Fund Investment Thesis

Paradigm shift

There are massive paradigm shifts happening in technology, economics, society, and ecology. Some of these shifts are bringing an evolution to the existing paradigms, whereas the others are disrupting the status and paving the way for a revolution. The combination of these holds the answers to some of the global problems that exist today. 

Technology

Culture, ideals, and aspirations of human civilization have shaped how societies are created, benefited from, or impeded by technology. Technological innovations have been a necessity for human societies to thrive and evolve. Technology reflects the very essence of a population’s needs and culture, and forms a cyclic relationship where society and technologies constantly affect each other. 

All technologies, even failed ones, have an impact on human society. On a macro-scale, technology helps attain higher levels of global progress by creating greater societal efficiency. On the micro-scale, technological developments change human behavior to the point of altering human adaptive mechanisms. 

Licensed and Centralized 

The Internet is arguably the most impactful technological advancement of the last century. The early days of the internet, also known as Web 1.0, had limited information with little user interaction. It was a one-way “read-only” highway where information mostly came from directories. 

Web 2.0 opened platforms for all users to interact with businesses and each other. Termed as the “writable” phase of the web, it allowed users to interact with one another, encouraging more participation, and efficient sharing of information. This led to a new era of social media networks, interactive web and gave participants an opportunity to voice their opinions. As big tech giants realized that there was an enormous amount of personal data at their fingertips, the most valued asset of the modern world, companies like Google, Facebook, Amazon started stockpiling this data. Before users realized the importance of this data, our identities, browsing, and online shopping habits were sold to the highest bidders. 

Technology companies such as Facebook, Google have become the most influential organizations in the world. Big tech is taking on some of the powers and responsibilities of institutions such as news, media, and governments, replacing previous systems with centralized control based on mass data collection and algorithmic curation. Social media companies in particular have privatized the public sphere. If it continues, this trend threatens to break the functioning of democratic self-government.

Distributed and Decentralized

Today, users worldwide have started looking away from the conveniences and are questioning the worth of services that compromise on privacy and expose their identity, personal and financial information. The web3 vision is about empowering consumers to control their own data and capitalize on their creations and digital identities. As this happens, incumbents will lose their primary competitive advantage, data monopolies, and network effects — creating massive opportunities for new value creation.

Even though web3 is just getting started, positive changes are happening even as we write this piece. The focus is shifting from centralized behemoths to users, individual creators, and smaller application developers. This will lead to a paradigm shift in how users interact with everything digital.

Economics

Global macroeconomic institutions have reacted to the previous two financial crises in a similar manner by using the tools of Quantitative easing, rate cuts to stabilize the economy. These tools have unintended consequences such as increasing income inequality, destabilization of emerging economies. We believe the global economic policy is long overdue for a paradigm shift. 

Controlled by One

In terms of global economic leadership, the 20th century was American, just as the 19th century was British and the 16th century was Spanish. Historically we have always had an economic powerhouse to dictate economic policy. The bigger an economy, the greater its systemic importance, and the more leverage its political representatives have in international decision-making. 

Globalisation has led to great benefits such as the flow of goods and services across borders, international capital flows, reduction in tariffs, and spread of technology and knowledge. But it has also led to an increase in the dependence of low and medium income countries on the fiscal and monetary policies of the high income countries over which they have no control. The magnitude of control the US economic policy wields can be seen with the January 2022 market turbulence across the world due to the announcement of a potential interest rate hike by the Federal Reserve. 

A similar tightening of monetary policy by the Fed in 2013, led to pain in emerging markets as it was the first tapering post-2009 stimulus policy of purchasing US Treasuries as investors begin moving dollars to “safe havens” and out of emerging market investments. The pace of outflow of US dollars from the Indian economy was so severe, that the rupee fell by 15% in 3 months, forcing the Reserve Bank of India to raise rates. Russia, Brazil, Turkey, Indonesia, and other many smaller EM economies suffered similar outflows.

Community Centric Economies

Globalisation opened up pandora’s box of opportunity for talent and labour around the world to showcase their skills. This helped economies make optimal use of their competitive advantages and only produce the goods and services that could be produced in the most efficient manner. All the other goods and services were outsourced to places with the competitive advantage and economies of scale to produce them. Due to this, we saw the emergence of China as the electronics and machinery manufacturer, Germany as the automobile hub, and Bangladesh as the textile manufacturing factory of the world. 

A negative effect of these changes was felt by local workers that worked in industries that were outsourced to other parts of the world. Over time, people also realised unfair trade practices employed such as poor working conditions, low wages, high government subsidies. This led to the emergence of the Local Economy Movement where people prefer the nearest local goods and services or from places utilising fair and sustainable practices. The guiding principle behind this movement is 

“Think global, Act local”  

The idea of community-centric economies has reached a critical inflection point with cities like Miami and New York experimenting with city coins which will be utilised to support local initiatives, artisans, and city development. 

Social

Social power is the ability to set standards, create norms and values that are deemed legitimate and desirable, without resorting to coercion.  

Might of the few

Currently, the concentration of this social power is in the hands of a selected few individuals, groups. These few are able to decide and drive which social issues get our attention, what social trends become popular. Social media platforms have transitioned from a source of entertainment, a platform for connecting people to becoming the primary source information and news for a large section of society

Societies have grappled with the benefits and drawbacks of centralization i.e. Short-term centralization facilitates getting started and getting things done faster, but over the long-term, it leads to apprehension to new ideas and endangers stability. Many people may argue that the advantages of centralization in social systems, such as simplicity and increased control, outweigh the disadvantages. However, centralized systems carry significant risks, the most significant of which is the creation of a single point of failure that can bring a system to a halt instantly, whether it’s a single product distribution center or an entire society run by a single leader.

Might of the many

Dencentralized and democratic systems such as the blockchain is changing the fabric of our society. It has the potential to reinvent the governance models, by making them more open and responsive — more like a network than an old command-and-control bureaucracy. Decentralized systems give people all over the world greater access to resources, not just a few wealthy individuals. Distributed and decentralized systems help to make the world a more equitable and better place.

We have at our fingertips the power to utilize the benefits of direct democracy in a scalable way. Decentralization, when done correctly, produces a system that is far more resilient, reliable, and scalable than a centralized social system. This paradigm shift of decentralization will be experienced across the national, community, major corporation, and small business levels. We are confident and optimistic that those who prepare for and embrace it will be the winners in the coming decade.

Ecology

Interactions among living things and their environment provides a unique understanding of vital natural systems and how they may change in the future. Knowledge of the interdependence between humans and nature is the first piece of the puzzle that we need in order to solve for problems including food production, providing clean air and water, and sustaining biodiversity in a changing climate.

Exploitative

Modern Industrial society as it is has been built in the last 150 years in inherently destructive and exploitative of the environment and the public goods it offers. The world’s largest and most advanced economies have been built by over-utilization and consumption of resources. At the same time, emerging economies require these same ecosystems to improve the standard of living for their population and their increasing needs. 

Every day, through news and other media, we read and hear about the ongoing destruction of the environment: the greenhouse effect, ozone depletion, deforestation, and air-water-sound-light pollution. In our quest for lifestyle, cultural and technological advancement, we have exploited nature increasingly over the last century through wars, arms race, rapid industrialization, and wasteful production.

2021’s weather disasters brought home the reality of our degraded ecosystems and how the path to recovery may be slow or may not be possible naturally even after their exploitation stops.

Conscious and Shared

Maintaining an ecological balance is difficult as it requires tackling “The Tragedy of Commons” on both a micro and macro scale. An effort to curb the emissions of emerging markets can be perceived as an attempt to keep them down.   

To solve this problem requires a 2 pronged approach: 

  1. Shared responsibility of all nation-states to incentivize migration to sustainable practices in major sectors like food production, transportation, energy production
  2. A conscious choice made by Industries to bring technological innovation that aligns their profit maximization goals with ecological balance.

Mega Trends of the Future

We at Woodstock believe there is a lot of chaos and opportunity at the intersection of these four macro pillars. The teams and individuals who can understand and navigate this chaos will create orders of magnitude larger opportunities in terms of innovation and investments.

The modern technological renaissance includes a variety of domains including – web3, Artificial Intelligence/Machine learning (AI/ML), Internet of Things (IoT), and Quantum Computing. Among all the aforementioned categories of innovation web3 has the maximum potential for mass adoption as it offers:

  • Ease of access – Anyone with a mobile device, internet connection can use web3 protocols 
  • Low barrier to entry for non-technical users – A majority of the population is being introduced via gaming, art and music  
  • Ability to plug into other technologies – web3 protocols are composable and can easily integrate with applications in AI/ML, IoT

web3/ Internet of the future is solving the issues of centralisation, censorship, anti-competitive practices that are plaguing the current internet landscape via the inclusive, community-driven and open nature of building and collaborating. web3 will act as the holy grail with distributed and decentralized networks becoming the rails for the future of our financial system, knowledge economy, and human coordination. This new ecosystem is being built with “inclusion and expression” as the underpinning ethos allowing equal access to all services independent of geographic, economical, and ideological boundaries. 

The 3 mega trends that will define the next decade and drive this movement forward are Convergence, Financialization, and Virtualization:

Convergence

Over the coming decade we will witness the convergence of ideas, cultures, technologies leading to accelerated development due to the shared resources and collective time spent on solving some of the most important problem statements around the world.  

