Which is more important, encrypted narrative or product construction?

Encrypted narrative or product construction which is more important?

Original Title: The Narrative Wedge

Original Author: JOEL JOHN

Original Source: Decentralized.co

Translation: MarsBit, MK

• LianGuai Observation | Understanding the July Cryptocurrency Market in 7 Pictures DeFi Unaffected by Curve Vulnerability
• Infinite ‘Bullets’? Discussing the Hidden Concerns of the Largest BTC Listed Company MSTR
• War against Coinbase MEKE forays into the Binance Smart Chain Layer 2 market.

TL:DR For readers who are eager to understand, please refer to the following summary:

• The price of tokens often affects cryptocurrency venture capital.

• The lifespan of the narrative that drives the price is short-lived.

• Scaling projects takes longer.

• Founders and investors choose themes based on the revenue brought by the narrative, but when the product goes live, attention may have already shifted elsewhere.

• The original sin of cryptocurrencies lies in charging users. Tools like account abstraction can lower the cost for founding teams to attract and retain users.

• A strong narrative cannot compensate for a bad product. Metrics manipulated by bots also cannot make up for the lack of a community.

These are some of my observations from last week. You could have invested in Axie Infinity1 at the beginning of the gaming market boom, then left, and returned to make more money than most Web3 game venture capitalists. At its lowest point, Axie’s trading price was $0.14. Currently, it is priced at $6. The return on investment was 40 times.

Its price once rose to over 1,000 times. The reason is that most seed-stage venture capital projects in the Web3 gaming market are either far from liquidity or likely to fail before raising more capital, which is the problem they face in the current market environment. I will explain this issue further with charts later.

But my idea has flaws.

Seed-stage projects should not generate returns within 18-24 months.

I assume that investors will invest in Axie Infinity before the game gains attention.

But the fundamental problem is that you could have invested in a liquid asset during a bear market and achieved better returns in early-stage venture capital transactions. This dilemma has led me to reflect on the risk scope, attention ahead of capital, and blind spots in the venture capital industry in the cryptocurrency field. This article summarizes some of my thoughts and explains how narratives drive funds and attention in our industry.

Before we begin, let’s look at some numbers. According to the information tracked by the data product I used, out of more than 3,500 tokens, fewer than 1,300 have been transferred in less than 10 wallets in the past month. Among the 14,000 dApps tracked by DappRadar, fewer than 150 had 1,000 users at the time of writing this article. As an industry, our attention shifts from one asset to another in a very short period of time. Our beliefs about fundraising mechanisms can also show similar patterns. The following data shows the mentions of ICOs and issuance platforms in important cryptocurrency communities in the past few years.

ICO used to attract the attention of retail investors, but was eventually replaced by the “launchpad” of exchanges – an example of a narrative evolving in real time.

If you were there in 2017, you might have thought that venture capital was about to change permanently. In that year, according to the data sources you provided, cryptocurrencies raised between $19 billion and $60 billion from retail and institutional investors. However, the survival rate of those ICO projects was comparable to that seen in traditional venture capital.

You can see the results from the chart between January 2019 and January 2021 – the golden age of cryptocurrency venture capital. Interest in ICOs quickly disappeared. Investors saw a brief period of opportunity where founders with wandering eyes could no longer access retail capital to build companies. Startup valuations ranged from $5 million to $10 million. Founders and investors had to start over to survive.

One reason founders turned to venture capital fundraising was a better understanding of the risks of token issuance too early. You have to spend time managing communities, doing legal work to ensure compliance, and tying your net worth to liquid assets – all while building a company. Because someone was dissatisfied with a comment from a team member on Discord and decided to dump all the tokens on an exchange with only $10,000 in liquidity, founders could wake up 20% poorer.

Years later, we are back in the season of launchpads – exchanges acting as gods, deciding which venture capital projects can raise millions of dollars from retail participants. Although there are more barriers this time, at least they ensure better conditions for retail investors when investing, no longer seeing valuations in the billions like ICOs in 2017.

