Original title: A New Framework For Identifying Moats In Crypto Markets
Original article by Robbie Petersen, Analyst at Delphi Digital
Original translation: Ismay, BlockBeats
Editor's Note: In the current highly competitive crypto market, the concept of 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 remain invincible in the long run. This article delves into how crypto applications can build truly defensible moats through differentiation of brand, user experience, and continuous introduction of new features. By analyzing cases such as Uniswap and Hyperliquid, we reveal that in this uncertain industry, continuous innovation is the key to resisting competition and achieving value capture.
The success of every company — whether it’s a tech giant or a century-old company — can be attributed to its moat. Whether it’s network effects, user migration costs, or economies of scale, moats ultimately allow companies to evade the natural laws of competition and sustainably capture value.
While defensibility is often an afterthought for cryptocurrency investors, I believe the concept of moats is even more important in the current market context. This is because there are three unique structural differences in crypto applications:
Forkability: The forkability of applications means lower barriers to entry in the crypto market.
Composability: Because applications and protocols are interoperable, switching costs for users are inherently lower.
Token-based user acquisition: Using token incentives as an effective user acquisition tool means that customer acquisition costs (CAC) for crypto projects are structurally lower.
Together, these unique properties accelerate the laws of competition for crypto applications. Once an application turns on the "fee switch", not only will there be countless other indistinguishable applications that provide a similar but cheaper user experience, but there may even be some applications that subsidize users through token subsidies and points.
Logically speaking, in the absence of a moat, 99% of applications will inevitably fall into a "price war" and will not be able to avoid the fate of commoditization.
While we have many precedents and inspirations for understanding moats in traditional markets, we lack a framework that can explain these structural differences. This article aims to fill this gap, delving into the fundamental elements that constitute a sustainable moat and identifying a small number of applications that can sustainably capture value.
A new framework for evaluating application defense capabilities
Warren Buffett, the “King of Defensiveness,” has a simple but effective way to identify companies with defensive capabilities. He asks himself, “If I had a billion dollars and built a business that competed with this company, could I capture a significant amount of market share?”
With some adjustments to this framework, we can apply the same logic to crypto markets, taking into account the structural differences mentioned earlier: “If I fork this application and invest $50 million in a token subsidy, can I capture and maintain market share?”
When you answer this question, you are actually modeling the laws of competition. If the answer is "yes", then it is likely only a matter of time before an emerging fork or undifferentiated competitor will erode the application's market share. Conversely, if the answer is "no", then the application is likely to have the characteristics that I believe all defensible crypto applications have in common.
The characteristics of "non-forkable" and "non-subsidizable"
To better understand what I mean, take Aave as an example. If I fork Aave today, no one will use my forked version because it will not have enough liquidity for users to lend, and there will not be enough users to borrow this liquidity. Therefore, in a lending market like Aave, TVL and bilateral network effects are "unforkable" characteristics.
However, while TVL does provide a degree of defensibility to lending markets, the key question is whether these features are also immune to subsidies. Imagine a well-funded team not only forked Aave, but also designed a $50 million incentive plan to acquire Aave users. If a competitor is able to reach a competitive liquidity threshold, users may not have much incentive to switch back to Aave because the lending market is essentially undifferentiated.
To be clear, I don’t think any team will be able to successfully drain Aave in the near term, and subsidizing $12 billion in TVL is no small task. However, I think there is a risk of losing significant market share to other lending markets that have not yet reached this scale. 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 fend off the threat of emerging competitors, they may not be fully able to defend against lateral integration from adjacent applications. For example, MakerDAO’s lending arm Spark has taken over 18% of market share from Aave since its Aave fork in August 2023. Given Maker’s market position, they are able to effectively attract and retain users as a logical extension of the Maker protocol.
Therefore, in the absence of other features that cannot be easily subsidized (such as collateralized debt positions CDPs embedded in the DeFi market structure), the structural defensibility of lending protocols may not be as strong as people think. Ask yourself again - if I fork this application and invest $50 million in token subsidies, can I seize and maintain market share? - I think that for most lending markets, the answer is actually yes.
