Bankless
180 - Top 5 Bear Market Bets with Avichal Garg & Sanjay Shah of Electric Capital
Mon Jul 17 2023Crypto InvestingLayer Two TokensETH KillersMulti-chain WorldRestakingNFTsHarmful MEVRevenue Generation ModelsGeneral-purpose ChainsApp-specific L2 ChainsDigital GoodsInvesting in NFTsTrade-offs in Blockchain DesignCash Flow and Pricing Power of TokensAnti-fragility of Crypto
Description
This episode covers various topics related to crypto investing during a bear market, including layer two tokens, ETH killers, multi-chain world, restaking, NFTs, harmful MEV, revenue generation models for layer twos, the role of layer twos in Ethereum, advantages of general-purpose chains vs app-specific L2 chains, digital goods and NFTs, investing in NFTs, trade-offs in blockchain design, cash flow and pricing power of tokens, and the anti-fragility of crypto. The episode provides insights into these topics and encourages critical thinking and consideration of other perspectives.
Insights
Alpha in a market comes from depth of understanding and recognizing the disconnect between perception and reality.
Investors should strive to have a deep understanding of the market and identify the gap between perception and reality.
Bear markets are an opportunity to test investor conviction and refine investment theses.
Bear markets provide an opportunity for investors to evaluate their convictions and improve their investment strategies.
Crypto provides opportunities for global participation in open systems outside local fiat regimes.
Cryptocurrency allows people worldwide to participate in open systems, providing an alternative to local fiat currencies.
Layer two tokens have potential value based on cash flows and sustainable products.
Tokens built on layer twos can have value through cash flows generated by sustainable products.
NFTs are not dead; they are this cycle's altcoins and may be under-hyped at the moment.
NFTs still have potential and should not be dismissed as they could become significant in the next cycle.
Digital goods are more efficient at accruing social capital than physical goods.
Spending on digital items, such as NFTs, is more efficient in terms of acquiring social capital compared to physical goods.
Understanding deeply what's happening with users, businesses, and markets is crucial before investing in NFTs.
Investors should have a deep understanding of the NFT market and its dynamics before making investment decisions.
The trade-off between decentralization and composability is a key consideration in blockchain design.
Blockchain designers need to balance decentralization and composability when designing blockchain architectures.
Cash flow and pricing power due to network effects can give a token a monetary premium.
Tokens with cash flow and pricing power resulting from network effects can have a higher value.
Crypto is more anti-fragile than people think, with social protocols securing the Bitcoin network.
Despite negative sentiment, the fundamentals of crypto are strong, and the industry has proven to be anti-fragile over the years.
Chapters
- Alpha in a market comes from depth of understanding and recognizing the disconnect between perception and reality.
- The bear market is a time to rebuild investment ideas and place bets accordingly.
- Cryptocurrency is about empowering people worldwide to participate in open systems.
- Harmful MEV is anything harmful to the user, like a sandwich attack.
- Different layer twos will experiment with different models for revenue generation, such as burning tokens, giving them as dividends, or investing in retroactive public goods.
- Ethereum is evolving into a credibly neutral and decentralized space that the US government cannot unilaterally shut out
- L2 tokens are investments in an emerging network state with network effects.
- Different types of chains within the NFT ecosystem, ranging from a general-purpose chain like Ethereum to app-specific chains like Cosmos
- There are advantages to being on an app-specific chain, such as customizability and protection from governance decisions.
- Centralized lending platforms were used more than DeFi due to better user experience, but now people are paying the price.
- Digital goods are more efficient at accruing social capital than physical goods.
- Over the last two years, there has been an overestimation of what would happen with NFTs, but in the next 10 years, there may be big winners that emerge.
- Investing in NFTs should be done to support artists rather than as a financial investment.
- The trade-off between decentralization and composability is a key consideration in blockchain design.
- Cash flow and pricing power due to network effects can give a token a monetary premium.
- Crypto is more anti-fragile than people think, with social protocols securing the Bitcoin network.
Summary
Transcript
Alpha in a market comes from depth of understanding and recognizing the disconnect between perception and reality.
00:00 - 06:31
- Bear markets are an opportunity to test investor conviction and refine investment theses.
- Avichol and Sanjay from Electric Capital discuss their bear market bets.
- Key questions for crypto investors during a bear market include the value of layer two tokens, the potential comeback of ETH killers, the future of a multi-chain world, the significance of restaking, and NFTs as this cycle's altcoins.
