Loose Push Revealing the Differences Between the Business Models of Web3 and Web2 from First Principles

Unpacking the Divergences in Business Models between Web3 and Web2 through First Principles in a Loosened Perspective

The business model of Web3 is different from Web2. Minimizing trust reduces the cost of user conversion, but the homogeneity of products in Web3 aggregators makes it difficult to achieve network effects. Users in Web3 bear variable costs, but layer 2 solutions can reduce the cost for each person. The principles of reshaping the Web3 business model are token incentives, minimizing trust, and permissionless.

Original author: DeFi Cheetah

Original source: Twitter@DeFi_Cheetah

Translation: Huoxing Finance, MK

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This article explains the business model of Web3 in a first-principles approach. It will be helpful for builders and VCs from Web3.

1. What are the differences between the successful models of Web3 and Web2?

Answer:

i. Minimizing trust reduces the conversion cost and loyalty of Web3 users, making it difficult for Web3 projects to expand their user base.

ii. Product homogenization due to the open nature of the industry leads to weaker network effects.

iii. Lack of economies of scale: The cost borne by current users has not significantly decreased with the increase of dapps.

2. Many Web3 projects attempt to replicate the successful business models of Web2 by bringing together suppliers, distributors, and users on the same platform. This pays tribute to the aggregation theory of Web2 enterprises, where most successful Web2 companies simplify the consumer market, such as FB and Amazon.

3. Why are Web2 aggregators so successful?

Answer:

a. User stickiness as a strong competitive barrier.

b. Increasing network effects as the cost of acquiring users decreases.

c. Economies of scale: The more users, the lower the cost per user.

But this is not the case in Web3.

4. In Web2, as aggregators grow, users become more sticky due to highly personalized services and brand recognition. Aggregators optimize the user experience through data accumulated through operations. Users also perceive a higher risk in establishing trust on new unknown platforms.

5. In other words, Web2 users must trust aggregators to provide high-quality control in service discovery and planning. This creates strong platform stickiness and leads to a clear “winner takes all” phenomenon.

6. For example, online shopping lacks delivery guarantees, so most people choose Amazon, which ensures the legitimacy of sellers through quality control and rating systems. The endorsement of the Amazon brand significantly reduces the risk of contract breach. Therefore, more consumers choose to stick with Amazon rather than easily switch to other new platforms.

7. However, in Web3, protocols operate with minimal trust through smart contracts, transparent operations, specific rules set in code, and automated by smart contracts. Therefore, the cost of transition in Web3 is significantly reduced, and brand awareness is relatively weak.

8. For example, Uniswap does not charge fees from liquidity providers. Some argue that this is due to regulatory considerations, but that is not convincing. A more reasonable explanation is that the Uniswap team recognizes that fee switches could have a huge negative impact on their trading volume (detailed explanation available at: https://x.com/DeFi_Cheetah/status/1611799774747058178?s=20).

9. Therefore, Uniswap does not directly monetize order flow but instead utilizes its first-mover advantage to expand horizontally and challenge existing liquidity aggregators like 1inch and CoWSwap by introducing an intent-driven Uniswap X architecture.

10. In addition to the majority of trading volume being generated by non-human entities, the trust cost for users on new Web3 platforms is not high because operations are open to the public, and anyone can verify the actual utility of new protocols. In contrast, Web2 aggregators hide their backend operations.

11. Some Web2 service providers require custody of user assets, necessitating users to rebuild trust with them. In Web3, however, users interact with aggregators in a non-custodial manner. All of this significantly lowers the user’s transition cost.

12. Furthermore, cleverly designed token incentives can allow emerging platforms to surpass market leaders. This is also how most successful protocol launches achieve initial TVL and user base and solve the cold-start problem in Web3. Before the Blur.io airdrop, OpenSea was the leader in the NFT market.

13. But it is well-known that Blur’s token incentive strategy overturned OpenSea’s position, forcing OpenSea to make significant adjustments in response to declining market share. This level of change enables newcomers to surpass market leaders, which is unprecedented in Web2.