The front end will capture more value
The prevalence of aggregators and forked front ends complicates the defensibility issues in the DEX market. Historically, if you asked me which model was more defensible — DEXs or aggregators — my answer would clearly be DEXs. Ultimately, the front end is just a different perspective on the back end, and switching costs between aggregators are inherently lower.
Conversely, decentralized exchanges have a liquidity layer, and switching costs to forked exchanges with less liquidity are much higher, resulting in more slippage and worse net execution outcomes. Therefore, I had argued that DEXs were more defensible given that liquidity cannot be forked and is more difficult to subsidize at scale.
While this view remains valid in the long term, I think the balance may be tilting towards the front end, and more and more value will be captured by the front end. My thinking can be summarized into four reasons:
Liquidity is more of a commodity than you think
Similar to TVL, while liquidity is inherently “unforkable”, it is not immune to subsidies. There are many precedents in DeFi history that seem to confirm this logic (such as the SushiSwap bloodsucking attack). The structural instability of the perpetual contract market also reflects the fact that liquidity alone cannot be a sustainable moat. The fact that countless emerging perpetual contract DEXs have been able to quickly gain market share shows that the barriers to launching liquidity are inherently low.
In less than 10 months, Hyperliquid has become the highest-volume perpetual contract DEX, surpassing dYdX and GMX, which once each accounted for more than 50% of the perpetual market share.
The front end is evolving
Today, the most popular “aggregators” are intent-based frontends. These frontends outsource execution tasks to a network of “solvers” who compete with each other to provide users with the best execution. Importantly, some intent-based DEXs also tap into off-chain sources of liquidity (e.g., centralized exchanges, market makers). This allows these frontends to bypass the liquidity onboarding phase and immediately provide competitive, or even better, execution results. Intuitively, this weakens the role of on-chain liquidity as a defensive moat for existing DEXs.
The front end has mastered the relationship with the end user
Frontends that command user attention have disproportionate bargaining power, which allows them to strike exclusive partnership deals and even vertically integrate. Through its intuitive frontend design and control over end users, Jupiter has become the fourth largest perpetual contract DEX on all chains. In addition, Jupiter has successfully integrated its own launch platform and SOL LST, and plans to build its own RFQ/solver model. Given Jupiter's close connection with end users, the premium of JUP is at least partially justified, although I expect this gap to narrow eventually.
Furthermore, as the ultimate front-end, no application is closer to the end user than the wallet. By connecting retail traders on mobile, wallets have the most valuable order flow - "fee-insensitive traffic". Given that wallets have inherently high switching costs, this allows wallet providers like MetaMask to earn more than $290 million in fees by strategically selling convenience rather than best execution to retail traders.
Furthermore, while the MEV supply chain will continue to evolve, one thing will become increasingly apparent - value will accumulate disproportionately in the hands of participants with the most exclusive order flow. In other words, all current initiatives aimed at redistributing MEV - both at the application layer (such as DEXs that consider LVR, etc.) and at a more basic level (such as encrypted memory pools, trusted execution environments, etc.) - will disproportionately benefit those roles closest to the starting point of order flow, which means that protocols and applications will become increasingly "thin", while wallets and other front-ends will become increasingly "thick" due to their proximity to end users.
I will expand on this idea in a future report titled (The Fat Wallet Theory).
Building an application moat
Specifically, I expect liquidity network effects to lead to inherent winner-take-all dynamics in large markets, however, we are still a long way from that future. Therefore, relying on liquidity alone is likely to remain an ineffective moat in the short to medium term.
Instead, I think liquidity and TVL are more like prerequisites, and real defensibility may come from intangible assets such as brand, differentiation in user experience (UX), and most importantly, the ability to continuously launch new features and products. Just as Uniswap was able to overcome Sushi's blood-sucking attack because they had the ability to "innovate beyond Sushi", similarly, Hyperliquid's rapid rise can be attributed to the team building arguably the most intuitive perpetual contract DEX to date and continuously launching new features.
In simple terms, while liquidity and TVL can be subsidized by emerging competitors, a team that consistently launches new products cannot be replicated. Therefore, I expect a high correlation between applications that can sustainably capture value and those with teams behind them that never stop innovating. In an industry where moats are almost impossible, this is undoubtedly the strongest source of defense.
