4 months ago • 5:19 mins
Before investing in a stock, legendary investor Warren Buffett always looks at the company’s “economic moat”: its ability to keep an edge over the competition, protecting its profits and market share. You can do the same before investing in a crypto project – and with all the options available right now, you probably should. Here’s how.
Most crypto projects are open source, meaning they’re quite susceptible to competitors copying (or “forking”) their code to build a competing project. That’s why one principal by the name of Parker McKee at successful venture capital firm Pillar looks at a combination of two key things to assess a project’s long-term value: its popularity and defensibility.
While popularity is easy to measure, defensibility isn’t. McKee tries to do it by looking at a project’s usefulness that cannot easily be forked by a competitive project. He calls this quality “unforkable utility” – the hard-to-replicate value to a crypto project’s user. This is how we’ll define a project’s economic moat. And to help us measure it, we’ll look at the five common forms of unforkable utility McKee has identified through his many investments in crypto.
Decentralized finance (DeFi) projects have capital – think deposits, collateral, and liquidity – that they rely on to operate their markets efficiently, and this capital is hard to fork. Take DeFi lending/borrowing project Anchor, which has over $15 billion worth of capital in the form of deposits (supplied by lenders) and collateral (supplied by borrowers). So while Anchor’s code can be copied, its $15 billion-plus worth of capital is unforkable utility to its users that serves as the project’s economic moat.
DeFi exchanges (also called decentralized exchanges, or “DEXs”) have liquidity pools of token pairs that allow them to act as market makers. Without these, DEXs can’t function. And once again, while you can copy a DEX’s code, its capital – in the form of liquidity pools – is unforkable utility to its users that serves as the project’s economic moat. Popular DEX Uniswap, for example, has over $7 billion worth of capital that’s impossible to fork.
It’s said that the value of a network is proportional to the square of the number of its users. So the more participants on a network, the more valuable it is to each user. This is the “network effect”, and it applies to crypto too.
Imagine a hypothetical messaging project – a sort of decentralized, crypto version of WhatsApp. As the number of users on this project grows, so does the utility to each user. Once the network reaches a critical mass, even if an incrementally better project is created, the difference in utility between the network with all the users and the network with no users is so great that it’s unlikely a migration will occur.
Here, the unforkable utility to the users is the users themselves: they increase the project’s network effect and act as its economic moat. A real example of this is the NFT marketplace OpenSea. Because it has (by far) the most users compared to other platforms, it’s the go-to marketplace for NFT creators, buyers, and sellers.
This is a bit more specific to blockchains like Ethereum, Solana, and Avalanche. Whether through mining or staking, network participants (also called blockchain validators) help keep the blockchains secure in exchange for some financial incentive (earning crypto). And the more users there are, the more secure the network becomes since it’s harder for hackers to execute a “51% attack”.
The more secure a blockchain is, the easier it becomes for the next marginal user to justify storing some of their wealth in that chain or projects built on top of it. That creates a positive feedback loop of more value, more users, and more value. This security is another example of unforkable utility that acts as a blockchain’s economic moat.
Similar to currencies, a project’s token can have unforkable utility if it’s generally accepted at face value as a method of payment. In the crypto space, there are a number of stablecoins – like USDC, USDT, and UST – that are starting to meet this definition. Their distribution and approval have been scaled to the point where many people will accept the tokens without questioning their value.
This is important: a recent survey by Visa showed a quarter of small businesses plan to accept crypto payments this year. These businesses will most likely accept only stablecoins to avoid exposing themselves to the wild fluctuations of other cryptocurrencies. So tokens like USDC, USDT, and UST have an economic moat in their acceptance by other parties, ecosystems, and applications – as well as exchanges where you can easily swap them for fiat.
While a project’s code can be forked, it’s a lot harder to steal its thriving community or replicate its brand. These are more “soft” forms of defensibility but still worth highlighting: community is really important in the crypto world since many projects are built and operated by the community itself. The whole idea of these decentralized projects is that they’re by the people, for the people – and not run by some centralized party. So a project with a really engaged community or strong brand has unforkable utility that acts as its economic moat.
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