Investing in the smart contract platform native tokens (like ETH or SOL) is like investing in an index of the innovative applications built on top of that platform
These native tokens act as the “picks and shovels” that power the blockchain networks
Many of these networks have strong value capture mechanisms, where value accrues to the native token
Although individual applications may have the potential to generate higher absolute returns, smart contract tokens provide attractive risk-adjusted exposure to the growth of blockchain and digital assets
Throughout the history of new technologies, investing in the infrastructure and platforms (the “picks and shovels”) that enable the new technology has been an optimal risk-weighted strategy to gain exposure to the new emerging technology. For example, investing in Shopify provided better risk-adjusted exposure to the growth of direct-to-consumer eComm than investing in individual DTC brands.
In blockchains, the underlying smart contract platforms like Ethereum, Solana, Polygon and Cosmos are the “picks and shovels”, or the foundational platforms upon which the technology will be built.
What are Smart Contract Platforms?
Smart contract platforms are ecosystems of decentralized applications (“dApps”) that run on blockchains. Ethereum was the first smart contract platform, launched in 2015. Ethereum modified Bitcoin’s blockchain design to add a new feature called “smart contracts” that enabled dApps to be built on the Ethereum blockchain.
Smart Contract Platforms are powered by native tokens (ETH, SOL, ATOM, etc.) that secure the network (through proof-of-stake staking) and pay for transaction fees (called “gas”)
The Smart Contract Platform Landscape
Since the launch of Ethereum, many other smart contract platforms have launched with different blockchain architectures and technology features. These alternative smart contracts also primarily use their own native tokens to power the networks.
Smart contract platforms primarily compete on scalability (how long does a transaction take to settle, how much does each transaction cost) and security (how secure are the assets on the network). A blockchain must make trade-offs in scalability and security, with different platforms making different design optimization choices:
The Ethereum Ecosystem
Ethereum (ETH Layer-1) acts as the foundational settlement layer for the Ethereum ecosystem
The Ethereum blockchain is powered by the ETH token, which is used to secure the network and pay for transaction fees
ETH Layer 1 optimizes for security and decentralization, however this comes at the cost of relatively slower, more expensive transactions
To enable the Ethereum network to handle a higher transaction volume, “Layer 2 blockchains” have been built on top of Ethereum’s Layer 1 foundation
Many of these blockchains have/will have their own native token
Value Accrual in the Ethereum Network
The Ethereum network is designed so that as demand to transact on the network increases, the price of ETH, and the value of the ETH network, increases. Below is an illustrative example:
An exciting new game launches on Ethereum that millions of people want to play
To play the game, demand for ETH increases as players need ETH to pay for transaction fees on the Ethereum network and pay for in-game NFT items, most of which are priced in ETH
Additionally, a portion of the ETH paid in transaction fees is burned, leading to a net decrease in the total ETH supply
As demand to transact on the ETH network increases, the price of gas increases, burning more ETH per transaction
Other Smart Contract Platforms
In 2021, as ETH Layer-1 become prohibitively expensive for the average user, many other smart contract platforms launched alternative platforms with less decentralization, but higher transaction speeds and lower fees. These competing smart contract platforms can be categorized into general purpose smart contract platforms, Layer-0 platforms, or category-specific platforms.
General Purpose Platforms
Alternative smart contract platforms have created entirely new Layer-1 blockchain designs, utilizing new architecture and programming languages. While several platforms like Solana and Avalanche have achieved some escape velocity and differentiated themselves, most of the layer-1 ecosystems will likely not maintain traction and fail over time.
Instead of creating their own blockchain, Layer-0 platforms like Cosmos and Polkadot create a foundation that make it easy for new projects to create their own blockchain within their ecosystem. Often called “appchains”, this presents an entirely new framework for smart contract platforms.
Due to the inherent scaling challenges with blockchains, entrepreneurs have created category-specific blockchains that specialize in a single use case like finance or NFTs. This focused approach can help optimize the blockchain design for that specific category.
Comparing Smart Contract Platforms
With so many competing smart contract platforms, it is important to have a clear framework to evaluate and compare the different platforms:
Value accrual potential for the native token: what is the value capture mechanism for the native token powering the network? Will the market cap of the native token grow as the ecosystem grows?
Adoption: Are developers building new and innovative applications and infrastructure to further the network? Are users engaging with the applications on the network, and how is retention overtime? Is total value on the network growing or declining?
Culture and community: How large and passionate is the community of users and developers?
Smart contract platforms are the picks and shovels powering the growth of web3 and blockchains. Native smart contract platform tokens with strong value capture mechanisms provide an attractive risk-adjusted strategy to gain exposure to growth of web3.
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