Convergence of technologies

Even though emerging technologies are solving major global issues they are associated with a steep learning curve which is off-putting for a lot of end-users. We believe in the convergence of emerging and traditional technologies to make the transition for users as smooth as possible. We need integrated systems and solutions like –

  • No/low code tools – to onboard non-technical creators, designers to build products  
  • Open APIs (application programming interface) – to build on top of existing products and shorten the development lifecycle
  • SDKs (software development kits) – to make systems more composable across the web3 space by standardizing development tools 

With emerging technologies including blockchain, AI / ML, quantum computing, IoT taking center stage in this decade, aforementioned building blocks will help reduce the time, effort and energy required to bring about radical paradigms shifts for existing spaces. Blockchains will increasingly become embedded as a bedrock technology in all our digital experiences as the industry matures building consumer-grade distributed networks with affordable fees, interoperable networks. 

Convergence of cultures

The Covid-19 lockdowns have contributed significantly in the melting of geographical boundaries and have led to massive scaling of online and offline infrastructure to support the gig economy of the future. It has become easier for people from different cultures to work together. With the emergence of work from home, organisations and project teams are transitioning from local to global. This has caused a melting of stereotypes as there is ever more focus on collaborative global talent rather than local talent. 

  • We see an increasing number of purpose-driven agile teams working across continents and shipping out tier-1 products and services.
  • A new world of opportunities is redefining the gig economy, providing local merchants exposure to a global stage, and setting new standards of customer service and consumer protection.

Financialization

We believe flow assets like equity, bonds can benefit from deeper liquidity and accelerated flows that 24×7 open markets can offer. Integrated spot, derivative, and forex markets will allow the true global financialization movement where investors both retail and institutional are not limited by geographies, timezones, and access to limited markets.

Dencentralized Finance will enable a rapid tokenization movement leading to the creation of new financial primitives. The protocols will lead the ongoing fintech movement as the next phase of innovation in the financial services industry. We believe many more interesting financialization applications are yet to be built and will be developed over the next decade.

These automated, open, and inclusive markets will allow local stock assets to become global investment products with the help of securitization, fractionalization, and tokenization. Alternative and abstract assets like Art are becoming commonplace and available to the masses. We can see this happening with digital collectibles – NFTs, in-game assets. 

Major Financial Institutions have already taken the first step towards integrating digital assets in their offerings and balance sheets.

Financial Integrations

 
El Salvador, a Central American country, accepts Bitcoin as legal tender JP Morgan launched a ‘digital assets Exposure Basket’ of Bitcoin proxy stocksMorgan Stanley offers its HNW clients access to Bitcoin funds
Goldman Sachs has a crypto trading desk and offers options and futures trading in EtherGrayscale has trust vehicles for investing in 13 digital tokens including tokens of projects like  Bitcoin, Ethereum, Chainlink, Decentraland, etc. GBTC alone has a market cap of US$ 5.8bn21shares has an AUM of US$ 241mn in its Bitcoin ETP. It offers a total of 14 ETPs
Microstrategy is raising US$ 500mn in notes to add more Bitcoin to its balance sheet. It currently holds 92,079 $BTC which is valued at US$ 3.7bn, as of 15-Jun-21 EOD Square holds 4,709 $BTC on its balance sheet which is valued at US$ 189mn, as of 15-Jun-21 EODTime Magazine will hold Bitcoin on its balance sheet soon

Endgame –  Flow – Stock – Abstract liquidity movement “at will” (through biometrics / AI / ML)

Virtualization

It is our belief that the Evolution of hardware and software has reached a tipping point. Computational power and data have become the new oil – thus chipsets and rare metals are new gold mines. Our interactions with the digital world are on a constantly increasing trajectory. The large opportunity in building these Virtual worlds is evident due to the transition of tech giants like Facebook to Meta, Microsoft’s vision of the metaverse and their acquisition of Activision Blizzard. The capital, talent, and vision working towards Virtualization of our lives strengthens our belief that we aren’t too far from a day where virtual worlds will become more real than the real world.

The Metaverses of the future need to be built around the 3 pillars of – Experience, Engagement, and Commerce. This will lead to a shift from physical to digital to immersive. 

  • Sports had a transformation to digital through the rise of Gaming and E-sports. And we believe it will be the category-leading shift to immersive due to major gaming studios focusing on virtual reality (VR) gaming.
  • Collectibles are transitioning from the physical world to digital through the wide cultural adoption of NFTs. 
  • Experimentation is underway to create immersive digital experiences by Metaversal music concerts hosted in Fortnite.
  • Leading commerce platforms have changed from Walmart (Physical stores) to Amazon (Digital stores). Incumbents like Amazon and Walmart are conducting their independent experiments in this domain. The industry is on the verge of a major paradigm shift of immersive experiences that can engage consumers more effectively.

We also believe that this future will not be siloed, controlled by monopolies but it will be a multiverse – a collection of smaller metaverses with their own communities and ecosystems. 

For these megatrends to pan out, Blockchain as embedded technology has to become consumer-grade, challenges around collaboration, coordination have to melt away and the virtual world has to become as seamless as the real world but more immersive and full of new possibilities. 

Our thesis is that even in the web3 movement, the major Western economies will continue to have an edge in capital deployment, risk management, research & development, innovation, and product management. At the same time, the consumption and large-scale utilization of these services will shift to the global East (India, South East Asia, Africa) due to the aspiring, educated, and young middle-class population. By 2030, India can become one of the largest consumer markets for web3 protocols supported by established information highways due to the omnipresence of cheap and reliable 4G – 5G data networks, mobile devices.

Over the coming years, we, at Woodstock will strive hard to build this East to West corridor, where we aim to invest in global teams and open up the consumer markets of the East for them and invest in the best entrepreneurs from India and Asia to provide them access to the western economies through our global network.

INDIA – BLOCKCHAIN INNOVATION HUB

India is the world’s largest democracy with a vibrant economy and sustainable GDP growth of 7-8%. According to a recent Chainanlaysis report, digital assets adoption from individual investors sees the second-fastest growth in India. A country with a 1.3 billion+ population, expanding middle class, robust legal and regulatory framework, and an entrepreneurial ecosystem that is constantly innovating. Individual investors and large crypto firms are both active in India. Indians’ investments in the digital market have surged to US$10 billion in 2021 from US$ 923 mn in 2020 at the same time. Coinbase launched its new tech hub in India, and the country recently welcomed its first digital assets Decacorn Polygon. Coinswitch Kuber, an Indian exchange, raised a hefty US$ 260 mn, resulting in a valuation of US$ 1.9 billion.

Source: Woodstock Research

WHY INDIA? 

According to the Global Innovation Index (GII) list 2020, India has joined the group of top 50 countries in the global innovation index for the first time, moving up four places to the 48th rank and keeping the top position among the nations in central and southern Asia. The report also mentions, “Thanks to universities such as the Indian Institute of Technology in Bombay and Delhi and the Indian Institute of Science in Bengaluru, and its top scientific publications, India is the lower middle-income economy with the highest innovation quality.”

We at Woodstock Fund, weigh in on India’s growth potential due to various reasons:

  • One of the World’s Fastest-Growing Economies

India keeps climbing as a favorable destination for foreign investments. In spite of the pandemic, India attracted the highest ever FDI inflow of US$ 81.72 bn in the financial year 2020-21 out of which 44% (US$ 35.3 bn) is contributed by the IT software and hardware sector. According to the International Monetary Fund, India is set to become the fastest-growing economy in the world by 2023-2024. According to the Ministry of Finance, India’s real GDP will record a growth of 11% in 2021-22 and nominal GDP by 15.4%, the highest since independence.

  • Largest Youth Population in the World

According to the United Nations Population Fund, India has its largest ever adolescent and youth population and will continue to have one of the youngest populations in the world till 2030. India boasts to have the highest number of English-speaking developer communities in the world. We have been working at the grassroots level with various top educational Institutes and Universities in India to help and assist them in contributing to the Blockchain Ecosystem. 

By 2030, it is estimated that around 42% of India’s population would be urbanised from 31% in 2011, which gives enormous potential to the emerging technologies to penetrate and gain traction and contribute to the India growth story. 

  • Growing Investment in Digital Assets Ecosystem

It has been a fantastic 2021 for India’s start-up ecosystem. In 2021, amidst a debilitating Second Wave, India acquired 44 new unicorns, taking the total to 85, the 3rd largest number in the world, after the US and China. In the blockchain and digital asset space also, India has inspiring growth stories. Polygon’s (formerly Matic) market capitalization zoomed from US $26mn in 2019 to over US $20 billion in Feb-22 with investments coming from industry stalwarts like Tiger Global, Softbank, Sequoia. State Governments have also started utilizing polygon’s blockchain technology to store covid test records. Many other projects like Biconomy, Mudrex, Frontier, Vauld are also developing and helping build the infrastructure for a robust blockchain ecosystem in India. LegitDoc, another blockchain firm, is assisting the Maharashtra government in the implementation of the world’s largest blockchain-powered educational credentialing system by issuing almost 1 million tamper-proof diploma certificates. 