The reason I used ICOs giving way to launchpads as an example is because there is data to support it. Enough time has passed since the heyday of ICOs, and now we can learn from the review what happened. If we look at some of the newer trending topics like DeFi, NFTs, or Web3 games, we find that public interest in these topics has significantly declined.

Unlike ICOs, the stories of DeFi, Web3 games, and NFTs are still evolving.

A declining narrative

DeFi has transitioned from a peak of expectations to a slope of recognition. No longer are new Uniswap competitors emerging every day. Aave and Compound have established a strong presence in the lending market (for peer-to-peer and over-collateralized assets). The subsequent versions of these products are either more consumer-oriented or focused on institutions, no longer obsessed with speculation as a use case as before.

Robert Leshner is shifting his focus to launching a mutual fund (CeDeFi?), while Stani is shifting his focus to Lens (Web3 social). This shows that founders who have been in the industry for some time are preparing for the next race.

Google search trends, Total Value Locked (TVL), and user counts are good places to observe attention and capital flows in DeFi. As of the time of writing this article, funds on DeFi platforms have dropped from a high of $160 billion to a low of $40 billion.

If you look at the user count data, it has decreased by 50% in the past few months. However, it is still 100 times higher compared to when DeFi summer started in March 2020.

In other words, although interest and usage have declined, the number of users in these product categories is still much higher than before. However, if you look at the search trends for the same functionalities, you will see a completely different situation.

Interest has returned to bear market levels in 2018. It’s as if no one cares about this industry anymore. I looked at the data for NFTs and ChatGPT, and their trends are similar. Meanwhile, the trend for searching related to “aliens” is on the rise.

Based on this data about DeFi, I have some observations to make.

• Narratives gradually emerge in the early stages of bull markets.

• The power of these tailwinds is often due to technological developments.

• Early participants in specific areas benefit from the expansion of narratives and usage simultaneously.

• Compound, UniSwap, and Bored Apes are examples of narratives and product usage combining to bring investors excess returns.

The challenge is to invest in a narrative tailwind that may disappear before seeing enough users. We may need to revisit Axie Infinity to understand what I mean.

Timing is crucial

I mentioned Axie because it captures several themes well:

1. It is a listed asset with about two years of product development before 2021.

2. You could argue that it was undervalued at the time.

3. Axie marks the beginning (and possibly the decline) of Web3 gaming as a theme.

If you pay attention to the chart above, you will notice that there was a significant increase in the number of users before Axie surged to $150. Through on-chain tracking, people could see the extent to which new users flocked to the product and priced it well before July 2021.

But by October, when the number of new users started to decrease, Axie became less like a product and more like an asset. This is a trap that all on-chain products are vulnerable to. The over-financialization of in-game assets means that hedge funds in New York may pay players who put effort into the game. The play-to-earn model relies on the inflow and liquidity of in-game assets. Sometimes, this liquidity comes from speculators and institutions.

Investment in the theme of venture capital has been gaining traction between July 2021 and January 2022. Many investors hesitate, form beliefs, and write papers exploring the development trends of the industry. Similarly, founders also realize the difficulties in building DeFi dApps and believe that gaming is the next big trend, just as many founders are now venturing into artificial intelligence.

The real risk lies in the 18 months after January 2022. Have you seen the sharp decline in the number of new users on the chart? This is the shrinking user base of all Web3 native gaming applications. Tools built at the fringes, such as “Steam for Web3 games” or “reputation for Web3 games,” quickly struggle to find users.

Mistaking short-term price increases for real consumer demand is a trap that many founders fall into. For these founders, the risk lies in the difficulty of raising funds again in the current market environment if there is not enough growth.

It is very likely that founders are entering the market at the right market but the wrong time to start a business. The danger for founders is closing the company before enough attention or capital inflows occur.

As a venture capitalist, on the one hand, you will see the fluid market heavily rewarding traders, and on the other hand, you will compete with a group of founders who are also venturing into the same theme as you. This is not a pleasant experience for everyone involved.

