Cryptocurrency’s killer capabilities: scale, on-chain reputation, and payments

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Original author: Li Jin

Original translation: Vernacular Blockchain

The largest companies on the planet are all marketplaces built on network effects. Companies like Amazon ($1.9 trillion), Meta ($1.2 trillion), Tencent ($4.59 trillion) all aggregate market supply and demand, and the more supply and demand they control, the more valuable their network becomes.

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

But when I look at the landscape of the Web2 and Web3 markets, I see not only markets that already exist, but also markets that don’t exist yet.

In my years of investing in marketplace startups, I’ve learned that there are marketplaces that should exist to help supply and demand find each other and provide important benefits to both parties. I have also seen firsthand how new technologies provide opportunities for new markets to emerge and thrive.

Markets are the most exciting opportunity in the cryptocurrency space. By leveraging the killer capabilities of cryptocurrency, namely token-based scalability and on-chain composability, entrepreneurs can create new markets that serve groups with hitherto unmet needs. This is an opportunity for leapfrogging innovation, not just incremental innovation.

1. Systemic barriers to market innovation in Web2

I’ve written before about the era of service marketplaces, specifically the evolution of internet marketplaces from the listings era of the 1990s (typified by Craigslist) to on-demand apps of the “Uber for X” era (2009-2015) to the era of managed marketplaces (mid-2010s).

Cryptocurrency’s killer capabilities: scale, on-chain reputation, and payments

Source: a16z, Li Jin and Andrew Chen

Each era developed in response to new technologies or emerging market needs. In the listing era, the Internet enabled individuals to post and find listings online. The Uber for X era, which emerged simultaneously with smartphones, provided instant access to a variety of services and utilized users real-time location information. Managed markets emerged in response to higher trust needs in complex markets after market opportunities gradually decreased.

However, each era also brought challenges that limited innovation. In the listing era, lack of trust and standardization limited growth. In the on-demand era, scaling marketplaces to provide nearly real-time services required huge capital investments. And managed marketplaces face high operating costs associated with building trust in transactions, impacting the viability of these marketplaces.

Many of these challenges still exist in Web2 markets, hindering the progress of innovation. Two issues in particular, scaling and trust, are hindering progress, and cryptocurrencies are uniquely positioned to address these issues.

2. Scaling issues

Traditional Web2 marketplaces can require enormous amounts of capital to build and scale, especially as a massive amount of scale is required before the marketplace can achieve utility. This need for capital creates a barrier to entry for new participants. It also means that entire categories of marketplaces may not be built and therefore fail to provide utility due to excessive costs to achieve the required scale.

Consider, for example, dating apps. In a dating network, good matches can only be facilitated if there are a large number of users on both sides. Traditionally, this has meant that platforms have to spend a lot of money to attract a large number of users before the app is useful to any individual user. Dating apps also suffer from low user retention rates because if the app is successful, users will leave, further hindering scalability. As a result, there are few breakout winners in the dating category.

3. Trust issues

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

To establish the required trust, managed marketplaces have built additional layers of services and operations. For example, child care marketplaces extensively vet providers before they can trade on the marketplace, including real-life interviews, background checks, and building software tools for real-time visibility and location. In real estate, some managed marketplaces have taken on responsibility for the entire end-to-end process, from repairs to acting as the marketplace transactor (“iBuyers”) for homes. These additional operations come with significant overhead. Furthermore, other marketplaces that wish to list supplies/providers on the marketplace must duplicate this effort, leading to inefficiencies in the marketplace.

4. Problem Solving: The Killer Ability of Cryptocurrency

Viewed through the lens 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 is one thing that cryptocurrencies are good at, it’s scale. Cryptocurrency incentives (in the form of tokens) have proven to be a very powerful tool for driving growth.

Compared to Web2 markets, the financial incentives provided by cryptocurrencies through tokens enable the market to grow sequentially, starting with the supply side and then expanding demand. For example, decentralized physical infrastructure networks (DePINs) Helium and Hivemapper started their supply side by providing token incentives to participants, while the revenue of the underlying network caught up later.

You can apply token incentives to many types of markets that don’t exist because the startup costs are too high. Imagine a hyperlocal social network that requires intensive use by a large number of users (similar to Citizen, but more broadly applicable to information or real-time events), or a new dating app. 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. Aggregating long-tail, private, and difficult-to-access datasets is almost impossible without smart incentives to mobilize large-scale user contributions.

2) On-chain reputation and history

One challenge mentioned above in Web2 marketplaces is that siloed marketplaces duplicate efforts when it comes to building trust. For example, Uber does background checks on all new drivers, but when the same driver downloads the Lyft app, the app also does a background check because the platforms are siloed.

One application of cryptocurrencies is as portable reputation systems. Instead of requiring individual background checks for each application, what if this information was stored on-chain and moved with any driver joining any marketplace? Further, other information about provider history, such as reliability and quality, could be represented on-chain, enabling marketplaces to combine and leverage a global repository of trust. Such a system could eliminate the need for different managed marketplaces to implement their own capital-intensive processes. In Web2, many managed marketplaces offer a great user experience but are ultimately not viable as a business model due to high operational costs. Global on-chain reputation could 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 of hubs. As users install different applications built on the protocol, their social data moves with them. You can already see interface-less markets emerging on Farcaster. One example is Bountycaster, where users can post and discover bounties on any Farcaster client, leveraging the rich reputation data on the Farcaster network. Because of this portable social data, you can imagine all kinds of new markets emerging in the Farcaster ecosystem, from smart contract audit markets to expert markets that leverage Farcaster’s connection graph and reputation.

3) Payment

Facilitating payments is a core component of modern marketplaces, but in Web2, supporting cross-border payments requires internationalization across local systems. This is particularly important for digital marketplaces, where customers and suppliers are often far apart. For example, over 80% of YouTube users are outside the United States. To support local currency payments in each geographic region, platforms must integrate with international payment gateways. Often, this leaves some marginal regions unserved, especially for resource-constrained, early-stage markets, or platforms that cannot internationalize.

Cryptocurrencies can operate internationally from the outset, enabling transactions between anyone with a crypto wallet. This allows resource-limited markets to have global reach from the outset. For example, I recently purchased an NFT in an on-chain data community called bytexplorers, which allows me to ask data-related questions to a community of analysts. Analysts who answer correctly are rewarded with tokens, enabling seamless payments and global participation.

5. Opportunities in the next generation market

If Ive learned anything over the years of investing in marketplace startups, its that the best opportunities occur when builders leverage new technologies to create significant improvements for the end user. Each generation of marketplace builders leverages new technologies to unlock new markets that couldnt exist before.

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

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