The Indian technology sector is transforming into a game-changer. It demonstrates a readiness to compete on a global scale and interact with other businesses across various industries. The signals are clear: India has the potential to transform itself from a destination for outsourcing to a center for technology innovation. And we believe DLT and Blockchain will make substantial contributions to this innovation economy. The pandemic has provided the government with an excellent opportunity to push Indian organisations to reinvent themselves. There will, without a question, be many obstacles ahead. However, with Indian projects now so prominent in the global ecosystem, and startups and entrepreneurs launching a campaign to lobby for greater recognition of the potential that the digital asset space can bring to the country, there is reason to believe that India will remain at the forefront of blockchain innovation in the years ahead. The current big-ticket investments in India are only the tip of the iceberg and we at Woodstock are confident and bullish on the India growth story.

Macroeconomic Outlook

Before the onset of the COVID shock in early 2020, major central banks were struggling to boost inflation after being below target in the last decade. The pandemic disrupted lives across all countries, communities and negatively affected global economic growth by an annualized rate of -3.2% in 2020 with global trade falling by 5.3% in 2020. 

Short-term interest rates, which were already low in most advanced economies, were quickly cut around the world, reaching around zero in all advanced economies and even in some emerging market economies. Monetary policy played a critical role as markets froze, capital flows to emerging markets collapsed, and economic activity slowed sharply. As a consequence, central banks quickly turned to the measures adopted during the Global Financial Crisis.

COVID-19 Effect

The pandemic shook the world and pushed the global economy into temporary panic and frenzy due to supply chain disrupment and closure of workplaces. As a response to the COVID-19 pandemic, the US FED resorted to deploying a range of tools to dispel any notion that monetary policymakers are either sparing ammunition or running out of unconventional tools.

  • Rate cuts to ease strains in markets as well as support aggregate demand and help economies to rebound. 
  • Asset purchases to address widespread dysfunction in key financial markets.
  • Liquidity provision and credit support by lending to financial firms, purchases of corporate securities, direct lending to non-financial firms. These measures were taken in conjunction with governments to support the provision of credit to businesses, to ensure that viable firms survive the crisis and would be able to ramp up production and support employment once the crisis ebbed. 
  • Regulatory easing and other reductions in requirements for liquidity and capital buffers to ensure banks would not amplify the contraction in credit and liquidity to meet regulatory standards. 

It began a new chapter in the FED’s money-printing regime, as it committed to keep expanding its balance sheet as necessary, rather than a commitment to a set amount.

Quantifying The Money Print

The M2 money supply measure includes cash, checking deposits, savings deposits, and money market securities in the US. This wide scope makes M2 a good indicator of the total money supply and future inflation.

Jan ‘18Jan ‘19Jan ‘20Jan ‘21Jan ‘22
M2 Supply (Trillion US$)13.8714.4415.4119.39*21.84
YoY Change4.39%4.12%6.67%25.88%12.62%

*Predicted M2 Supply for Jan ’22

Data Source: Board of Governors of the Federal Reserve System (US)

The Impact of Money Printing

Even though the FED was printing more money, the supply of consumer goods like sugar, oil etc could not be increased artificially. Coupled with the lockdown restrictions around the world The value of paper money started decreasing drastically and investors started to diversify their investments into riskier instruments like equities, real estate, and digital assets instead of holding on to cash in order to preserve their wealth and purchasing power. 

The main reason why the markets have gone up so much since March 2020, was the easy money flowing into them. As long as interest rates stayed low and the liquidity tap remained open, financial markets around the world went up. Investors and traders weren’t concerned about a huge crash, despite Covid, because they knew the flow of easy money would continue. Thus, ‘buy the dip’ was the theme driving the markets.

Macroeconomic Risks in Global Markets

The combination of increasing money supply due to COVID relief programs by governments across the world and breakdown of supply chains led to more money following fewer essential goods and services. The consequences of longevity in the monetary and fiscal policies employed is the building of two different types of imbalances — inflation and bubbles, both of which are hard to navigate.

Understanding Bubble Risk

Bubbles pose a significant risk to the economic cycle as they can emerge quickly and are more difficult for policy makers to manage. Dot-com and Housing bubbles have been the reason for ending 2 of the last 3 cycles.

Product bubbles are narrow, sector-specific and of limited consequences for the broader economy. Cross-sectional bubbles feed off an initial bubble and are more consequential as they build a cascade of effects on the financial and real markets. While inherently more threatening to the macroeconomy, these bubbles are rooted in fundamentals. Macroeconomic cycle-ending bubbles are likely to be cross-sectional ones reaching sufficient size that when they are unwound, it creates financial headwinds ending prolonged growth periods in an economy.

Considering today’s low-interest rates which, are exceptionally low and likely to remain low till some time in the future. Prolonged low rates coupled with fiscal deficits can lead to bubbles in debt, equity, and alternative asset markets.

Understanding Inflationary Risk

Inflation that is consistently above the target range and further encouraged by policy stimulus has the potential to undermine a well-anchored inflation regime. We are observing the consequences of policy imbalance in Turkey in January 2022 with inflation rates soaring to 36% eroding the purchasing power of residents especially for imported goods like food and energy.

Consumable asset inflation due to volatility in prices can be mitigated but labour market imbalance can lead to the feedback loop of rising inflation if not supported by equivalent or higher growth in the real economy. COVID-19 related job closures and widespread voluntary unemployment in the recovery phase of the pandemic has created a labour shortage driving inflationary pressure in the market and driving wages higher. Shortage in labour markets will lead to lower production of goods and services causing further asset price increases over time adding to inflation fears. 

There is an additional risk from policy makers needing to manage market expectations with regards to inflation. These expectations have assumed easy monetary policy for many years to come and pivoting to a faster rise in rates might be difficult to execute without creating market turbulence, rapid asset price corrections, and high volatility.

Management of Inflation and Bubble Risks

We believe that the above risks can lead to conditions of recession or stagflation in the future which can cause a significant correction in prices, extended underperformance across riskier asset classes. At the same time, looking at the quick response of central banks and governments across the globe during the Covid crisis we believe conditions like a recession or stagflation would probably not persist for more than a year or two. 

Reserve banks and governments can use their extensive arsenal of tools including Quantitative easing, Rate cuts/ hikes, Asset repurchases, fiscal deficits, public works projects, unemployment benefits, labour incentive programs to tailor a solution to combat major macroeconomic downturns and challenges.  

Weak Global Markets in 2022

The Federal Reserve’s monetary policy led to one of the strongest bull runs across asset classes in the 21st century and helped the global economy to recover from the Covid crisis in record time. Consequently, Inflation hit 7% in 2021, the most since the 1980s, and a tight labor market is forcing the Federal Reserve to take its foot off the gas after their Covid-19 response.

The Federal Reserve in its first policy meeting of 2022 U.S. announced its intent of hiking Interest-rates and pivoting to tighten policy. Chairman Powell has discussed the possibility of a rate increase at every meeting in 2022, starting in March. This information spooked the global markets:

  • Equity markets – S&P 500 had fallen more than 11% since its peak in late December
  • Digital asset market – Bitcoin is down 18% from the beginning of January 
  • Real Estate – Vanguard Real Estate ETF has lost 8.9% value 

Despite the macroeconomic outlook and potential recession concerns across global markets, we strongly believe this will be a temporary blip in the journey and evolution of web3 and digital assets. The incredible amount of talent and capital being attracted to build the web3 and the next generation of financial services, coupled with the strong network effects that accompany them, will play a key role in making blockchain continue to be the fastest-growing technology sector in this decade. Let’s dive deeper into how web3 has emerged and why are we so excited about what’s coming.

COMPUTATION PROGRESSION

Every decade, we see new technologies emerge and integrate into people’s lives.

Every leap in computing gives birth to new applications that leverage the strengths of the upgraded technology stack. For example, PCs introduced the masses to keyboard typing. Gmail, a Web 2.0 application, built upon this capability, is now used by over 1.5bn people.

Bitcoin is the first immutable ledger or implementation of a blockchain that created a new class of Digital Assets & Distributed Ledger Technology (DLT). The whitepaper was written in 2008 by Satoshi Nakamoto, the famous pseudonymous creator of Bitcoin. The scope of blockchain technology has been dramatically expanded by a global community of researchers and coders. We believe that DLT’s capability to encode trust will shift paradigms in the coming decade and propel the decade of digitization

THE POWER OF DECENTRALIZATION

It is a common belief that “decentralization” is simply the opposite of “centralization”. In centralized systems, there is a trusted entity that is responsible for the functioning of the protocol. However, decentralized systems are often imagined as chaotic systems with a limited method to the madness. 

Zooming out of the frothy NFT prices, fraudulent ICOs, and malicious application hacks, we recognize that decentralization does not mean the removal of a centralized authority, but a fair distribution of power among trustworthy actors. This also implies that decentralization demands a high level of responsibility and ownership from these groups who are in turn held accountable by communities at large. We believe that decentralization promoted by DLTs will lead to equal divisions of power in the long run. 

WHY NOW?

FOUNDATIONAL TECHNOLOGY DEVELOPMENTS

  • Bitcoin solves the trustless transfer of value problem on a global scale, however, it was Ethereum in 2015 that brought programmability into blockchains. 
  • Both these legacy chains have a large community but they suffer from low TPS (speed) and high transaction costs. 