- The episode also touches on a brief debate about Ether's money-ness.
- Listeners should approach these ideas with critical thinking and consider other perspectives.
The bear market is a time to rebuild investment ideas and place bets accordingly.
06:03 - 12:10
- Question 1: Are Layer 2 tokens worthless governance tokens?
- Question 2: Will ETH killers make a comeback?
- Question 3: Will there be millions of chains or just a few big winners in the layer two world?
- Question 4: Is restaking and eigenlayer a big deal or overhyped? Is it an existential crisis for Ethereum?
- Question 5: Are NFTs dead or will they make a comeback?
- Layer two tokens have potential value based on cash flows and sustainable products.
- Cash flow does not necessarily make a token a security.
- Crypto provides opportunities for global participation in open systems outside local fiat regimes.
Cryptocurrency is about empowering people worldwide to participate in open systems.
11:47 - 18:28
- Altcoins provide opportunities for global participation and value capture without being classified as securities.
- Real-world assets like property can generate cash flow without being considered securities.
- Regulatory frameworks need to be careful not to stifle technological innovation.
- Cryptocurrency and AI challenge traditional regulatory models due to their non-jurisdictional nature.
- The invention of the Joint Stock Corporation in the past faced similar challenges and led to new regulations that unlocked the industrial revolution.
- Crypto and AI are the first technologies in centuries that require a rethinking of regulation.
- The properties of cryptocurrency are truly internet-native, creating unique regulatory challenges.
- Cash flow entities that allow broad participation without being securities are a side effect of this new technology.
- Regulation is a complex topic with many aspects to consider, but it's hoped that crypto regulation can progress faster than previous regulatory developments.
- Tokens have the potential to accrue value globally, but revenue generation depends on factors like MEV (Miner Extractable Value) and transaction fees.
- Rollups currently generate revenue from transaction fees but not from MEV due to centralized sequencers' decisions not to extract MEV.
- In the future, rollups could generate significant revenue from MEV if it is turned on, distinguishing between harmful MEV (e.g., sandwich attacks) and beneficial MEV (e.g., arbitrage).
Harmful MEV is anything harmful to the user, like a sandwich attack.
18:00 - 24:57
- Good MEV includes arbitrage and liquidation, which benefit the ecosystem.
- Businesses and blockchains have incentives to mitigate or rebate harmful MEV.
- Multiple projects are working on combating harmful MEV.
- Roll-ups generate revenue through MEV and transaction fees.
- Layer 2 designers aim to minimize harmful MEV and potentially rebate it to users.
- Examples of harmful MEV include sandwich attacks that manipulate prices against users' trades.
- Examples of good MEV include arbitrage and liquidation that benefit users and protocols.
- Shared sequencers are implementing encryption to block harmful MEV and optimize beneficial transactions through auctions.
- Different layer twos may experiment with various models for distributing value, such as burning tokens, giving dividends, or investing in public goods.
Different layer twos will experiment with different models for revenue generation, such as burning tokens, giving them as dividends, or investing in retroactive public goods.
24:31 - 31:23
- Auctions may be used to determine the value that goes back to the protocol.
- MEV (Miner Extractable Value) is expected to be a significant source of revenue.
- Layer twos currently charge transaction fees by breaking down costs into L1 cost, L2 operational cost, and L2 gas fee.
- Layer twos can be seen as value-added resellers of layer one block space.
- The pricing of L2 block space does not have to be a fixed percentage above L1 block space; it can vary based on its value.
- Layer twos create value by making their block spaces valuable and charging whatever the market is willing to pay.
- Analogies for layer twos include companies selling products and emerging economies within a nation-state model.
Ethereum is evolving into a credibly neutral and decentralized space that the US government cannot unilaterally shut out
31:02 - 37:07
- Layer two solutions in Ethereum can be compared to states within a country, like California, with their own pricing power and network effects,
- States like California have pricing power due to factors such as valuable real estate, brand value, and network effects,
- Layer twos also have different forms of pricing power, including network effects in DeFi and technical modes like building ZK-based systems,
- The analogy of layer twos as states on top of the federal government is a great way to understand their role,
- Currently, there is no way to invest directly in layer twos or states like California, but investing in L2 tokens can be seen as an investment in the emerging network state,
- L2 tokens represent an investment in the services and network effects provided by layer twos,
- Defecting from one layer two to another is possible if the services and network effects are not worth it
L2 tokens are investments in an emerging network state with network effects.
