How Open-Source Software, Forks, and L1s Push Us Forward
Web2's Walled Garden
Walled gardens characterize the world of Web2. The “walled garden” metaphor is commonly used as a reference to gated tech ecosystems that make it highly attractive for consumers to stay in, but make it difficult for them to leave.
From a consumer welfare perspective, walled gardens are bad because they create barriers between markets and stifle positive externalities that create spontaneous innovation. From a business perspective, however, they are inevitable.
For many Web2 companies, success is contingent on gaining a sizable network effect. Not to be confused with economies of scale, economists think of network effects as a positive feedback loop that is generated when more users join, increasing the overall network value.
Network effects are especially true for social media platforms like Facebook, Instagram, LinkedIn, and Twitter, which make it easy for us to connect with our friends, family, and co-workers. The same applies to e-commerce businesses like eBay, Amazon, Airbnb, and TripAdvisor which are trying to match the largest number of sellers and buyers, and boast a more dynamic marketplace than their competitors.
Web2 companies want to keep the doors to their networks open to achieve a critical mass, but as soon as their networks reach an optimal level, will slowly erect exit barriers to prevent user exodus into competitor’s networks.
How do they do this?
Look to the dominant tech companies of any given period across telecommunications and the mass media. Perhaps the best-known example, Apple’s product ecosystem, is meticulously designed to seamlessly integrate an efficient user experience across its devices, software, and services.
With every purchase of an Apple product, the benefits for users scale incrementally. Economists refer to this as “indirect network effects”. Before they know it, users are “locked” into Apple’s product suite, creating inertia to exit to their competitor’s offerings. Apple is notorious for curating a walled garden, but they are not the only company guilty of it.
It is commonplace for tech companies to privilege the placement of their own software and services in their products by including them as the default option. Microsoft does this with Windows and Office; while Google does the same with its expansive suite of web products across Gmail, Google Cloud Platform, Chrome, and more.
Within modern digital marketing, both Facebook and Google want advertisers to adopt their entire marketing stack from audience tracking, targeting, and performance monitoring. Exiting any one application is not an option, as it would mean abandoning the entire technological stack and incurring significant business costs.
The Harvard Law professor Jonathan Zittrain observed this tendency in his bestselling 2008 book The Future of the Internet and How to Stop It and forewarned that tech corporations such as Apple, AOL, and cellphone networks would kill the creative spirit of the Internet.
As companies battle for the biggest walled garden of their era, consumers are presented with a “take it or leave it” choice. Big corporations would:
[…] push mainstream users away from a generative Internet that fosters innovation and disruption, to an appliancized network that incorporates some of the most powerful features of today’s Internet while greatly limiting its innovative capacity. […] Internet users are again embracing a range of “tethered appliances,” reflecting a resurgence of the initial model of bundled hardware and software that is created and controlled by one company. This will affect how readily behavior on the Internet can be regulated, which in turn will determine the extent that regulators and commercial incumbents can constrain amateur innovation, which has been responsible for much of what we now consider precious about the Internet.
A Game Where Only a Few Players Win
This competitive “survival of the biggest network” dynamic has been apparent in the oligopolistic nature of the tech world since the Internet’s inception in the 90s. Tech companies come and go, but at any one time, the throne is occupied by only a few players.
Today, “The Big Five” refers to Facebook, Apple, Amazon, Google and Microsoft. Before them, it was MySpace, Friendster and Yahoo. And even further back was “The Big Three” Web Portals: AOL, Prodigy and CompuServe.
The Internet dramatically democratized information to the masses, and the world is far better off.
However, the multi-trillion dollars of revenue created through the Internet is largely accrued by a handful of tech companies, even though users drive most content creation.
It is this status quo, wherein the Internet is gated by a select few walled gardens, that Web3 offers radical change.
Web3 Has No Walls
Web3’s nature is open-source, composable, and interoperable. All of these facets let developers easily copy the code of a competitor’s product, and allow users to transport the value of their assets into a different ecosystem.
This was unachievable in Web2, where most code is private intellectual property. The lack of data portability means that social media influencers cannot easily transport their audiences (social capital) to another platform, video gamers cannot uproot their hard-earned in-game items and achievements to another game, and Medium writers cannot transfer their subscribers and portfolios to a competitor platform’s blog.
Because the software is often open-source, Web3 companies are largely unable to trap users by surrounding their product offerings with walls and exclude competitors from reaping the social benefits of their ecosystems.
Consider one of DeFi’s latest innovations: Olympus DAO, a recent Ethereum-based protocol known for spearheading the new wave of “DeFi 2.0” protocols that are attracting liquidity in new and innovative ways.
Olympus launched in March 2021, and in less than a year, there have been more than 50 copycats of its protocol across every Layer 1 (L1).
This is hardly an isolated example.
Recall that Uniswap pioneered the automated market maker model, which was quickly forked by SushiSwap. Soon, dozens of other decentralized exchanges followed suit, each slapping a different name in front of “swap”.
In lending, Compound led the way for Aave and the slew of subsequent lending platforms. In the stablecoin sector, everyone that came after Maker simply followed in its footsteps by adapting DAI’s algorithmic stabilization model.