Builders are enhancing the current blockchains by building faster, more efficient, and more secure layer-1s. The underlying blockchains are now able to support complex use cases like on-chain high-frequency trading, secure interactions between private nodes, processing of high-value NFTs, unified identities across multiple chains etc.

Although the space has grown at breakneck speeds, we are still in the early phases of innovation and are confident that the improved infrastructure will support decentralized applications used by billions of users.

INSTITUTIONAL INTEREST

Institutions are adopting blockchain technology to improve their products and services. They are also entering the digital assets market to invest in this new asset class.

Technology Integrations

Visa settles payments with crypto partners directly on Ethereum Salesforce is using blockchain to deliver verifiable vaccine and health passesBNY Mellon announced crypto custody servicesAmazon Web Services supports Ethereum and has a blockchain solution vertical
PayPal enables its users to buy, hold and sell digital assetsIBM offers a host of blockchain solutionsFidelity offers custody and trade execution servicesGoogle’s BigQuery platform provides insights for Polygon Network
NFTs saw celebrities like Eminem, Pele, Muhammad Ali, Shawn Mendes, etc use blockchain to engage with their fansMany corporates have acquired blockchain projects to make inroads into the ecosystemPayPal acquired CurvNomura backed KomainuDocuSign bought the IP of Clause

This non-exhaustive list provides a glimpse of how traditional corporations are developing a thesis around blockchain technology and looking beyond Bitcoin in the distributed ledger space. As their thesis strengthens around the foundational technology, they will start leveraging regulated assets to build powerful products. Institutions that are pro-actively trying to understand the space now will be in a great place to adopt these products quickly.

We see the development of institutional-grade infrastructure which can support traditional organizations getting into the digital assets ecosystem.

Technical Infrastructure
Private blockchainsDevelopment StudiosConsultancies
Financial Infrastructure
ExchangesCustody partnersBrokers

 

To summarize this section, Softwares solutions scale easily. Furthermore, because of the open-source nature of blockchain, the space is growing rapidly.  However, with a reach to merely 3% of the global population, digital assets are still in the early phases of adoption which means that there lies an asymmetric opportunity ahead of us as investors to capitalize on this emerging technology.

Web 3.0

PROTOCOL LAYER

The world was first introduced to the Internet through TCP/IP (transmission control protocol/internet protocol) in 1972. Information was transmitted by digitizing it and breaking it down into very small packets that contained the destination address. After being released into the network, the packets could take any route to the recipient. Nodes at the network’s edges disassemble and reassemble the packets to interpret the encoded data. This created an open, shared, public network with no central authority responsible for its maintenance and improvement.

InternetBlockchain
With the internet, the key value was in the application layer, in the form of data. The internet stack is composed of “thin” protocols and “fat applications”.Investing in applications like Amazon, PayPal, and Netflix produced high returns when compared to investing in the protocol layer.In the blockchain stack, value is concentrated at the lower level with protocols like Bitcoin and Ethereum with a market cap of US$ 1 trillion+ and dominating 60% of the market. This is called the Fat protocol thesis, and is critical to understanding where value will accrue in the blockchain space.

The underlying argument of the Fat Protocol thesis is that blockchain technology is fundamentally flipping that dynamic such that the protocol layer accrues more value than the application layer. The theory posits two main reasons why this happens:

  • Shared data layer
    • Allows user data to be held on the blockchain and to be shared equally among the applications. Historically data was siloed and barriers to entry were large. With a shared data center, it’s easier for companies to build on top and for them to work together. For example, transferring shares between 2 brokers is more difficult compared to transfer of tokens between Coinbase and Binance.
  • Speculative token attachment
    • Speculation around protocol token encourages building on early stage protocols, as applications built on top of the protocol increase it’s value and create a positive feedback loop of value creation. As more applications are built, the protocol accrues more value which incentivizes people to build more applications. Since the tokens are needed to access & use apps built on the protocol, they go up in value the more a protocol is used.

We believe that the Fat Protocol thesis and some of its core assumptions are valid even today and the protocol layer will continue to accrue majority of the value until the protocol has decentralized sufficiently and is secure from potential attacks. If applications achieve a market capitalization greater than that of underlying protocols before sufficient decentralization, attackers could be incentivized to take control of the protocol by purchasing 66% of staked tokens (to perform double spends on these networks).

In the future, after achieving the targeted levels of decentralization, security (through hash rate distribution or staked tokens), and network value, it will become increasingly difficult to attack, halt these protocols as costs for doing so will run into 100s of Billions of dollars. At this point in the lifecycle of blockchain protocols, we will observe significant value creation and accrual happening at the application layer. We are observing this thesis in action on Ethereum with a highly secure, decentralized protocol layer worth US$320 Billion and growth of numerous applications with market capitalizations up to US$10 Billion.

Before we deep dive into specific sections, here’s a glimpse of how the overall web3 stack and digital assets ecosystem is shaping up:

PROTOCOL LAYER

LAYER 1 PROTOCOLS

What are Layer-1 blockchain protocols?

The root blockchain architecture is called Layer-1. In this layer, rules of the blockchain such as consensus mechanism, computation, data storage are hardcoded. The first layer-1 to be launched was the Bitcoin network, whereas Ethereum was conceived later. Ethereum, a layer-1 computing platform enabled smart contracts and the building of decentralized applications.

These initial Layer-1 architecture implementations suffer from the blockchain trilemma – a tricky relationship between decentralization, scalability, and security. The trilemma influences blockchain to compromise on one property to maximize the other two. In the last few years, the upcoming layer-1 protocols have addressed the above problems with rapid innovation.

Why do we need multiple Layer-1 protocols?

Over the last few years increasing popularity of the Ethereum ecosystem and its Dapps have caused congestion of the network leading to transaction costs reaching 100s of dollars. Ethereum’s plans to navigate around the trilemma are still under development and taking longer than expected. 

Ethereum’s popularity and challenges motivated the launch of dozens of new Layer-1 platforms, bringing in new technical designs, network architecture, consensus algorithms, varying degrees of decentralization and performance, and execution environments. This has further empowered layer-1 platforms to become scalable, secure, decentralized, and interoperable. 

These layer-1 platforms have an opportunity to gain significant market share owing to the delay in Ethereum’s scaling plans and the rising popularity of DeFi and NFT sectors in 2020 and 2021 respectively. Both developers and users are seeking new platforms to deploy new applications as a result of sizable growth in awareness and usage of public blockchains.

EVM Compatible Ecosystem

The first ecosystem to see adoption was Binance Smart Chain (BSC) which forked the Go Ethereum protocol (GETH) to utilise EVM compatibility. This along with token incentives helped to bootstrap the initial capital and attracted users and developers to BSC. Daily transactions reached 8 million in May 2021. To scale sizably, BSC compromised on decentralization with only 21 nodes processing transactions. 

Subsequently, other chains such as Avalanche, Elrond and Fantom have successfully applied this playbook with new technical designs and consensus mechanisms to gain traction.

Non-EVM Ecosystem

The EVM ecosystem has a massive resource advantage including the best developer tooling and largest developer mindshare. For any layer-1 to acquire traction in the near term, building EVM compatibility is the fastest way. Major layer-1s, building network effects from scratch by not focusing on EVM compatibility are Solana, Terra and Elrond. 

  • Solana significantly expands the costs, minimum hardware requirements for running a node on the network making it less decentralized than Ethereum. But by doing so, it reaches theoretical speeds of 50,000 tps. With this capability, Solana can support applications such as Serum, an order-book DEX, that isn’t feasible to build using Ethereum layer-1.
  • Terra’s efforts have been focused on building use-cases to drive adoption of its decentralized, algorithmic stablecoin UST and thereby driving users to its network.
  • Elrond utilizes the combination of network sharding, transaction sharding and state sharding with over 3200 validator nodes and provides a throughput of 15,000 tps.

Modular Scaling Protocols

Several promising blockchains have undertaken a modular scaling approach. Modular systems split processing, consensus, or storage responsibilities across multiple independent layers/chains. Aside from Ethereum, protocols following this approach are Avalanche, Cosmos, and Polkadot. 

  • Polkadot, an interoperable Layer 0, has a base layer with limited execution capabilities but generalized security. Most of its functionalities are outsourced to customizable execution layers or parachains. 
  • Cosmos is building an almost identical architecture with one key difference – it’s completely optional for chains built using the Cosmos SDK to connect to the Cosmos Hub. Each chain needs to choose the level of security succinct for its purpose, while incentivizing a rational validator market to provide that security. 
  • Avalanche has distinct application, execution, and consensus layers that allow for the creation of subnets that enable the creation of use-case specific networks.

With notable growth in the layer-1 ecosystem in 2021, more than 10 Layer-1 smart contact platforms saw significant growth and Total value locked exceeding US$5 bn. Based on market cap, out of the top 25 tokens, 11 are layer-1 smart contract platforms (as of 4th February, 2022). 

Today, the world of blockchains is starting to resemble the physical world in several ways. It’s defined by nations (chains) that have their own economies, governed by their own rules.

THE ROAD AHEAD FOR LAYER 1s

We expect the layer-1 ecosystem to be diverse, and have multiple ecosystems thriving on multiple chains. The factors that will determine the long-term success for layer-1 protocols will be  the ability to attract developers and users, liquidity locked (TVL) and user incentives.