My viewpoint is:

1. The market often incorporates narratives into pricing in the short term.

2. Given the liquidity nature of Web3 investments, liquid assets may provide exit opportunities within a quarter.

3. Considering the illiquidity of venture capital, venture capital projects may not have a market to exploit after the product goes live because the product takes time to develop and grow.

4. This often means a slow death and a bet on user return. The product effectively becomes a bet on “bull market return”.

An exception is when a category expands to have enough interested users and you build something unique. Ironically, DeFi has already crossed the chasm. DeFi founders with 3 million users no longer need to worry about new users entering the market.

As long as they are not producing the 30th copycat, they will have enough user interest.

The investment approach of local cryptocurrency investors in venture capital is either tastemakers or pioneers. They either have enough distribution and influence to open up a new category or have foresight to recognize an emerging field. If they only see price action as the driving factor for emerging themes, then they are likely entering the market very late. It is very possible that they will not see meaningful exit opportunities unless it is a business that can develop into an IPO or be acquired, both of which are rare in the token field.

In such a market, making the right decisions is crucial. Both investors and founders must keep a clear head and realize that short-term price fluctuations do not always reflect true user demand and long-term value. They need to see the potential behind the trend, not just the current popularity. At the same time, they also need to recognize that both investment and entrepreneurship require patience and should not be blinded by short-term profits and passions.

Overall, the cryptocurrency field is an area full of opportunities and challenges. The right narratives and themes can bring substantial returns, but it also requires caution and determination. In this ever-evolving industry, paying attention to technological developments and changes in user demand is crucial for making wise investment and entrepreneurial decisions.

This situation has an impact on founders when their business models evolve. For example, the effective royalty rate for NFTs has dropped from about 2.5% to 0.6% in the past year, thanks to the emergence of royalty-free markets like Blur. As of the writing of this article, about 90% of NFT transactions have no royalty fees.

In essence, this means that any idea based on the influx of a large number of traditional artists into the industry and their need to deal with income will be completely wiped out by risk capital. In the past year, countless creator economy startups have had to change their strategies because the patterns have changed.

Like all emerging technologies, chaos is a way of life in the cryptocurrency field.

Freedom

Let’s go back to the late 2000s. After a full day at school, you log in to Facebook to chat with friends. There are countless interesting videos on YouTube. Google gets you hooked on the secret, secret rabbit hole of banking groups. There are ads in all these activities, but you rarely pay for them. The Internet cultivated your habits before expecting you to pay.

LimeWire introduced us to free music…and malicious software.

In contrast, the obsession with ownership and exclusivity in Web3 has created small user communities that interact in echo chambers. According to their blog, Arkham Intelligence has over 100,000 users. Nansen’s V2 product has already surpassed 500,000 registered users today. Dune has one of the largest communities of data scientists in the industry. The only thing they have in common is that they all have free tiers.

The genius of the Internet is that it allows users to bear the cost of most actions. In return, it gains widespread dissemination. The huge risk that Web3 faces is how high the cost of each interaction is. For users who do not need online communities, it is not attractive to spend $8 to buy a picture on the blockchain. When you have friends on Reddit, why bother to get an ape (referring to NFT collectibles) worth $10,000?

For users who have had free email addresses for decades, the value proposition of buying an ENS for $50 may not be obvious. Axie Infinity initially required spending $1200 to buy NFTs to play the game. The guild mode relies on this high barrier to entry. Last year, they released a free version of the game, realizing the risk of maintaining a high barrier to entry.

On Reddit, the combination of “free” and “ownership” is quite clever to some extent. The social network with 400 million monthly active users is a behemoth. So far, about 15 million wallets have collected their collectibles. This is about twice the number of monthly active users in DeFi at its peak. Specific age and profile accounts can purchase collectibles from Reddit.

In this case, most users are still using the “free” product, and only a small number of users are minting, trading, and owning collectibles. The distribution problem has been solved through a website that has been running for 18 years.

A new type of application has attracted a large number of users by offering compiling opportunities. Rabbithole and Layer3 are typical examples of this. They do not charge users, but provide value to those who are willing to explore new opportunities on the chain. According to a tweet from the founder of Layer3, the product has provided about 15 million on-chain actions for users interested in cryptocurrency.

