing. He asked Chris and Ryan if they also sensed the cautious attitude of funds when considering this value shift.
Ryan stated that from his perspective, any relative value trade typically has two factors: either overvalued assets decline, or undervalued assets rise. He believes that the valuation gap of infrastructure will narrow over time, but he tends to think that the multiples of infrastructure will decline rather than the multiples of applications will rise.
Valuation of applications and infrastructure
Ryan continues to analyze the valuations of applications in the current market, pointing out that while some applications are generating considerable revenue, their multiples are not cheap. He compared the valuations of software companies, finding that many high-growth, high-profit companies trade at multiples between 10 and 20, while some DeFi protocols have average multiples as high as 44, which is not cheap in absolute terms. He questioned why investors would be willing to purchase these applications at such high valuations, especially when many applications have yet to demonstrate stability within the crypto economy.
Market sentiment and investor behavior
Chris agreed with Ryan's views, believing that market changes may be slower than many expect. He added that the valuation of infrastructure will ultimately be lower than that of applications, while the valuation of applications may be comparable to tech stocks. He believes that while meme coins may not have fundamentals, their popularity may force infrastructure and applications to share profits, driving the maturation of the entire market.
Market maturation and changes in investors
Ryan emphasized that as asset classes mature, investor expectations will become more realistic. He pointed out that while there may have been rapid high returns in the past, the current market environment requires investors to view returns more rationally. He mentioned that while applications have the potential to generate good returns, current investors are more inclined to chase those assets that are hard to assess.
Chris added that changes in market participants will also drive this shift. With the introduction of Bitcoin and Ethereum ETFs, Wall Street's research and valuation methods will increasingly penetrate the crypto space. He believes that as market infrastructure continues to overlap, professional investors will begin to focus on applications with stable income bases rather than speculative meme coins.
Impact of ETFs on the market
Michael raised two questions about ETFs: first, the differences in capital flows between Bitcoin ETFs and Ethereum ETFs; second, whether ETFs will lead to increased or decreased market volatility. Chris responded that volatility typically decreases as the asset base increases. He believes that although there may be periods of increased volatility, overall volatility is declining in the long run.
Capital flows between Bitcoin and Ethereum
Chris further analyzed the market performance of Bitcoin and Ethereum ETFs. He pointed out that Bitcoin ETFs have received more support and recognition in traditional finance, while Ethereum lacks similar backing. He mentioned that the narrative around Ethereum in the market is not unified, leading to relatively weaker attractiveness. Ryan also agreed with this view, believing that the timing of Ethereum's launch and the lack of a clear narrative have caused it to lag behind Bitcoin in capital inflows.
Ryan also noted that the way the market valued Ethereum in the previous cycle may have led to incorrect expectations. He believes it is inappropriate to value Ethereum as a stock-like asset, as changes in business models and declining transaction fees have impacted Ethereum's attractiveness.
The duality of fees
Michael expressed understanding regarding the discussion on fees, believing that to some extent, low transaction fees and high total fees are complementary. He pointed out that while some argue that the level of fees can directly reflect the health of the market, in reality, transaction fees are not the only measure; overall economic activity and value creation are key.
Long-term market outlook
Chris finally emphasized that although there are different asset performances in the market, he remains optimistic about Ethereum. He suggested that if one does not invest in cryptocurrencies, they should consider diversifying their funds into major assets such as Bitcoin, Ethereum, and Solana. He believes that over time, these assets will become long-term winners.
Views on DeFi 1.0 and AI fields
Michael began discussing DeFi 1.0 and the AI field, asking Chris and Ryan for their views on these two areas. He noted that some projects in DeFi 1.0 (like Maker and Aave) have performed well within the Ethereum ecosystem and that the market supply situation of these projects has improved, making their market cap to fully diluted market cap (FDV) ratio more robust.
Potential of DeFi 1.0
Ryan expressed a positive view of DeFi 1.0, believing that despite the overall application market being overvalued, projects like Maker and Aave still show attraction at reasonable multiples. He pointed out that these projects are not only growing rapidly but also have significant upgrades coming, and they have built valuable businesses on the blockchain that can generate considerable fees.
Ryan also mentioned that the market's focus on supply dynamics is reasonable, as many token economic structures have been poorly designed in the past, even disadvantaging retail investors. However, some assets have fully addressed their supply release issues, making them more attractive in the market. For example, Maker conducted a substantial amount of token buybacks last year, which effectively supported its own token.