Short TermLong Term
Focus on User experience: Layer-1s focusing on UX will continue to build the edge over other platforms to attract and onboard millions of non-tech savvy users in the coming years.  Elrond’s Maiar application is a pioneer with respect to UX. It has enabled users worldwide to enter the DeFi ecosystem using an interface that they are well acquainted with. (Read More)Geographic adoption of L1s: Going back to the blockchains as a world nations analogy, geographic advantage will play a major role in layer-1 adoption. Polygon will attract one of the largest developer mindshare through its strong grassroots network in IndiaTerra found product market fit as one of its application facilitated the largest payment network in South KoreaApplication Specific chains: Flow and Tezos position themselves as NFT specific chains, Fantom and Terra become DeFi centric chains, whereas Polkadot and Cosmos will build major ecosystems by offering exceptional flexibility for building other application specific chains.Ethereum will remain the leading L1 platform: Ethereum will continue to be the dominant platform in the foreseeable future, due to it being the home base of maximum innovation in DeFi and NFTs and adoption by organizations like Visa and Reddit.Ethereum will maintain its edge over competitors through their large and diverse developer community, battle-tested applications, and spirited user fraternity. 

LAYER-2

Why do blockchain protocols need to scale?

As mentioned earlier, blockchain trilemma revolves around the three fundamental principles: security, scalability, and decentralization. In order to prioritize two of these principles, a blockchain system must sacrifice the third principle to achieve execution. However, in blockchains, as in any financial infrastructure, security is always of the utmost importance. If security is treated as a constant and a non-negotiable metric, scalability and decentralization remain the only two variables to consider.

The nature of the relationship between scalability and decentralization is hyperbolic i.e. following an inverse relationship. Decentralization is the critical component of creating distributed, trustless systems as it deters the ability of external actors to exert authority and degrade the functionality of the network. Thus, early networks were not optimized for scaling. Scalability has been a thorn in the on-chain experience for both developers and users. Most popular blockchain networks cannot scale up transactions when network traffic increases and transaction costs can balloon to 100s of dollars.

How can we scale blockchains?

There are two ways to achieve scalability: on-chain or off-chain solutions. Blockchain networks can achieve on-chain scalability by improving the base layer-1 via better consensus algorithms, different block parameters, or distribution techniques such as sharding. Some of these solutions adopted by a few blockchain protocols require a reduction in the number of validators, or dedicated hardware for running nodes (reducing decentralization and thus indirectly compromising on the security of the network).

Layer-2 solutions are off-chain scaling technologies that help layer-1s achieve more scalability and cost-effectiveness. Layer-2 (Off-chain scaling) solutions have emerged as a viable solution to this scaling conundrum. They run on top of the layer-1 blockchain, as opposed to on-chain solutions, which attempt to improve the performance of the blockchain protocol itself. They inherit the underlying blockchain’s security features and enable more throughput (transaction processing capacity) with lower transaction fees and faster transaction confirmations.

Description of Layer-2 Solutions

We wrote a blog post wherein we discuss the evolution of layer-2 solutions, explain the technology behind them, talk about different companies building these systems, and provide detailed information about their advantages and trade-offs. We encourage the reader to go through the primer to understand layer-2 scaling in depth. The figure below compares some of the layer-2 technologies:

THE ROAD AHEAD FOR LAYER-2s

Layer-2s are already seeing substantial adoption by popular DeFi, NFT applications given that they are essential components to ease Ethereum’s scalability woes. 

Short TermLong Term
Optimistic Rollups (OR): Adoption for OR will be on an accelerating trajectory due to EVM-equivalence, which will lead to billions of dollars flowing inside these layer-2 solutions. ZK-Rollups: Application-specific ZK-rollups will come to mainstream users, followed by general-purpose ZK-rollups being adopted at the protocol level of layer-1.Token Incentives: Ethereum layer-2 solutions launching their own tokens and incentive programs will bring a new wave of users as well as help bring back users who migrated to other layer-1s due to high gas fees on Ethereum.Growth of Applications: Majority of applications on Ethereum will extend their functionalities to multiple layer-2s.Seamless Integration with Layer-1: Layer-2s are expected to ultimately merge with layer-1s, existing as a single composable system. Tight coupling between them would obscure their present distinction and smoothen the user experience.Cross layer-2 communication: Solutions that allows for quick and efficient movement of assets and data, directly from one layer-2 to another without incurring the expense of going through the underlying layer-1.

MIDDLEWARE LAYER

As seen above, the computation layer consisting of various blockchain solutions paves way for a “decentralized network of everything”, as envisioned in the broader goal of web3. In conjunction, the infrastructure layer provides additional functionalities that make various applications on the blockchain a reality for millions, and soon, billions of users. To support the influx of the next billion users, web3 requires scalable infrastructure which does not compromise the security of consumers and decentralization of the network.

Middleware solutions are pieces of computer software that provide services to other software applications beyond those available from the underlying blockchain protocol. Middleware services are the glue holding together the blockchain protocol layer with the applications making rapid development and deployment possible.

In the previous cycle we witnessed the development of numerous middleware solutions which has helped strengthen the infrastructure which will allow applications to scale easily. These can be divided into various categories as listed below –

  • Data Indexing and Querying Solutions
    • Data runs the world economy, and blockchain data is no different. The metadata associated with smart contracts, tokens, and mempools is immense and holds valuable information
    • Indexing and querying solutions like Covalent and The Graph do for web3, what Google did for web2 
    • Users are dependent on data provided by these solutions for development, analytics, and insights
  • Data Oracles
    • Oracle layer provides off-chain and real-time data such as price feeds, standard datasets, sports feeds, and weather data to blockchains 
    • Smart contracts access this off-chain data to perform logical operations allowing the creation of smart contracts that can interface with real-world events
    • Due to their blockchain agnostic nature, data oracles such as Chainlink and Band Protocol serve a large multichain market and can capture a lot of value as applications between web2 and web3 become interoperable over time
  • Decentralised Hosting and Storage 
    • InterPlanetary File System (IPFS) protocol revolutionizes decentralized storage as it serves information based on what it is as opposed to where it is (location) and major applications such as Filecoin and Arcana are building on top of it
    • While Peer to Peer (P2P) file-sharing networks, such as BitTorrent, have existed for quite some time, distributed hosting is relatively a new concept
    • 99% of projects are still hosted using centralized services like AWS, Azure, and Google Cloud. There is a clear market gap here to be filled
  • Cross-chain Protocols
    • Token Bridges such as Hop Protocol, Biconomy’s Hyphen, Router Protocol facilitate secure and easy movement of assets between chains, allowing users to access new platforms and developers to collaborate on building new products
    • Cross-chain services which focus on state-sharing (such as relayer networks) between and amongst layer-1s and layer-2s are crucial pieces for network interoperability
    • Both of the above are crucial for a composable and interoperable future
  • Privacy and Security
    • We believe that the world requires more privacy, and owner control over data usage; privacy should be inherent in every facet with a discretionary opt-out choice. Security and privacy-enhancing solutions should be implemented to provide safer user experiences 
    • Privacy Solutions like private transactions are able to break the link between input and output of a transaction, private wallets can create a new address for every transaction
    • Decentralized virtual Private Networks (dVPNs) and secure browsers hinder data collection practices and let users maintain privacy. 
  • Wallets
    • The digital assets market is worth over US$ 1.7tn, as of 4th February 2022, with the doubling of people owning and holding cryptocurrencies from 100Mn to 200Mn in 2021.
    • With the rising popularity of digital assets, adoption will continue to grow rapidly towards 1bn users, and so will the demand for secure, easy-to-use, and non-custodial digital wallets to store these assets securely. 
    • We believe that this rising demand will be met by various secure software and hardware wallets
  • Digital Asset Management
    • For institutional investors and wealthy individuals, digital asset custody providers are the go-to choice as they provide layers of security for their corpus of funds. 
    • These solutions also offer complementary services like insurance on stored assets, direct integrations with exchanges to facilitate instant transactions, providing staking services for Proof-of-Stake tokens, and tie-ups with fund administrators, tax accounting firms to aid better digital asset management.
  • Developer Tooling
    • Developer tooling enables faster development and deployment of applications on a blockchain network. It gets programmers the right tools to build their applications from the best templates and the most reliable data.  
    • If there is anything that is as important as infrastructure, it is developer tooling. With blockchain seeing exponential growth, the emergence of new development tools play a crucial role to bring in more developers and more applications.

THE ROAD AHEAD FOR MIDDLEWARE SOLUTIONS

Although the aforementioned middleware sectors have seen significant development over the years, there is still a long way to go before the industry matures and sees periods of stagnation. As the multi-chain future pans out, top middleware solutions will integrate with many layer-1 protocols and present some incredible layer-1 agnostic growth opportunities. Therefore, we are incredibly bullish on this sector in the coming years. 

Short TermLong Term
Tools to deploy smart contracts on several layer-1s simultaneously will help applications become cross-chain quickly and appeal to a larger userbase.We will experience challenges around the security risks associated with bridges, causing cross-chain interoperability to be standardized around a few widely integrated protocols.We will see explosive growth in sectors like wallet-to-wallet and cross-chain communication, web3 notification services, and SDK development tools focused on modular frameworks. These technologies will help make the application stack more useful for the billions of people yet to be onboarded.A credibly decentralized, battle-tested and well-integrated bridge is likely to emerge as the preferred choice for maximum liquidity, low fees, and slippage.

