ArkStream Capital 2023 Outlook: In which scenarios will Web3 applications explode?

In July 2018, Dr. Xiao Feng, Vice Chairman of Wanxiang Holding, predicted that the blockchain industry might see companies with a market value of $5 trillion. At that time, the total market capitalization of the entire crypto market was only over $200 billion, and after a whole year of decline, it fell to $100 billion. From the highest point of $830 billion in January 2018 to the lowest point of $100 billion in December, the entire crypto market dropped by 88%, a 50-fold gap from the $5 trillion market value. At that time, despair and confusion filled the hearts of almost every crypto participant, and most people lost their direction.

During this cycle we have experienced, there has been a large-scale explosion in both the application layer and the protocol layer: DeFi protocols are creating value, and the discussion of "fat protocols" versus "fat applications" has entered the spotlight; public chains are prioritizing ecological development; blue-chip NFTs like CryptoPunk and BAYC have successfully expanded their reach. In November 2021, the market capitalization of the crypto market reached 3 trillion dollars, less than a factor of 2 away from 5 trillion. The number of global crypto users reached 100 million. Although we have since entered a long decline, we believe that with the further purging of the industry, the bottom of the bear market has already emerged, and 2023 is an important moment for transition.

Instead of timing the market, we should think more about which sectors will give rise to trillion-dollar applications when the global number of crypto users reaches 1 billion and 15% of humanity enters Web3. How should these applications develop in the next cycle? We will analyze multiple sectors and explore the layout strategies for 2023.

Application or Infrastructure?

We believe that the next cycle is highly likely to witness an explosion in the application layer. This is similar to the development path of the internet, where developers focus on building infrastructure when it is difficult for the infrastructure to become widespread. Once a large number of users meet the conditions for influx, industry giants become monopolistic application developers. The path of Web3 is similar; after several cycles of exploration, the discourse power of "applications" has gradually increased. Those who master users and own traffic entry points hold the discourse power of Web3. Therefore, in the next cycle, although the infrastructure has not yet supported a billion-level user base, for application developers, this is the dawn of seizing the "high ground."

DeFi

The future exploration of DeFi may focus on two aspects: one is how to attract clients from centralized financial institutions within the industry, and the other is how to attract unbanked users outside the industry. The chain reaction triggered by the collapse of Luna in 2022 has led many users to question Crypto. However, we have seen the trading volume of DEXs double rapidly after the FTX crash, as the panic towards centralized institutions shifted to trust in decentralized financial protocols. This is one of the narratives for the next round of DeFi, which is to replace existing centralized financial institutions.

Of course, CEX still occupies the vast majority of the market share, while DEX still has significant growth potential. Especially in the derivatives sector, the growth space for DeFi is even larger. To achieve the same trading experience for derivatives as CEX, existing DEXs still need to improve in areas such as response speed, high concurrency handling capacity, depth, and convenience. This requires exploration in multiple areas such as L2 and other scaling solutions, cross-chain asset solutions, account privacy protection, and new liquidity solutions.

Another direction in DeFi development is how to grow in low-financialization third world countries and acquire users with low barriers to entry. DeFi may help these countries bypass traditional financial systems and directly use digital currencies for everyday payments. This requires technological iterations to lower the barriers, such as the development of AA wallets and smart contract wallets, and the establishment of pure on-chain credit mechanisms, while also considering localization, grassroots promotion, and user education.

X to Earn

X to Earn emphasizes X, rather than Earn. Earn can assist projects in cold start and early user expansion, but it should not be the sole objective. After completing the cold start, projects should quickly allow the Ponzi model to softly land, diminishing the benefits for early users. "X" is the key to the project's continued operation; the application itself should generate more user demand, and user retention should rely on user behavior within the application, rather than acquiring more tokens.

Lowering user thresholds and attracting external traffic is the consensus for the next cycle and an inevitable path for the transition from Web2 to Web3. Ponzi schemes will still exist, and some will undoubtedly shine brightly. But remember: 1. There is never a "too big to fail"; 2. What can help you succeed can often also lead to your downfall.

