The killer ability of cryptocurrency: how scale, on-chain reputation, and payments build emerging markets?

Author: Li Jin

Compile: Blockchain in Plain Language

The largest companies on Earth are markets built on network effects. Companies like Amazon (Market Cap $1.9 trillion), Meta (Market Cap $1.2 trillion), Tencent (Market Cap $4.59 trillion), etc., gather market supply and demand. The more supply and demand they control, the higher their network value.

The same is true in the field of cryptocurrencies. High-value networks like Bitcoin (market cap of $1.4 trillion), Solana (market cap of $79 billion), and Ethereum (market cap of $460 billion) are multi-sided networks composed of developers, users, and network operators, which become more valuable as they scale up.

But when I look at the pattern of the Web2 and Web3 markets, I not only see the existing market, but also the market that does not yet exist.

In my years of market entrepreneurship and investment, I have come to understand that there are certain markets that should exist. They can help both the supply and demand sides find each other and provide important utility for both parties. However, due to the limitations of the systems they have built, these markets do not currently exist. I have also witnessed firsthand how new technologies provide opportunities for new markets to emerge and thrive.

The market is the most exciting opportunity in the cryptocurrency field. By leveraging the killer ability of cryptocurrency, that is, the scale expansion and on-chain composability based on Token incentives, entrepreneurs can create new markets and provide services to demand groups that have not been satisfied so far. This is a breakthrough opportunity, not just an incremental innovation.

1. Systemic barriers to market innovation in Web2

I have previously written about the era of service markets. Specifically, the internet market has gradually developed from the list era of the 1990s (represented by Craigslist) to the on-demand application era of ‘Uber for X’ (2009-2015), and then to the era of managed markets (mid-2010s).

Source: a16z, Li Jin and Andrew Chen

The development of each era is a response to the demand for new technologies or emerging markets. In the list era, the Internet allows individuals to publish and search for lists online. The ‘Uber for X’ era, which appeared simultaneously with smartphones, provides instant access to various services and utilizes users’ real-time location information. The managed market emerged to meet higher trust needs in the complex market as market opportunities gradually diminish.

However, each era also brings challenges that limit innovation. In the era of listings, lack of trust and standardization hindered growth. In the era of on-demand, expanding market size to provide near real-time services requires massive capital investment. And managed markets face high operating costs related to establishing transaction trust, which has an impact on the feasibility of these markets.

Many of these challenges still exist in the Web2 market, hindering the progress of innovation. In particular, two issues, scalability and trust, have hindered progress, while cryptocurrency has unique advantages in addressing these issues.

2. Scalability Issues

Traditional Web2 markets may require huge amounts of capital to establish and expand, especially on a large scale before the market achieves practicality. This demand for capital sets a barrier to entry for new participants. It also means that the entire market category may not be established due to the high cost of achieving the required scale, and therefore cannot provide practicality.

For example, consider a dating app. In a dating network, good matches can only be made when there are a large number of users on both sides. Traditionally, this means that the platform must spend a lot of money attracting a large number of users before the application can be useful to any individual user. Dating apps also face the problem of low user retention, as successful users will leave the app, further hindering scale expansion. Therefore, there are few breakthrough winners in the dating category.

3, Trust Issue

The second persistent challenge in the Web2 market is trust. Certain industry verticals require a high level of trust between market participants to conduct transactions. For example, in certain categories, there is a high risk in matching with the right provider/service (e.g., child care or elderly care). Other areas have high order values (e.g., luxury goods, art, real estate).

In order to establish the required trust, managed markets have built additional service and operation layers. For example, the childcare market extensively audits providers before they can transact on the market, including real-life interviews, background checks, and the development of software tools for real-time visibility and positioning. In the real estate sector, some managed markets have taken on the responsibility for the entire end-to-end process, from maintenance to acting as market traders for homes (“iBuyers”). These additional operations bring significant expenses. In addition, other markets that wish to list suppliers/providers must replicate these efforts, resulting in inefficiencies in the market.