APPLICATION LAYER

DECENTRALIZED FINANCE

Over the last decade, the internet helped replace the intermediary barrier in traditional media by providing an audience, creative tools to content creators. DeFi is doing to finance what the internet did to the media by democratizing the creation of new financial instruments.

DeFi (Decentralized Finance) is a system that utilizes digital assets, smart contracts, and decentralized applications on blockchains to build financial services that are open to everyone. DeFi represents a broad category of financial applications developed on top of open-source, permissionless, intermediary-free, and censorship-resistant networks to improve the legacy financial services or create entirely new financial primitives.

WHAT EXCITES US ABOUT DEFI?

DeFi is the gateway towards the megatrend of Financialization with the ideas of transparency, cost efficiency, and inclusivity embedded deep into the ecosystem. 

  • DeFi protocols work with code as law, thus offering equal service, yield, and opportunities to everyone. 
  • The revolution of financial services will resemble that of the software industry – towards cloud-native services, cost efficiencies, and new business models. 
  • DeFi can disrupt and replace the software infrastructure of existing fintech applications by sheer automation. 
  • With ERC20 standards, we could see rapid tokenization and financialization as anyone can write a smart contract with negligible costs.
  • DeFi protocols act like money legos. Each protocol focuses on providing the best experience for one use case e.g. lending, asset exchange etc compared to banks who strive to provide all services. New projects can directly access established DeFi functionality, liquidity and build on top of it – thereby saving time, resources leading to rapid development.
  • Smart contracts have already brought new innovative products like flash loans, automated market makers and liquid staking derivatives that weren’t possible or scalable before.

DEFI COMPARED TO TRADFI

TradFiDeFi
Traditional payment gateways process about 1.5k-2k transactions per second and claim to theoretically reach 25k transactions/second.Even though the present transaction speeds of Bitcoin and Ethereum aren’t comparable to Visa & Mastercard, other layer-1 chains can process around 15k to 50k transactions per second.
Exchanges like Nasdaq, ICE allow users to participate in equities, derivatives, commodity markets with market capitalisations of US$ 31.56 bn, US$ 66.12 bn respectively.In DeFi, decentralized exchanges facilitate the swapping of digital assets using automated algorithms. The market value of the protocol tokens of Uniswap, PancakeSwap are US$ 9.6 bn, US$ 2.8 bn respectively.
The total consumer credit outstanding in just the United States is equivalent to US$ 4.279 Trillion. The interest rate for these loans is decided through mechanisms like FICO scores.As of Jan‘22, blockchain facilitated lending is concentrated in providing over-collateralized loans with a TVL of US$ 30 bn
Asset management is a huge industry with up to $103 tn AUM. Retail investors are not allowed to invest through hedge funds, private equity. Whereas HNIs and organizations have better access to more aggressive strategies. DeFi asset management protocols offer the same investment opportunities to everyone. These projects will also help retail consumers attain better returns on their volatile assets and stablecoin holdings. Currently, TVL is < US$ 20 bn.

STATISTICS ABOUT DEFI GROWTH

Total value locked (TVL) in DeFi apps across L1 protocolsSource: DeFi LlamaConstantly increasing new DeFi applications Source: State of the DApps 

THE DEFI ECOSYSTEM

The evolution of DeFi can be classified into the development and adoption of the following 

  • Decentralized Exchanges (DEX) and Exchange Aggregators
    • Exchanges like Uniswap, Curve developed Automated market-making (AMM) algorithms that allowed users to trade 24/7 in a safe, permissionless manner.
    • The development of different market-making algorithms caused fragmentation of liquidity across applications. 
    • This led to the creation of DEX Aggregators like Paraswap, 1inch that can compare prices and split an order over multiple exchanges to offer the best swap rate.
  • Lending and borrowing 
    • Credit and lending are the backbones of the global financial services industry. 
    • DeFi credit markets such as Compound, Aave have demonstrated product-market fit through universal access, instant settlement, greater transparency about outstanding loan books and better risk management controls in the system.
  • Derivatives
    • Decentralized derivatives volume is dominated by perpetual futures offered by applications like dYdX, Perpetual protocol with daily volumes over US$ 5bn.
    • The on-chain options market is still nascent and navigating through the challenges of high transaction fees, hedging mechanisms, and collateral requirements. 
    • We believe this will be the most innovative DeFi category with new primitives like Option vaults (Ribbon), Squeeth (Opyn), perpetual options being developed.
  • Yield Aggregators
    • Platforms like Yearn give users higher returns for providing liquidity by directing the combined liquidity to applications with the highest yield and regularly reinvesting returns to maximize the yield through auto compounding.
  • Stablecoins 
    • Stablecoins are the units of value, trading in the blockchain ecosystem as more assets pairs have USDT, USDC as base tokens as compared to ETH, BTC.
    • USDC, USDT are centralized stablecoins issued by Tether, Circle respectively, and are backed by US dollar holdings. 
    • DAI (backed through digital asset collateral), UST (pegged algorithmically) are popular DeFi-native stablecoins holding a value of US$1.
  • Insurance 
    • Traditional insurance companies are wary about underwriting risks related to DeFi apps due to a history of exploits, losses denominated in cryptocurrencies.
    • Institutional investors are looking to enter the digital asset space, so the emphasis will shift from early adopters to more risk savvy investors – making insurance a key problem to overcome for their involvement.
    • Companies like Nexus Mutual, Nayms are building on-chain insurance services for blockchain applications and provide the qualities of transparency, instant settlement to insurance services as well.
  • Frontend Applications
    • Front-facing user interfaces, which simplify interactions with DeFi DApps will be crucial to bring mass adoption and fulfil the vision of banking the unbanked. 
    • The end goal is to provide access to all financial services, portfolio monitoring, tax calculation tools from a single interface and dashboard.
    • Projects like Zapper, Zerion, DeBank and Frontier are building these tools for widespread adoption.

THE ROAD AHEAD FOR DEFI

Short TermLong Term
Efficient exchanges: DEXs will become capital efficient via innovation in market-making algorithms and become more competitive in trading fees as compared to centralized exchanges. Trading tools: We will see the development of trading infrastructure to support the next generation of institutional HFT, quant, and market-making firms entering the digital assets market.Derivatives: Conventional derivatives like Options, futures, and unconventional derivatives like perpetuals, option vaults, will help grow the transaction volume on-chain. This will also help users mitigate risks through option strategies, reducing the volatility of the system. Interest rate products: Products like interest rate swaps, fixed-rate lending will make on-chain credit markets more efficient and approachable for risk averse players.Staking primitives: Liquid staking solutions and staking yield derivatives will open up a lot of liquidity and help in decentralisation of PoS networks.Real World Assets: Tokenization of real world assets will bring stability and expand the use cases and impact of DeFi. We see real world assets as the next opportunity to increase DeFi’s market size exponentially.Insurance: DeFi insurance will expand beyond blockchain applications and facilitate Home, Motor, Fire & Crop insurance with the help of oracles and off-chain trust providers.DeFi x CeFi (Centralized Finance) x TradFi (Traditional Finance): With the entry of major traditional players like Visa, consumers will be able to use their digital assets as collateral to obtain credit and spend their crypto to purchase goods at physical stores. Assets locked in CeFi platforms like Binance will be used as liquidity for DeFi applications – helping CeFi offer better interest rates and in turn, helping DeFi improve its liquidity.

 

NON FUNGIBLE TOKENS

Non-Fungible Tokens (NFTs) are digital assets with blockchain-managed ownership. 

We wrote a blog post wherein we covered the evolution of these tokens, explained the technology behind them,  discussed the ecosystem, and spoke about the foundations of the NFT sector. We encourage the reader to go through the primer to understand NFTs in depth.

CATEGORIES OF NFTs

We have segmented the NFTs ecosystem into two parts: 

  • Cultural NFTs
    • NFTs representing art, music, and collectibles are clubbed under this category. 
  • Utility NFTs
    • NFTs are being used in the tokenization of real-world assets (real estate digitization, legal document digitization), news source tracking, fundraising, in-game items, building decentralized social media platforms, forming digital identities for individuals/organizations, and management of loyalty programs.

CULTURAL NFTs

NFTs minted by popular artists have introduced millions of fans to this emerging technology. Cultural NFTs are an easy and relatable way to learn about blockchains. They have a strong network effect and are essential for onboarding the next 100 million users into the space.    

THE CELEBRITIES’ NFT STORM

Instagram Followers: 253,000,000Instagram Followers: 32,200,000Instagram Followers: 7,000,000Instagram Followers: 105,000,000

As of 10th Feb‘22

BAYC is an all-stars club now

A major driver of this market boost was the sale of Beeple’s Opus for US$ 69mn and the subsequent entry of actors, musicians, TV show hosts, sports stars, Hollywood IPs, gamers, memes, etc into the world of NFTs. 