36:46 - 43:19
- Analogies can be helpful in understanding early-stage technology.
- Choosing to live in a certain location can reflect cultural values, similar to choosing an L2 network.
- Lower switching costs make L2 tokens more valuable as infrastructure improves.
- L2 tokens can be valued as capital assets with cash flow potential.
- Tokens that generate unique states will be the most valuable on L2 networks.
- There could be millions of L2s, including both open and permissioned chains.
Different types of chains within the NFT ecosystem, ranging from a general-purpose chain like Ethereum to app-specific chains like Cosmos
42:54 - 48:51
- Speculation on Coinbase potentially creating a KYC chain using their existing user base
- The observation that computational resources are always fully utilized by developers
- Expectation that millions of applications will emerge on blockchain platforms
- Early use cases for blockchain platforms often involve games, with DeFi and NFTs being considered as social games played across the internet
- Discussion on how much of real life can be seen as a game and the role of social capital in various industries
- The idea that expanding the definition of games can encompass many different use cases, such as real estate transactions
- The notion that playing video games can provide valuable training for understanding crypto investments
- Advantages of being on a general-purpose chain versus an app-specific L2 chain, including asynchronous composability and interoperability
There are advantages to being on an app-specific chain, such as customizability and protection from governance decisions.
48:28 - 54:58
- App-specific chains offer more flexibility for apps to switch chains if they disagree with certain decisions.
- There will likely be a mix of general purpose rollups and app-specific L2s in the future.
- The current UX for moving between different chains is challenging, but there are efforts to improve interoperability and reduce friction.
- Standards and shared sequencers could enable interoperability between different chains.
- User experience is a major bottleneck for crypto adoption, and if not addressed properly, it could hinder the success of L2 solutions.
- The ease of getting into crypto can lead to people losing their assets and having a negative experience, which could discourage further participation.
- In the past, centralized lending platforms were preferred due to better UX, but now users are paying the price for that choice.
Centralized lending platforms were used more than DeFi due to better user experience, but now people are paying the price.
54:30 - 1:00:52
- NFTs did not become big enough this cycle, but there is a chance they will in the next cycle.
- There is a tension between making crypto easy to use and implementing safety measures to protect users.
- A long bear market could allow for the development of better and safer user experiences.
- NFTs are not dead; they are this cycle's altcoins and may be under-hyped at the moment.
- Non-fungible items like purses, watches, and shoes hold value because of the emotions humans attach to them.
- Digital goods will likely follow the path of online ads, with money flowing where people spend their time.
Over the last two years, there has been an overestimation of what would happen with NFTs, but in the next 10 years, there may be big winners that emerge.
1:05:48 - 1:11:49
- Investing in NFTs requires navigating through various options and understanding the market better than anyone else.
- To generate value as an investor, one needs to identify the delta between perception and reality in a specific sub-sector.
- There are multiple ways to invest in NFTs, such as buying art, investing in picks and shovel infrastructure, or looking at established brands entering the space.
- Patience is important in investing, and finding opportunities where you have a deep understanding can lead to success.
- Most people should not view NFTs or early stage crypto as investments; instead, they should buy for the art and community support.
Investing in NFTs should be done to support artists rather than as a financial investment.
1:11:30 - 1:17:40
- Investors need to understand the market better than anyone else and have deep insights before investing in NFTs.
- Patience is key when investing in emerging markets like NFTs.
- The size of the market for successful investments can be much larger than anticipated.
- Understanding deeply what's happening with users, businesses, and markets is crucial before investing.
- There may be contenders for Ethereum's throne in the future, but Ethereum's modular approach with layer two scaling has advantages.
- Monolithic chains like Solana offer real-time composability, while modular chains sacrifice it for other benefits.
- The trade-off between decentralization and composability is an interesting design exercise for blockchain architectures.
The trade-off between decentralization and composability is a key consideration in blockchain design.
1:17:12 - 1:23:48
- Having multiple approaches and ecosystems is important for the resilience of the space.
- Layer ones are not necessarily competing for monetary premium, but can have pricing power due to network effects.
- Bitcoin is a special case as it behaves more like a commodity than a computational network.
- There's a middle ground where tokens can have cash flow and pricing power without being base money.