The rise of AI
When discussing AI, Michael expressed a strong interest in the field, believing that AI could become an important narrative theme. Ryan also stated that AI is becoming a true knowledge domain, attracting increasing attention and usage. He believes that the application of AI will continue to expand and may intersect with other technologies (such as blockchain), creating new business models and opportunities.
Experiments with small L1 and L2
Chris raised an interesting point that small L1 and L2 may 'nationalize' their financial infrastructure. He mentioned that projects like Ronin may adopt open-source components to create their own decentralized exchanges (DEX) and lending platforms, thereby returning liquidity and profitability to their own tokens. This model may enable small ecosystems to better support their core teams and drive the value growth of their tokens.
Intersection of cryptocurrency and AI
When discussing the intersection of cryptocurrency and AI, Michael expressed his strong interest in the AI field, believing that this could be a '0 to 1' innovation opportunity. He mentioned that although the market is filled with investment enthusiasm for AI, there are no clear investment pathways in traditional markets. He feels that the potential in this area is exciting, reminiscent of the DeFi summer, where unprecedented innovations may emerge.
Analogy of DeFi Summer
Chris concurred with this view, considering the DeFi summer to be a good analogy. He pointed out that while the space has experienced a lot of volatility and misunderstandings, there are also some important truths. For instance, blockchain, as an open data structure, can provide rich data sources for AI, and this characteristic makes the combination of the two very natural. He mentioned that blockchain is permissionless, allowing various machines and systems to utilize it, which provides a solid foundation for AI development.
Early experiments and developments
Ryan shared his perspective, believing that we are currently in the early experimental phase at the intersection of AI and blockchain. He reflected on the early stages of DeFi, noting that the protocols at that time were relatively clunky, yet there was still reason for excitement. He mentioned that projects like BidTensor are rethinking the distribution of block rewards, particularly how to leverage AI-related resources to incentivize and support the development of GPU infrastructure.
The rise of AI agents
Ryan further mentioned that the rise of AI agents is a trend worth noting. He pointed out that some autonomous AI agents have recently emerged, capable of interacting with blockchains through simple natural language commands. This new mode of interaction may attract more people to participate in on-chain development, lowering the technical barriers.
Cultural and emotional impacts
Chris also emphasized the changing ways in which AI interacts with humans, suggesting that we are no longer simply directing machines, but rather trying to understand and gain their attention. This new mode of interaction may have profound effects on our emotions, altering our relationship with technology.
Future outlook
Ryan added that in the future, some autonomous AI agents may emerge, capable of controlling their own funds and compensating humans for the services they provide. This concept raises thoughts about future work and income models and may change our relationship with technology.
Ryan continued to explore the current rise of AI agents, noting that although this is still in its early stages, more and more enthusiastic participants are driving development in this field. He mentioned that he was recently surprised by the potential of AI agents, especially as the autonomy of on-chain agents began to show different levels in recent weeks.
Potential of AI agents
Ryan illustrated that Coinbase recently released a new agent development framework that makes it easy to connect ChatGPT to its platform. Users can simply input commands in natural language, allowing the agent to perform tasks like creating tokens. This simplified process enables more people to participate in on-chain development without needing to delve deeply into programming languages.
He further elaborated on potential applications of this technology, such as crowdfunding capital to support on-chain automated trading bots. This model allows different investors to co-fund a project, enabling it to run automatically on-chain. This idea excites him, and he believes it will bring new possibilities to DeFi protocols.
Outlook for the future
Ryan also mentioned that many friends' excitement during the DeFi summer is returning. He believes the current market is experiencing a maturation of asset classes and a rationalization of valuations, making this space more intriguing. He anticipates that in the coming weeks, some new innovations and projects may emerge, similar to the rapid developments seen during the DeFi summer.
Dual perspective on AI
Michael added that another interesting aspect of the AI field is the clear divergence of opinions within the industry. Some believe AI is full of potential, while others view it as an illusory bubble or scam. This divergence often signals opportunities worth noting.
He also mentioned that the rise of AI creators may exceed expectations, becoming pioneers of technological applications. This emerging ecosystem of AI creators may bring many new business models and application scenarios.
New modes of interaction
Chris further explored the changing ways of interacting with AI, emphasizing that we are no longer simply directing machines, but rather establishing a new relationship with them. The emergence of AI agents has led us to begin viewing them as equals, a shift that may have profound impacts on emotional and social levels.
