FTX Update:
We begin this piece on a somber note. The implosion of FTX has opened fresh wounds in an industry already beaten down by the Luna/UST debacle and casts new doubt on the solvency of existing players. Frictionless Capital did not incur any losses during this event: We did not custody any assets on FTX, nor did we have any exposure to FTT.
We continue to take a proactive approach to opsec and safeguarding LP assets as our first priority. Unfortunately, many individuals and companies have been affected, and the full extent of the repercussions will only become evident in the months and years to come. Heightened vigilance and caution will be needed.
Reaffirming Thesis of Next Generation Blockchains
One of our competitive advantages is our research driven thesis which allows us to cut through the noise and analyze tech from first principles. This is essential in order to make apples-to-apples comparisons on key blockchain features to objectively evaluate the properties and performance of networks. We find that too often, investors rely on secondary or tertiary information without reasoning for themselves or gathering information from founders and builders directly, broadly allocating according to narratives and themes.
We do not feel this is an effective approach to investing nor one that is likely to result in relative outperformance. Our research-driven thesis guides us and grants us the conviction to center in on key areas of focus that we believe will accrue the most users and value, even when they are contrarian or minority views.
Fundamentally, if you are investing on the wrong chains, even if the products / applications have found some level of product-market fit, their growth and adoption will be bottlenecked by the performance chain they were built on. Streaming HD video and movies was not possible on dial-up internet, and similarly, creating seamless Web2-like apps with virtually 0 fees and latency will not be possible on legacy blockchain technology.
So why now, when the storm rages and the night is darkest, are we doubling down on our thesis of next generation blockchains? We believe that rarely in the technology space the first or second iteration of tech is the long-term winner. The preferences of early crypto adopters and innovators resulted in tradeoffs that prioritized decentralization and redundancy over performance, and legacy blockchains such as Bitcoin and Ethereum are grappling with huge amounts of “tech debt” and are slow or unable to retrofit their architectures with the features required to support mass adopters. Sweeping narratives and disinformation about emergent technologies are creating a generational investment opportunity.
New Blockchain Designs, Built From the Ground Up
In contrast with legacy blockchains, next generation blockchains are built from the ground up with different design choices and optimizations that enable a new paradigm of performance and user experience. For the purpose of this article, we will summarize a few of the features and properties that give next-gen tech the greatest chance of onboarding hundreds of millions and ultimately billions of users.
- Scalability: throughput (commonly measured as TPS) of next-generation blockchains increases as compute (hardware) and bandwidth (internet speeds) increase. Multicore performance of hardware and internet speeds double every ~2 years. Legacy blockchains that don’t scale with increasing hardware and bandwidth will be unable to compete on throughput with next-gen chains. High throughput is a requirement to support millions of applications and users concurrently.
- Abundant Blockspace: enabled by high data propagation, an abundance of blockspace means that gas fees are likely to remain low. When blockspace becomes scarce, L2 solutions can effectively compress data by batching multiple transactions down to the L1, however the blockchain with the largest block propagation at the base layer will have the greatest absolute benefit from L2 compression (e.g. compressing 100 Mbps 500x = 50Gbps vs compressing 1.3 Mbps 500x = 650 Mbps)
- Local Fee Markets: enables gas fees to be assigned per contract, allowing for local “hotspots” of activity like a NFT mint to have gas fees bid up while other activities like DeFi remain virtually costless on the rest of the network. It is paramount that gas fees remain as low as possible to replicate the Web2 UX. $50-$100 transactions are simply not cost-effective for the vast majority of incremental Web2 users, especially in the developing world.
- Preservation of Composability: the ability to natively compose dApps on top of each other will lead to much greater compounding of innovation and acceleration of network effects / user onboarding. Blockchains that break composability early in their lifecycles by relying on sharding & L2 solutions will stifle the innovation of their ecosystem and lose on massive growth compounding in the long term.
Tech for the sake of tech is not as interesting as creating the properties and features outlined above, which give product and application engineers a much larger sandbox to ideate in, and create applications with potentially global impact and reach. When the limits of blockchain are pushed further and further, we will begin to see levels of performance that enable unbounded application development. It is these applications and products themselves that will onboard the next billion users to crypto.
When we cut through the market noise of the crypto space, there are only a small handful of blockchains even aiming to push the theoretical limits of physics. Crypto VCs must possess in-depth knowledge of the technical nuances of blockchain to avoid misallocating to technologies that simply will not scale to 1bn+ users. As the space evolves and more investment flows in, we do not feel that being early is enough anymore, you have to be right about the tech. We feel very confident that our objective view of the space, research, and unparalleled ecosystem presence on the chains we invest in is a highly differentiated approach to investing.
Legal Disclaimer:
This article does not constitute investment advice and is not intended to be relied about as the basis for an investment decision, and is not, and should not assumed to be complete. The contents are provided for informational purposes only and are not to be construed as advice, any prospective investor should conduct their own research and could lose all or a substantial portion of its investment.