14. In Web3, due to lower user loyalty, the relationship between aggregators and users is more dynamic, making it more difficult for protocols to scale their user base. Competitors can maintain their competitive edge by executing vampire attacks or lowering fees.

15. For Web2 aggregators, as the user base grows, more and more service providers are attracted to their platforms, which in turn attracts more users because they become more valuable to users. Therefore, as time goes on, the cost of user acquisition gradually decreases. However, Web3 dynamics are drastically different.

16. That is to say, Web2 aggregators can create more value for users by integrating more service providers onto their platforms. This product heterogeneity allows aggregators to differentiate themselves from other platforms.

17. For example, as more and more small real estate owners join Airbnb, more travelers become its members because it can provide them with more apartment/accommodation options. When network effects begin to bring more value to users, Airbnb doesn’t need to spend too much to attract users.

18. In contrast, even if Web3 aggregators integrate more service providers, product homogeneity due to the openness of the industry makes it difficult to launch the network effect flywheel in Web3: most dApps provide similar value to users and are easily accessible.

19. … In fact, unless market leaders continue to innovate and provide more advanced functionalities, they cannot offer users a very different product portfolio that newcomers can easily replicate. The continuous development and maintenance costs become…

20. …the acquisition cost of Web3 aggregators. For cross-chain bridges, they need to constantly add support for emerging blockchain ecosystems. Not to mention that token incentives are another way to retain users. These recurring costs greatly undermine the network effects that Web3 aggregators can enjoy.

21. In Web2, users benefit from economies of scale because the more users there are, the less cost each person bears. This is because a significant portion of aggregator expenses is fixed costs. Netflix is a typical example of economies of scale.

22. On Netflix, having the same amount of on-demand video content, the more users there are, the lower the cost per person, because the cost is fixed. Therefore, more users lower costs.

Again, this is not the case in Web3.

23. Although ongoing R&D and maintenance costs continue in Web3, users still need to bear significant variable costs unrelated to economies of scale—the blockchain state consensus fees paid to validators.

24. EIP-4844 can help reduce on-chain data (DA) costs, but the congestion costs caused by limited block space are unrelated to economies of scale, weakening the advantages and moats of aggregators. Regardless of how dominant 1inch is, users still need to pay high fees when the network is congested.

25. The only exception is Layer 2 solutions (L2s). Here, the more users, the less cost each person bears. L2 costs typically include a fixed cost and a variable cost: (i) the cost of publishing blocks on Ethereum and (ii) the cost of running sequencers.

Take Optimism as an example:

26. Assuming the gas price on Ethereum is 25 Gwei and the price of 1 ETH is $2000:

• The one-time cost of deploying an OP stack on the mainnet is approximately 1 ETH.

• Even without any transaction execution, the daily fixed cost (ii) of the OP stack is approximately 0.5 ETH.

• The variable cost (DA) per transaction (i) is 0.000075 ETH.

27. After EIP-4844, assuming (i) a 10x decrease, meaning the lower limit per transaction is approximately $0.015 + (ii) a fixed cost of 0.00001 ETH (around $0.02) as a transaction fee to cover the fixed costs, it would require 50,000 transactions per day to cover the costs of (i) + (ii) (before EIP-4844, the price per transaction was approximately $0.17, and after it was around $0.03).

28. Assuming a positive correlation between the number of users and the number of transactions, the higher the number of users, the more transactions, and the lower the transaction fees needed to cover L2 costs. However, for most Web3 aggregators, simply relying on user growth does not easily achieve economies of scale.

29. Therefore, by simplifying the essence of the Web3 industry into its simplest dimensions and reasoning from there, the advantages enjoyed by Web2 aggregators cannot be directly applied to Web3: user stickiness, network effects, or economies of scale. Token incentives, minimal trust, and permissionless are some of the fundamental principles reshaping Web3 business models.

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