Investing in the "Picks and Shovels"

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.

Layer-0 Platforms

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.

Category-Specific

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?

Conclusion

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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Disclosures

Oath Digital, Inc. All content is original and has been researched and produced by Oath Digital, Inc (“Oath Digital”) unless otherwise stated herein.  This report is for informational purposes only and does not constitute an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. There is not enough information contained in this report to make an investment decision and any information contained herein should not be used as a basis for this purpose. This report does not constitute a recommendation or take into account the particular investment objectives, financial situations, or needs of investors. Investors are not to construe the contents of this report as legal, tax or investment advice, and should consult their own advisors concerning an investment in digital assets. The price and value of assets referred to in this research and the income from them may fluctuate. Past performance is not indicative of the future performance of any assets referred to herein. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments.

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