The Risks of Overbuilding Crypto Infrastructure

by

As a seasoned crypto investor with a decade of experience under my belt, I can’t help but feel a mix of excitement and concern when I look at the current state of Web3 infrastructure. With my first investment in Bitcoin back in 2011, I’ve seen the rise and fall of countless projects, and I’ve learned that one key to success is finding the balance between infrastructure building and application development.

As a technology analyst, I find myself reflecting on the evolving landscape of the Web3 ecosystem, often hailed as the future internet backbone. Despite the Ethereum white paper being released nearly a decade ago, mainstream applications utilizing this infrastructure remain scarce.

Why is this happening? Simply because it’s profitable to build infrastructure in Web3.

Web3 defies some of the conventional market adoption patterns in tech infrastructure, creating both a rapid path to profitability and unique risks for its evolution. To explore this thesis further, we must understand how value is typically created in infrastructure technology trends, how Web3 diverges from this norm, and the risks posed by overbuilding infrastructure.

The Infrastructure-Application Value Creation Cycle in Tech Markets

Typically, generating value in technology markets tends to oscillate between the infrastructure and application tiers, striking an agile equilibrium between them both.

In the early days of the Web1 period, giants such as Cisco, IBM, and Sun Microsystems laid the groundwork for the internet’s foundation. However, even back then, innovative applications like Netscape and AOL were born, seizing a substantial portion of the value. The following era, known as Web2, was characterized by cloud infrastructure that led to the rise of SaaS services and social platforms, which in turn stimulated the development of new cloud infrastructure.

Lately, the focus has shifted towards advancements in generative AI, which initially started as a foundation laid by model developers. However, innovations like ChatGPT, NotebookLM, and Perplexity have gained significant traction, fostering the need for fresh infrastructure to accommodate this new wave of AI applications. This cycle of innovation seems poised to persist for several rounds.

In many tech markets, there’s a consistent equilibrium between the value creation of application and infrastructure layers. However, Web3 stands out as an exception due to a significant imbalance in these layers. Yet, what causes this disparity in Web3?

The Infrastructure Casino

In simpler terms, one key distinction between Web3 and earlier versions lies in the swift way infrastructure projects can gather funds and achieve liquidity. In Web3, these projects usually issue tradeable tokens, offering immediate liquidity to investors, developers, and user communities. This is quite different from traditional markets where investors’ liquidity comes from company buyouts or initial public offerings, both of which tend to take a long time. The majority of venture capital firms work with a timeline of ten years or more. While quick access to capital is an advantage in Web3, it can sometimes lead to misaligned team goals, discouraging the creation of lasting value.

The “infrastructure casino” is a questionable trend within Web3 as it encourages developers and investors to focus more on infrastructure development rather than applications. Given that L2 tokens can attain staggering valuations worth billions in a short period with limited usage, the appeal is obvious. However, this strategy poses numerous problems, many of which are intricate and challenging to resolve.

The Challenges of Overbuilding Web3 Infrastructure

1) Building Without Adoption Feedback

One potential concern when constructing too much infrastructure in the Web3 ecosystem is the absence of direct feedback from applications developed on this foundation. Applications serve as the tangible manifestation of consumer and business needs and frequently inspire innovative uses within the infrastructure itself. When there’s no feedback from these applications, Web3 risks developing infrastructure for hypothetical use cases that may be disconnected from real-world market trends and requirements.

2) Extreme Liquidity Fragmentation

One key factor leading to the division of liquidity within the Web3 space is the continuous introduction of fresh Web3 infrastructure ecosystems. These newly established blockchains typically demand massive financial resources, often running into billions of dollars, to seed liquidity and attract top-tier DeFi projects to their systems. Contrasted to this, the growth in the number of new L1 and L2 blockchains has been swifter than the influx of fresh capital into the market over the past few months. This discrepancy has resulted in a more fragmented distribution of capital within Web3, posing considerable hurdles for adoption.

3) Inevitable, Increasing Complexity

Have you given some newer blockchain-based wallets, decentralized apps (dApps), and bridges a try? Users often find the experience challenging because as technology advances, it tends to become more intricate. However, applications constructed on this complex infrastructure are designed to hide this complexity from end users. In Web3, where there’s less development of user-friendly applications, users must directly engage with increasingly complex blockchains, which can make adoption difficult.

4) Limited Developer Communities

If the development of Web3 infrastructure is advancing faster than the accumulation of capital, then the task becomes even more daunting when considering developer communities. Since decentralized applications (dApps) are constructed by developers, establishing new developer communities remains a formidable challenge. Most emerging Web3 infrastructure projects encounter this difficulty due to their reliance on the same small pool of talent, which is insufficient to support the extensive amount of infrastructure being created.

5) Widening Gap with Web2

Building too much infrastructure in the Web3 world, without a corresponding increase in app usage, is leading to a growing divide with Web2. Innovations like generative AI are driving the creation of a new wave of Web2 applications and reshaping industries such as SaaS and mobile. Instead of capitalizing on this progress, the main trend in Web3 remains the construction of additional blockchains.

Ending the Vicious Circle

Investing in or developing L1 and L2 blockchains can be financially rewarding for both investors and development teams, but such profit doesn’t automatically guarantee lasting advantages for the Web3 community. At present, Web3 is in its infancy, and while additional infrastructure components are undoubtedly necessary, much of the industry is constructing infrastructure without taking market feedback into account.

In essence, the majority of input we receive about the market is from apps built on our infrastructure, yet these apps are rarely found in Web3. Instead, most usage of our Web3 infrastructure originates from other Web3 projects. We persist in constructing infrastructure, issuing tokens, and gathering funds, but we’re essentially operating in the dark.

Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.

Read More

2024-12-18 02:17