Business development is the backbone of B2C cultural NFT projects. We have identified two approaches for the same:

LicensingCommunity First
top-down approach to building an audiencebottom-up approach to building an audience 
The companies acquire IP rights to iconic assets of an entity like a Hollywood movie, an eSports team, a band, etc. They even work with major artists to create new content in the form of NFTs.Fans of the celebrity or franchise engage with the NFT of their favorite IP on the platform.The audience is now further segmented into one-time users and explorers. By regularly launching exciting NFTs, the platforms are able to create a large inventory of NFTs, the platforms are able to convert the one-time users into explorers who finally become repeat customers.They work at the grassroots level to empower the creators with intuitive tooling to create new content or tokenize old pieces.They support creator economies by allowing artists and organizations to leverage NFTs to engage with their fans in meaningful ways (limited edition signed memorabilia for fans, group calls, access to unreleased content etc), monetize their content without giving a cut to multiple middlemen, stream payments, get perpetual royalties etc.The creators bring their communities onto the platform. By attracting high-quality artists and organizations, the platforms are able to become a hub for enthusiasts. 

B2B solutions often engage with enterprises like talent management agencies and brands looking to use collectibles to reach out to their customers. 

We have made investments in leading players in this sector: Terra Virtua, an immersive collectibles platform. Mintbase, a marketplace built on NEAR protocol. Wall, a social discovery platform for web3.

UTILITY NFTs

If we analyze the segmentation provided above, it is evident that cultural NFTs are eye-catching, however, utility NFTs will be instrumental in unlocking massive value for enterprise use cases. These NFTs could integrate into traditional infrastructures and improve the efficiency of operations by bringing transparency. They also empower entities by enabling the self-custody of data. As in the case of real world asset tokenization, they can sometimes be a security token.

B2C utility NFT solutions tend to give power back into the hands of individuals. Digital identities, decentralized social media platforms, and assets with in-game utilities provide end-users with control over their data, privacy, and assets. 

These projects are driven by customer education and making the masses aware of the problems with the current state of big companies’ data mining on individuals and controlling digital assets even after they have been ‘bought’.  

For B2B utility NFT projects, we have identified three crucial pillars:

  • Institutional Grade Technology
    • For companies to trust a blockchain solution with assets worth millions, the underlying technology has to be institution grade. The project must have: 
      • Exhaustive documentation
      • Multiple audits and pilot projects
      • Compatibility with existing systems and external parties
      • Disaster recovery plans 
  • Engagement with Regulators
    • Enterprises must adhere to industry specific compliance requirements. 
    • Because of the nascency of blockchain technology, projects often need to educate and work with their local policymakers to integrate their solution into the existing regulatory framework.
  • Business Development Skills
    • The appeal of blockchain’s transparency and increased operational efficiency is easy to grasp for innovative business. 
    • However, most utility NFT solutions will still have long sales cycles. The project has to convince enterprises to do pilot projects which can eventually lead to long term contracts.
    • Both getting a pilot and converting it into a sale requires strong business development skills.

Our investments in this sector: Persistence: it facilitates decentralized commodities trading via NFTs and staking-as-a-service. SuperFarm: provides a host of tools for the NFT world like a launchpad, staking, generation, and marketplace. 

The 30-day avg of US$ NFT sale has ballooned from US$ 10.1mn on 1st Jan ‘21 to US$ 3312mn on 14th Feb ‘21. 

THE NFT ECOSYSTEM

THE ROAD AHEAD FOR NFTs

  • In our primer, we predicted that a NFT game would go viral soon. Four months later, Axie Infinity, an Ethereum based game, hit 1 million daily active users. 
  • Another trend that is catching up from our predictions is marketing NFTs. Marquee brands are leveraging NFTs for customer engagement. Coca Cola auctioned NFTs in Decentraland and Louis Vuitton announced its plan for an NFT game. Countless other enterprises have explored NFTs as a way to engage with their customers. 

We believe over the next 5 years, utility NFTs will play a major role in upgrading many industries along with cultural NFTs supporting creators. Here are some impact areas that we are excited about are:

Short TermLong Term
Creator economy infrastructure: streaming of payments, fan tokens, access NFTs, direct to fan content, revenue split for stakeholders, curator DAOs and in-built charity donations via NFT sales.Financialization of NFTs: fractionalization, lending, borrowing, indices, baskets, real world assets.Improvements in price discovery mechanisms through open data available on blockchains.Dynamic NFTs: real world assets change their characteristics in response to modifications in their environment. NFTs will mimic the same behaviour by building in function calls to respond to inbound data. Digital identity: all documents like driver’s license, certificates, health records, educational degrees, land deeds etc can be linked to a single NFT that identifies a person instead of the fragmented identities we have today. The use of zero-knowledge proofs will allow individuals to only disclose information they want and distributed storage of information will decrease the risk of data concentration and leaks.Supply chain management: individual items can be represented as ERC-1155 tokens and end user can track the item’s journey without trusting a central entity.Loyalty management: proof-of-attendance, tickets, discounts, cashbacks, kickbacks, point system, and collections of memorabilia.   

GAMING

The gaming industry has been experiencing massive growth, acquisitions, technological development, and onset of next-gen consoles. Major publications are headlined by news of global tech giants foraying into gaming, virtual experiences and the Metaverse.

How will gaming benefit from integrating with Blockchains?

Gaming over the last decade has been a largely centralized activity with all data, assets, and in-game currency confined to the game itself. This created very siloed ecosystems, and the ownership was retained by the developers of the game itself with no benefits being passed onto the gamers who are crucial in the journey to success. 

The addition of blockchain and distributed systems sets the stage for a decentralized gaming future where items won, purchased in one game could be transferable and composable with other games and ownership will help attach a real value on game assets. 

Source: DappRadar 

The idea of integrating NFTs as in-game assets will help with both current monetization (in-game purchases) and new monetization models (royalties from secondary sales).. Blockchain gaming received acclaim as we witnessed the meteoric rise in Play to Earn Gaming and Axie Infinity. Axie Infinity’s daily and monthly active users (DAU and MAU) have been on the rise, despite the reduction in player earnings, incentives provided by Axie due to the fall in the SLP token price. 

With Axie’s growth, we saw the whole gaming industry flourish, and create a thriving ecosystem around the same.

BLOCKCHAIN GAMING ECOSYSTEM

Play to Earn Games

  • Play to earn (P2E) revolutionizes the relationship between the game and the player by allowing them to earn an income in exchange for their time, skill playing the game.
  • Gamers create value for other gamers and developers by engaging in the in-game economy and earning assets (NFTs) or in-game currency (tokens) for their contributions.
  • We believe Play to earn can be a great mechanism for customer acquisition and can help improve customer retention if implemented correctly.  
  • Even though play-to-earn games can provide sizable monetary incentives for gamers, developers still need to create visually appealing, entertaining, and fun-to-play games to ensure longevity.
  • For play-to-earn games, we have identified a few crucial pillars: 
    • Low barrier to Entry – There is widespread evidence about how freemium and free-to-play games have been able to generate massive revenue.
    • Multiple paths to winning – Top games can segment players and group them with like-minded folks. Games can support multiple PVE, PVP, and multiplayer modes.
    • Tokenizing inputs rather than finished goods – Game designers should make systems where finished goods need to be crafted rather than bought. This will promote psychological effects such as time, skill-related success. 
    • Decentralized markets – Games should let players self-organize, determine prices, and trade directly with one another. 

Guilds

  • At the peak of Axie Infinity popularity the cost to enter had rocketed to US$ 500. Guilds were started to remove the barrier of entry into P2E games having a high cost of entry.
  • Guilds would purchase in-game assets (i.e. Axies) en masse and sponsor the new players by lending assets to them for a small percentage of their game earnings.
  • Guilds at their core are asset managers. They pick games to invest in, purchase token and NFT assets, lend those out to scholars, and earn a yield on their activity. 
  • Most Guilds are currently building out custom tooling, wallet management, and reputation software for their scholars. There is a significant gap in this market that can be fixed by a great white-labeled solution.
  • Further, the process to delegate virtual land, other assets to scholars has certain trust assumptions. A platform that allows lending and borrowing of these assets would make the operations trustless, and reduce some of the risks.
  • Yield Guild Games (YGG) employs a franchising model via a structure known as “Guild of Guilds.” The smaller guilds (subDAOs) can be game or region-specific that share revenues with the main guild. 
  • Merit Circle builds it’s subDAOs in-house rather than franchising. Merit Circle wants to produce homegrown skilled players by creating an end-to-end training system. Thus Merit Circle plans to operate like an E-sports management company.  

Infrastructure

  • As blockchain gaming is still in its infancy, the underlying infrastructure to create and build games and a seamless experience are still missing. 
    • Wallet technology needs to be deeply integrated into games to provide an immersive experience.
    • Users shouldn’t have to sign and pay gas for all transactions manually. The backend should configure this and effectively batch transactions for lower fees and a more complete gaming experience. 
    • KYC and Compliance layer to onboard traditional game developers in the space, and create competitive blockchain gaming applications.
  • Most web3 games run on centralized servers and the core infrastructure is very similar to web2 games. Current engines such as Unity and Unreal do not provide support for blockchain integration in games and will significantly limit their use until this functionality is built. 
  • Game Engines built to support blockchains, tokens, wallets and NFTs natively will become a massive opportunity. A decentralized gaming engine that provides graphics, rendering, audio, hosting and other services in a distributed manner without a single point of failure will have massive demand. Ecosystem participants and power users can contribute to the game in multiple ways and be awarded for the services they provide, and strengthening the community and utility of the tokens.
  • Low Code/No Code platforms that enable gamers, artists to contribute in a creative capacity such as create and sell assets for games, develop in-game experiences/side-quests coupled with the right token incentives would drive users and real utility to the platform.

