To provide more perspective on crypto and DeFi markets, we’re pleased to present quarterly notes from Goliath. In this edition, we will highlight our leadership’s thoughts on four game-changing developments that have us excited and sourcing new investments. To find out more information about available LP opportunities, please contact us at [email protected].
As we bask in the heat of summer, much has transpired since our last general update. Fresh from ETH CC this year in Paris, there are several salient themes I’d like to share with the Goliath community. Generally speaking, things are looking up. Optimism pervades more than ever before. With the negativity of FTX behind us, the lion’s share of the bad debt unearthed, and the momentum of the XRP decision propelling the space forward, this year’s ETH CC had a special buzz I hadn’t experienced in quite some time.
On the whole, many who are still standing have reduced their burn rates and managed to raise enough capital to propel them into the next development phase. Consequently, the discourse has shifted from fundraising to discovering Product-Market Fit (PMF). Interestingly, there are various strategies in play to achieve this.
Firstly, there’s a noticeable push further along the risk/design curve for DeFi products. Exotic options, novel AMMs, account abstraction, MEV public goods funding, and more—I’m seeing the next wave of product offerings, complemented by a superbloom of young and eager teams. As a longstanding DeFi Maxi, this refreshes me greatly.
Next up, which I find somewhat controversial and misguided, is the emerging trend of teams creating their own appchains. Does anyone recall Cosmos Zones and Polkadot Parachains? This time around, however, eyes are on L2 territory, specifically Optimism and the SuperChain ecosystem they’re nurturing. There’s some talk about other L2s, like Linea, Arbitrum, and the like, but the allure of a genuinely open-source license that Optimism promotes is starting to come to light. While I have my own reservations about this (the main one being that siloed appchains disrupt composability), this is undeniably a theme that can’t be overlooked. Their future may not consist of the multitude of super chains that OP envisions, but there might be a select few capable of harnessing the efficiencies that a dedicated chain or rollup can offer. Particularly when it comes to DeFi and high-volume DApps, gas fees are paramount.
Moving on, and arguably the most critical theme I wish to discuss, is the misalignment of incentives that currently exist within the space, especially amongst protocol partnerships. This is evident in situations like L2s, where OP is isolated from ARB communities, and vice versa. They’re both eager to attract users but want to keep them all on their own rollup to capture more TVL and, in the long run, fees. Why might you ask?
Principally, it boils down to the native rollup token—OP and ARB in this instance. Disparate economic models, divided token holders, and tribalism that fuels TVL and market cap growth. Feel like debating politics, religion, culture? None of these discussions hold a candle to that of money. And in crypto—an open-source ecosystem where meritocratic systems prevail—the discourse is deafening. Consequently, people vote with their wallets and their portfolios.
With these stakeholders in mind, if you’re operating a DeFi protocol, you’re significantly incentivized to capture as large a fee share as possible for your community. This encapsulates the state of protocol partnerships. It’s becoming apparent that DeFi is gradually gaining traction, nibbling away at CeFi’s dominance. As a result, partnerships are becoming fiercely competitive and intricate. While this might be a good problem to have, given the formation of a tangible market that’s starting to generate real revenue, it’s nonetheless leading to considerable friction amongst partnerships. I’m privy to a few where the partnerships have already been announced, retweeted tens of thousands of times, and yet the economics are still up in the air. I’m also aware of DeFi protocols that agreed on economic terms only to backpedal due to competition.
One could argue we’re entering a stage where we’re paying for our past indiscretions—specifically, DeFi tokens. The contention that everything should run on ETH is somewhat fallacious, as there are no incentives potent enough to lure talent into providing robust financial primitives to power the next global system if all the proceeds flow to ETH premine participants. Conversely, counterarguments regarding a “Tragedy of the Commons”-like scenario emerging due to self-centered interests are aging rather well. I’m privy to one situation that sees weekly revenues of $1 million, where these two protocols find themselves in a frenemies situation.
One is disgruntled with the other, yet while the other relishes its superior position, it understands it cannot make an enemy of the former as 95% of the $50 million ARR stems from them. Another protocol, on the brink of launching a highly anticipated system, is demanding an exorbitant amount of fees per user, per use. They’re negotiating from a high starting point, hoping to end low, but it’s unearthed a can of worms, dredging up past grievances—both good and bad—and putting the entirety of their high-profile relationship in jeopardy.
So, what does all this imply? For starters, the pie is growing, which is a positive sign. Protocols that have amassed hundreds of millions, and which now boast multi-billion market caps, are feeling the pressure to live up to their valuations—which is beneficial. And young teams, beginning to taste the promise of wealth, are asserting their value—which is commendable.
But how will we resolve all of this? We simply can’t sever all our relationships and technology stacks that are so interdependent, with substantial sunk costs in time and engineering. Yet, we also can’t allow a heavy-handed protocol to monopolize the industry—it’s almost as if the entire space is set to… decentralize.
These deals are pragmatic, open to discussion, and hinge on compromise. I believe these will all come to fruition, leading to an efficient market that will ultimately generate the most value for users at the lowest fees, and redirect fundamental cash flows and liquidity moats to token holders.
My hunch is a consolidation towards two main themes.
(1) The first being vertical value drivers, primarily security.
(2) The second, horizontal value drivers, predominantly DeFi protocols offering product granularity.
But that’s a conversation for another time. Right now, we must continue to build and collaborate. We are observing and investing in this, closely. Please feel free to reach out if you’d like to discuss any of the above in more detail.