This shift in product strategy is already happening. If you visit Beam.eco, you will find a wallet that can be set up in less than 10 seconds. Asset.money helps you collect NFTs in less than 3 clicks. Users don’t have to worry about gas costs, getting started, and setting up wallets. Of course, there are security trade-offs here. This kind of change is similar to the change in email, from everyone running their own servers to being hosted on third-party servers operated by companies like Hotmail and Google.

Hedge Trading

Remember when I said that risk investment in the cryptocurrency field cannot be timed based solely on narratives? The only way to escape the trap is the oldest trick in the book:

• Attract a user base and keep them for the long term

• Accumulate value steadily over a longer time frame

In this industry, some tokens have successfully done this. In the DeFi field, Uniswap is an example. Despite the attack on royalties, OpenSea still maintains relevance. The tail end of risk investment is a bet on attention and capital flow.

The only way to break free from an unhealthy reliance on investor or speculator capital is to rely on the purest form of capital that all businesses have access to – the attention of their customers. With the contraction of venture capital, more and more startups (and protocols) will have to return to finding users who care.

The most relevant example I found is Manifold.xyz. The product focuses on making it relatively easy for creators to mint NFTs. According to TokenTerminal data, their fees exceeded $1 million last month. Maybe not so exciting? But it is very important in the current market.

I found that many participants who perform well in market cycles have early advantages. This is a recurring story.

A small team enters an industry when the thematic narrative reaches its peak. They see the market gradually drying up while competitors are leaving. When attention and capital return, they are the most likely to achieve scale expansion. From this perspective, those themes that large investors are giving up on, as long as you can survive, you should participate.

Usually, founders are shaken by a transformation before they fall into trouble. Not long ago, being part of Web3 was “trendy”. Now, mentioning your work in this industry can be embarrassing. Teams feel the need to fabricate statistics to stay relevant. We often see founders exaggerating their products through airdrop-driven robot activities.

For experienced investors, these games are often quite obvious and send the wrong signals about the team, regardless of how good their products are.

In the cryptocurrency field, to survive and succeed in fierce market competition, one needs to be more cautious and rational. Relying solely on narratives and short-term popularity is not enough. Entrepreneurs and investors must stick to their original intentions, focus on long-term value, and always pay attention to the development of technology and changes in user needs. Only in this way can success be achieved in this industry full of opportunities and challenges.

For founders, here is a survival checklist:

1. Understand the difference between venture capitalists betting on narratives and deep exploration of the theme you are exploring. One may just be flipping your SAFT (Simple Agreement for Future Tokens), while the other may co-write a whitepaper with you.

2. Entering the market early is an advantage. But it also means that it may take months for someone to have confidence in what you are creating. Most of your demos will become educational courses for investors. This is a blessing and a curse.

3. In a market where all peers have died, survival is the ultimate show-off. Keeping expenses at a minimum level to survive is often the right approach.

4. Consumer attention often comes before investor capital. It is helpful to communicate with users and iterate on the product before pitching it to investors.

5. If market fit cannot be found within a meaningful timeframe, it is acceptable to shut down a venture capital firm. Life is too short and you shouldn’t be employed by your venture capital firm forever. There needs to be more honest discussions about how to end operations with minimal friction. (This is difficult to write, but must be mentioned).

Given the liquidity of the cryptocurrency market, it is important for investors (in terms of time or capital) to understand whether they are early adopters in a particular theme or following a trend. The trap often lies in spending years on a collapsing theme. It is worth mentioning that I don’t believe the Web3 game as a theme has come to an end. Its story is still being written by countless founders who remain confident in this theme. Personally, I spend every week trying to understand different chapters of this story.

The trap lies in confusing the price movements of the public market with investment opportunities in the private market. A narrative may have disappeared by the time a product is listed. Follow-up funding may disappear as well. And consumers may not care. This is a difficult struggle that many founders will have to face in the coming quarters.

We will continue to update Blocking; if you have any questions or suggestions, please contact us!