THE ROAD AHEAD FOR BLOCKCHAIN GAMING

Short Time HorizonLong Time Horizon
  • User Experience: The user experience of blockchain games will improve significantly with gasless transactions, transaction batching (to reduce costs), and seamless integrations.
  • GameFi 2.0: Games will attempt to launch their own guilds to control asset inflation, avoid distribution of in-game assets at low prices to guilds.  
  • New means of Monetization: Token economies within games will see rapid innovation, with several alternative x-to-earn platforms and games. This onboards non-gamers into the ecosystem like artists via draw-to-earn, fitness enthusiasts via run-to-earn.
  • Viral games: Strengthening of play-to-earn models, widely utilizable in-game assets, will lead to the creation of multiple viral games bringing in first time blockchain users. 
  • AAA Quality games by major game studios will compete with top titles from the gaming industry by leveraging the power of NFT assets.
  • Guilds will launch their own Esports teams to compete in these AAA games.
  • Studios: In the casual, hyper-casual, and mid-core gaming categories we will see the emergence of a few major studios that can build the entire ecosystem around interoperable NFTs and a shared token economy.
  • Infrastructure: Products helping an easy addition of blockchain solutions like wallets, NFTs, tokens, and distributed records of gameplay to Android, IOS, PC, and console games will accelerate the transition to a gamer-friendly landscape. 

Decentralized Autonomous Organizations

To run these global organizations that will be at the forefront of DeFi, NFTs and gaming will require truly distributed teams that can become a convergence point for people with different professional, educational and cultural backgrounds. These organizations of the future should be able to improve as they scale without losing the agility of their original setup. We believe Decentralized Autonomous Organizations (DAO) are the potential candidates to successfully execute this vision. 

DAO is an entity with no central leadership. Decisions are made from the bottom-up, governed by a community organized around a set of rules enforced on a blockchain. They are like fluid communities with built-in treasuries whose assets are managed by their members. Decisions are made via proposals the community votes on during a specified period. DAOs distribute power to all stakeholders (suppliers, developers, end-users) of an organization. 

What problems do DAOs solve?

Organizations suffer from the principal-agent dilemma, a common challenge that occurs when an agent (a centralized entity/ individual) has to make decisions that satisfy the divergent goals, priorities and needs of the group (principal) without compromising their own interests. This dilemma is prevalent among public and private entities and DAOs aim to solve this by replacing hierarchical centralized forms of decision-making with a trustless system where all stakeholders of the organization are able to participate in the governance and decision-making of the group.

Lack of transparency can have devastating effects that sometimes leave a permanent stain on a company’s image. Consumer-facing organizations cannot thrive without the public’s trust. An example displaying the negative outcomes of failing to be transparent is the emissions scandal at Volkswagen. The DAO model represents a world-changing governance structure that can introduce fairness and transparency across multiple industries.

DAOs wil be critical to the idea of a decentralized web and we believe the parabolic increase in these types of organisations will effectively spur the demand for DAO infrastructure, tooling and products.

Challenges facing DAO governance

DAOs today hold and manage more than $9B+ in their treasuries, but they are still far from being operationally efficient. Customizable DAO tooling is an empirical need right now across crypto communities, as protocols are now onboarding people at an accelerated pace but retention and engagement is lagging significantly.  

Traditional companies have learnt, formulated processes to design efficient systems that helped them grow and efficiently manage their massive task forces. As we envision that token-governed cooperatives are going to replace traditional companies in the future, DAO governance processes, coordination frameworks, management tools will need improvements multiple orders of magnitude to achieve operational efficiency. 

Human resources, marketing, research, operations, legal, sales and other departments are critical to the growth of an organization and the problem does not lie in this structure but the bureaucratic, centralized and untransparent channels that are commonplace in present-day organizations. Governance accountability, community Human Resources, contributor engagement and communications, etc. are all surmountable challenges for DAOs. 

Jai from Rari Capital suggests a basic playbook by breaking roles into “bubbles” which allows for sub-DAOs and discrete, fluid teams. Such structures and clear written documentation will make the onboarding and exiting process simpler from DAOs. Blockchain has provided the necessary infrastructure to eliminate these problems but DAOs today lack this structure that would be critical to scaling the decentralized economy. 

THE ROAD AHEAD FOR DAOs

A lot more innovation is needed in the space to develop DAOs  as the next frontier for organizations to work. Some areas where a lot more work is needed are treasury management and analysis, governance, legal structures and regulations. Initial DAO implementations are suffering from centralization, and lack of transparency while also struggling to effectively retain the community.

Short TermLong Term
DAO Structuring: Operational  Improvement through adoption of sub-DAOs/pods model. Each sub-DAO will manage one functional role and members will have common expertise. These independent pods will have their own-codified rules, while ensuring that they collectively contribute to the originating entity’s goals and visionDAOs will have more than 20M members by the end of this decade. Legal Clarity and Adoption: DAOs will be legalized with sound regulations, we will increasing participation in the DAO ecosystem with a significant increase in Service DAOs. 

OUR PREDICTIONS FOR THIS DECADE

Protocol Layer

  • Layer-1
    • The number of blockchain wallet addresses will surpass the total number of Google users (approximately ~ 4bn)
    • This decade will witness significant consolidation in layer-1 protocols, and possibly, only the top 5-8 layer-1 chains will survive. Other chains will either be acquired or focus on niche use-cases or fade away.
    • The value captured by layer-1 tokens for securing the underlying protocol will continue to grow but at a slower rate beyond a certain scale level. This growth will then be focused on the application layer.
  • Layer-2

Middleware

  • Hacks and exploits of cross-chain bridges will be common due to centralization and communication barriers between blockchains
  • The blockchain data and indexing segment will blow up to become a US$ 500bn industry
  • Tech giants like Apple and Google will also try to bring their own crypto wallets for their users

Application Layer

The total market cap of all layer-1 applications will be many times larger than the layer-1s themselves.

  • DeFi
    • More than 80% of global financial transactions will be settled on blockchains as DeFi applications become user-friendly 
    • Staking will be one of the most widely used fixed income products
    • DeFi will be a US$ 10tn industry. The number stood at ~ US$ 200bn on 31st Jan 2022.
  • NFTs
    • NFT trading volume will cross US$ 0.5tn by 2024. The number stood at ~ US$ 20bn on 31st Jan 2022.
    • 95% of the cultural NFT collections will see a drastic (>60%) loss from their ATH within 6 months of launch.
    • Cross-chain transfers will see cases of NFTs being lost or losing their traits as the inter-chain standards are in nascent stages of compatibility.
  • Gaming
    • 90% of games will 
  • DAOs
    • DAOs will be managing treasury assets worth $100B+ by the end of this decade.
    • Some DAO will purchase a well-known Web 2 company and tokenize it within the next 5 years.
    • A publicly-listed DAO will be included in S&P500

THE WOODSTOCK VALUES

Our Vision

Investing responsibly for an inclusive future

Value Addition

We work closely with our portfolio companies to provide maximum value to their growth and development journey. Our partnership with them extends beyond the monetary investment as we bring our expertise, research to 

  • Building East to West corridor for ecosystem growth
    • People over the world want to connect with VCs, entrepreneurs, and projects in India. We want to help them get a piece of the growing Indian market and make money.
    • With our strong presence in the region, we help western funds get access to deal flows from the Indian and wider Asian markets.
  • Token engineering and Incentive design
    • Over the last couple of years, we have built a deeper understanding of token economic models, token utility, incentive mechanisms that have been utilized by some of the most successful protocols and applications.
    • We use this knowledge to recommend good token design practices to our portfolio companies and help them design incentive programs that are sustainable over the long term.
  • Product Feedback and development
    • As highlighted earlier, we believe that applications, protocols will need to focus on improving the user experience to increase accessibility and ease to use. 
    • We provide in-depth product feedback, help with planning the roadmap and brainstorming on product requirements, guide on improving application performance with detailed insights on SEO and social media outreach.
  • Validator Nodes
    • We run validator nodes for our portfolio companies to make sure we are contributing to the goal of true decentralization. 
    • Currently, we are running validator nodes for Band Protocol, Casper Labs, Persistence, Sentinel, Marlin Protocol (relayer cluster), and Elrond.
  • Enterprise and Web2 connections
    • Our top management team has experience in entrepreneurship, investment banking and traditional finance, and everyone in the Web 2 space has a first-degree link to us.
    • We assist our portfolio companies with their hiring requirements owing to our strong connections in the Indian ecosystem, allowing us access to the best founders and the largest English-speaking developer community in India. 
  • Media and Public outreach
    • As one of India’s leading blockchain-focused funds, we have extensive contacts with journalists, media outlets, and influencers.
    • We assist our projects in connecting with the appropriate influencers and media publications in order to promote and reach the appropriate audience.

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RISK WARNING

Every financial product, asset class, or investment has risk. A cryptocurrency (also known as digital tokens, digital coins, or crypto(s)) is no different. That is why it is important for users and limited liability partners to be aware of the potential risks present in cryptocurrency and blockchain projects. You should not invest funds in the cryptocurrency market that you are not prepared to completely lose; i.e., only allocate risk capital to digital tokens. Furthermore, we will not accept liability for any loss or damage which may arise directly or indirectly from any such investments.

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