Original author: DeFi Cheetah
Original compilation: Deep Chao TechFlow
The purpose of this article is to explain how the first principles of Web3 come into play in the different business models of Web3 and Web2. If you are a builder or coming from Web3 VC, this will be helpful for you.
How does a successful Web3 model differ from a Web2 model?
i. The trust-minimized setting reduces the switching cost and loyalty of Web3 users, making it difficult for the Web3 project to expand the user scale.
ii. The industry is open source, products are homogeneous, and network effects are weak.
iii. Lack of economies of scale: The costs borne by current Dapp users do not decrease much with each additional user.
Many Web3 projects attempt to replicate successful Web2 business models, bringing together suppliers, resellers, and users on a single platform. This is a nod to the aggregation theory that most successful Web2 businesses have simplified for consumer marketplaces, such as FB and Amazon.
Why are Web2 aggregators so successful?
a. User stickiness is a powerful weapon against competition.
b. Powerful network effects reduce user acquisition costs.
c) Economies of scale: The more users there are, the less everyone pays.
This is not the case in Web3.
For a, as aggregators grow, Web2 users become more sticky due to greater customizability of services and greater brand recognition. Aggregators have more data to optimize user experience when running their businesses. Users also find it risky to build trust and confidence in new and unknown platforms.
in other words,In Web2, users must trust the aggregator to provide excellent service discovery and curation through good quality control of service providers. Therefore, the platform is highly sticky and"winner takes all"The phenomenon is obvious.
For example, there is no guarantee of goods delivery when shopping online, so most people choose Amazon because it has quality control and rating systems to ensure that the seller is legitimate. Coupled with Amazons brand, the risk of default is much lower compared to sellers on unknown platforms. Therefore, more consumers choose to shop online on Amazon instead of easily switching to other new platforms.
But protocols in Web3 are run by smart contracts as a trust-minimized setup, where operations are transparent, predetermined by certain rules in the code, and automated by smart contracts. therefore,Switching costs are much lower in Web3 and brand recognition is much weaker.
For example, Uniswap does not take a commission from LP fees. Some believe this is due to regulatory issues, but this is not convincing. A more reasonable explanation is that the Uniswap team knew that fee changes could have a huge negative impact on its trading volume.
Therefore, rather than directly profiting from order flow, Uniswap prefers to use its first-mover advantage to expand horizontally, challenging current liquidity aggregators such as 1inch and CoWSwap by launching Uniswap X, an intent-oriented architecture.
In addition to the fact that most transaction volume does not come from natural persons, the cost for users to trust the new Web3 platform is not high, because the operation is open to the public through the code, so everyone can know whether the new protocol really works; in contrast, Web2 Aggregators hide how they work under the hood. Some Web2 service providers need to take over users assets in hosting, requiring users to re-establish more trust in them, while in Web3, users interact with aggregators in a non-hosted manner. All of this reduces switching costs for users.
at the same time, cleverly planned token incentive mechanisms in Web3 can allow new entrants to surpass market leaders.This is how most successful protocols bootstrap the initial Total Value Locked (TVL) and users in Web3, and solve the cold start problem in Web3. Before Blur’s airdrop, Opensea was the market leader in the NFT market. But as we all know, Blur’s token incentives overturned Opensea’s dominance, forcing Opensea to make major adjustments to its declining market share. For a newcomer to be able to overtake the market leader, this is unprecedented in Web2.
In Web3, due to lower user loyalty and a more dynamic relationship between aggregators and users, it is more difficult for the protocol to expand user scale. Competitors can perform"vampire attack"Or lower fees to stay competitive.
For b, as the user base in Web2 aggregators grows, more service providers are attracted to them, which in turn attracts more users because they become more valuable to users. Therefore, user acquisition costs decrease over time. But the dynamics of Web3 are completely different.
in other words,Web2 aggregators can create more value for users as they integrate more service providers into their platforms.This product heterogeneity allows aggregators to differentiate themselves from other competitors in the market.
For example, as more small property owners join Airbnb, more travelers will become members because it can provide them with more apartment/accommodation options for their vacations. When network effects start to provide more value to users, Airbnb doesn’t have to spend as much to acquire users.
In contrast, even with the integration of more service providers in Web3 aggregators,The flywheel of network effects will not easily kick off in Web3 either, as the permissionless nature of Web3 results in product homogeneity:Most supply-side dApps are open source and generally accessible to aggregators, and they provide similar value to users.
In fact, unless they continue to innovate and offer more advanced features, market leaders cannot offer users a very different suite of products that newcomers can easily copy. Ongoing development and maintenance costs are a form of acquisition cost for Web3 aggregators.
For cross-chain bridges, they need to continuously add support for new blockchains as new blockchain ecosystems emerge. Not to mention token incentives as another form of cost to retain users. These recurring costs greatly reduce the network effects that Web3 aggregators can enjoy.
Users in Web2 benefit from economies of scale because the more users there are, the less cost each user has to bear on average. This is because fixed costs are a significant part of some aggregators’ expenses. Netflix is an illustrative example of economies of scale.
On Netflix, even with the same amount of on-demand video content, the more users there are, the less cost each user should bear because the cost is already fixed. Therefore, more users reduce costs. Again, this is not the case in Web3.
Despite the ongoing RD and maintenance overhead in Web3, users must still bear a huge variable cost independent of economies of scale anyway - the cost of decentralization, paying validator fees for consensus on the blockchain state.
EIP-4844 can help reduce fees on DA, but the aggregators dominance and moat are weakened due to congestion fees due to limited block space that are not related to economies of scale. No matter how cheap 1inch is, users will still have to pay more when the network is congested.
There is one exception: L2. The more users there are, the less fees each user should bear.
L2 fees typically consist of a fixed cost and a variable cost: (i) the fee to publish a block on Ethereum and (ii) the fee to run the sequencer.
Lets take Optimism as an example:
Assume that the Gas price on Ethereum is 25 gwei and 1 ETH is 2k USD:
The one-time cost of deploying OP Stack on the mainnet = approximately 1 $ETH
Fixed cost of OP Stack, even without running any transactions, (ii): ~0.5 $ETH per day
Variable Cost (DA), (i): 0.000075 $ETH per transaction
After EIP-4844, assuming (i) a 10x reduction, i.e. ~$0.015 per Tx + (ii) fixed cost, use 0.00001 $ETH (~$0.02) as a Tx markup to cover the fixed cost, which needs to be done daily 50k transactions to cover (i) + (ii) costs (price per Tx before EIP-4844 is about $0.17, $0.03 after)
Assuming there is a positive correlation between users and the number of transactions, the more users and the more transactions, the lower the Tx markup to cover L2 costs. But for most Web3 aggregators, economies of scale cannot be easily achieved as the number of users increases.
So by applying first principles to reduce the nature of the Web3 industry to its simplest dimensions and reasoning from there, Web2 aggregators enjoy things that cannot be directly applied to Web3: user stickiness, network effects, or economies of scale. Token incentives, trust minimization, and permissionlessness are some of the fundamentals that are reinventing the Web3 business model.