Yearn Finance, which seeks to make DeFi a user-friendly place to earn yield, has been forked any number of times.
This copying is also rampant in the L1 wars.
Ethereum’s DeFi market share in terms of total-value-locked (TVL) went from a near 100% monopoly to 70%, when a new wave of smart contract L1s entered the fray in Q1 2021, reducing Ethereum’s DeFi dominance by almost a third within the span of a few months.
Ethereum’s open-source nature allowed this to take place quickly.
Competitor blockchains simply copied and improved on its code for their own purposes. Ethereum’s founders could have deterred copycats by creating a traditional Web2 walled garden around its code, but centralizing control over its blockchain and native token would have curbed the incentives for developers (and users) to build.
Web3 is a world where users can hop to a competitor with greater ease and are no longer confined within one ecosystem or product suite. The latest project that you’re giddy with excitement about will soon be duplicated, tinkered with, adapted, and improved upon before your excitement has time to subside.
Ethereum Is Losing Due to Copycats, Not Because Its Less Innovative
Note what is taking place here. Although Ethereum is losing its once-monopolistic grip over DeFi, it is not because other L1 blockchains are outcompeting its ecosystem through new and innovative protocols.
When we look at the DeFi ecosystems of other L1s, there is little to no differentiation in the dApps built on top of it.
Competing L1 ecosystems are littered with the same types of decentralized exchanges, lending protocols, yield aggregators, stablecoin protocols, and derivative products that were first pioneered in Ethereum.
What this means is that new L1 competitors are successfully wresting part of DeFi’s pie via efficient copycats of existing product models on top of an improved technological stack.
Tech companies can no longer stop competitors from reaping the benefits of their network effects; if you create a successful product, anyone can enter your network and ride its momentum.
These “vampire attacks” have huge implications for innovation in Web3.
Competition based on bigger network effects will soon become irrelevant, and competition based on sheer innovation will start to increase.
If copying a competitor is easier, the speed of market saturation increases, thereby forcing new entrants and entrepreneurs to return to the innovation wheel in order to win.
The ability to easily copy in Web3 does not imply that entrepreneurs lack a significant first-mover advantage.
Take for example the NFT boom on Ethereum in Q3 2021.
Launching NFTs on any other blockchain would’ve been technologically easy, yet the bulk of NFT trading volume in 2021 still indicates that Ethereum maintains a strong lead ahead of other L1s.
According to on-chain data from a Chainalysis report, 2021 saw at least $26.9 billion worth of cryptoassets sent to ERC-721 and ERC-1155 contracts, the two types of NFT token standards on Ethereum.
No other chain comes close in terms of NFT trading volume, despite many faster L1s eating the Ethereum’s overall market share!
This tells us is that even in the absence of walled gardens, the prize for being a first-mover is still significant — and that is what L1s compete for: attracting the innovative first-movers (the Uniswaps, Compounds, Axie Infinities, and Olympus DAOs of the world).
L1s that fail to do so may be viable competitors, but they will be forced to play second fiddle to the first-movers.
Implications For L1s
For L1s to succeed, it is crucial to create the most attractive protocol layers so their chain becomes the ideal destination for dApp developers to launch their products. Part of this is creating a great UX for users that developers can leverage, but successful L1s must also excel at just being a stable and predictable place to build. L1s must be attractive to both users and developers.
Again, note the stark contrast to Web2 where incumbents preserve their dominant market position by walling off their networks and creating as much synchronization within their ecosystem so users do not want to leave. Web2 didn’t need to innovate and be attractive to developers, but Web3 incumbents cannot rely on such an advantage and must persistently innovate to survive.
The blockchain qualities that are important to dApp developers varies depending on developers’ needs, but we can expect the following four general attributes to be crucial:
Security: Blockchains with the most decentralized and robust security will mean that it is resistant to 51% attacks, smart contract manipulation, and regulatory scrutiny. Ethereum leads in this aspect, with its high number of node validators and highly distributed token validation.
Throughput: A fast transaction-to-finality speed will be pertinent for a decentralized financial system, especially in areas of DeFi where many transactions are required, such as blockchain gaming. This is where many new Layer-1s such as BSC, Avalanche, and Solana have an edge over Ethereum.
Comparison of validators and TPS across blockchains
Interoperability: This determines how easily blockchains can bridge and connect its native assets to a different ecosystem. Chains that lack fast interoperability will deter users from initial entry, from fear of being locked into a dead-end. EVM-compatible chains and Layer-0 platforms such as Polkadot and Cosmos lead on this front.
Monetary stability: Since Layer-1 native tokens are tied to important utility functions like transaction fees and governance decisions, dApp developers have a vested interest in making sure that the native token of the chain they’re building on is not arbitrarily inflated or disproportionately concentrated in a few holders. L1s that fail to manage their tokenomics will experience systemic instability, leading to user and developer flux.
A blockchain that excels in all areas will come out on top because they allow dApp developers to build with certainty and capture the maximum value provided to users. Those that fail to do so are destined to play catch-up.
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