4、Solving Problems: The Killer Ability of Cryptocurrency

From the perspective of these challenges, cryptocurrencies have three killer capabilities that open up new potential directions for market innovation: scale, on-chain reputation, and payments.

1) Scale

If there’s one thing that cryptocurrency excels at, it’s scale. Cryptocurrency incentives (in the form of tokens) have proven to be a very powerful tool for driving rise.

Compared to the Web2 market, cryptocurrencies enable the market to grow in sequence through the financial incentives provided by tokens, starting with the supply side and then expanding the demand. For example, the decentralized physical infrastructure network (DePINs) Helium and Hivemapper kick-start their supply side by providing token incentives to participants, with the underlying network’s revenue catching up later.

You can apply Token incentives to many types of markets that do not exist due to high start-up costs. Imagine the need for highly user-intensive hyperlocal social webs (similar to Citizen, but more widely applicable to information or real-time events), or new dating applications. In the field of artificial intelligence, we have seen developers apply Token incentives to create new markets that have no precedent in the Web2 world. For example, networks like Vana and Rainfall enable users to contribute data for AI training and receive Token rewards. Without intelligent incentives to mobilize large-scale user contributions, aggregating long-tail, private, and inaccessible datasets is almost impossible.

2) On-chain reputation and historical records

One challenge mentioned in the Web2 market is the repetition of efforts in building trust in isolated markets. For example, Uber conducts background checks on all new drivers, but when the same driver downloads the Lyft application, the application also conducts a background check because these platforms are isolated.

One application of cryptocurrency is as a portable reputation system. Instead of each application requiring individual background checks, what if this information is stored on-chain and moves with the driver as they join any market? Furthermore, additional information about provider history, such as reliability and quality, can be represented in an on-chain form, allowing markets to aggregate and leverage a global repository of trust. Such a system can eliminate the need for different managed markets to implement their own capital-intensive processes. In Web2, many managed markets offer excellent user experiences, but due to high operating costs, they are not ultimately feasible as a business model. Global on-chain reputation can fundamentally change their cost structure.

You can find a microcosm of this idea in the Farcaster ecosystem. This social media protocol stores posts, likes, follows, and profiles in a decentralized network. When users install different applications built on this protocol, their social data moves with them. We can already see the emergence of interfaceless markets on Farcaster. An example is Bountycaster, where users can publish and discover bounties on any Farcaster client, leveraging the rich reputation data on the Farcaster network. With this portable social data, you can imagine various new markets emerging in the Farcaster ecosystem, from the smart contract audit market to expert markets utilizing Farcaster’s connectivity graph and reputation.

3) Payment

Facilitating payments is a core component of the modern market, but in Web2, supporting cross-border payments requires internationalization between various local systems. This is particularly important for digital markets, as customers and suppliers are often far apart. For example, over 80% of YouTube users are located outside of the United States. In order to support local currency payments in each geographical region, platforms must integrate with international payment gateways. This typically results in some underserved areas, especially for resource-limited, emerging markets, or platforms unable to internationalize.

Cryptocurrencies can operate internationally from the very beginning, allowing anyone with a crypto wallet to trade with each other. This gives markets with limited resources global reach from the outset. For example, I recently purchased an NFT on a data community on-chain called bytexplorers, which allowed me to ask data-related questions to the analyst community. Analysts who answered correctly were rewarded with tokens, enabling seamless payments and global participation.

5. Opportunities in the Next Generation Market

If there’s one thing I’ve learned in my years of entrepreneurial investment in the market, it’s that the best opportunities arise when builders use new technology to create significant improvements for end users. Every generation of market builders uses new technology to unlock new markets that were previously impossible.

Cryptocurrency represents the next stage of this evolution. By leveraging tokens for incentives, new markets can grow in a more capital-efficient manner. On-chain reputation and history can reduce costs for any given market operator. Cryptocurrency-based payment methods allow markets to seamlessly operate across borders from the outset. All of this will not only improve existing markets but also give rise to new markets that can only exist under new cost structures and expansion strategies.