Games and the Metaverse

Whether a game can attract people ultimately depends on how fun it is. The immersion and real-world mapping emphasized by the metaverse, along with the Ponzi model and economic benefits brought by NFTs and token economies, are merely supplements to the gaming experience. The "playability" of the game itself is the true hard power.

Web3 games that can explode in the next cycle should be based on being already fun enough to attract players and having positive cash flow, supplemented by a lightweight token model. Tokens can serve as dividend rights rather than being strongly tied to user behavior. Players and investors should be separated; players who enjoy immersing themselves in the virtual world should continue to pursue their "hero dreams," while investors hoping for financial returns should focus on profit-making decisions.

The gaming industry is divided into infrastructure, distribution platforms, and the games themselves. We also pay attention to the construction of gaming infrastructure, which is closer to the concept of the "metaverse." Over the past year, we have invested in several infrastructure projects, such as Fragcolor, which provides a native blockchain game development engine, and Anima, which creates on-chain AR interaction methods. What can truly change the world are those products that bring us novel experiences and are full of imagination.

NFTFi

The trading volume in the NFT market has begun to stabilize. Rather than a cliff-like drop, it is more accurate to say that Social Money, which often exceeds ten thousand dollars, was originally beyond its rightful value, and the market has returned to a healthy growth phase.

For NFTs, the biggest difference between NFTfi and DeFi lies in the fact that mainstream NFT works, such as PFPs, currently possess both consistency and inconsistency. This fragmentation prevents NFTfi from experiencing the rapid growth seen in the early days of DeFi.

In terms of trading liquidity, there are three types of solutions: Marketplace, AMM Protocol, and Aggregator. The Marketplace is highly competitive, with a sharp decline in trading volume for art-related NFT exchanges in 2022. The comprehensive NFT trading market is led by Opensea, but it also faces competition from many challengers.

Looking at the entire NFTfi market, we find that it is still in a very early stage. Liquidity solutions for NFTs remain a current priority and are the foundational building blocks of the entire NFTfi stack. We believe that the subfields of Marketplace, AMM Protocol, and Lending Protocol, which are at the base of liquidity, are still the areas that investors need to pay the most attention to.

Wallet

Wallets, as the largest user entry point, play an indispensable role in lowering user barriers. In recent years, the development of wallets has branched into smart contract wallets and MPC wallets, but neither of these is the final solution. The development of wallets may ultimately still rely on account abstraction schemes. With the deployment of EIP-4337, features such as gas payment on behalf of users and social recovery will lead to a significant reduction in user barriers.

For wallets, there are two paths to take: one is to start from the application, developing users in reverse, forming an application-centric ecosystem; the other is to start from B-end services, providing SDKs to allow more applications to integrate into the wallet system, rapidly expanding the customer base. In the case where the technical implementation methods are quite similar, the core competitiveness of the new wallet team lies in how to expand user boundaries through strong operations.

Social

We believe that Web3 social data should exist on the blockchain, and users should have absolute control over their account data. This is part of the social infrastructure and part of what top teams in the industry are building. The content generated based on these social protocols is blockchain-based, and the ownership of data and accounts belongs to the users themselves.

After determining data ownership, the next step for Web3 social requires a large amount of data to build a moat. Tokens may play an important role in this, serving as user incentives or helping applications build better business models. Frontend construction is also key to acquiring users.

After having a large amount of data, how to mine the value generated by the data will be the most discussed topic in the post-Web3 era. Currently, Web3 social is still in the infrastructure construction stage, and the success rate of investing in infrastructure is much higher than finding client-side products.

AI

The explosive popularity of ChatGPT has brought the combination of AI and Crypto back into the discussion spotlight. The future ways in which AI and Crypto will merge are hard to predict, but there are currently some potential use cases being developed or discussed, such as in the fields of DeFi and financial transactions, DAO management, privacy, and data security.

Some projects are already exploring the integration of AI and Crypto, such as Ocean Protocol. The development of AI technology and the popularity of Crypto are also driving the advancement of smart contracts. The integration of AI and Crypto could bring about a series of new applications, as well as a more efficient, secure, and trustworthy financial system.

The combination of digital currency and AI may be more straightforward, serving merely as a settlement unit for future interactions between AIs, helping AIGC products better acquire users.

Conclusion

Looking ahead to the next cycle, applications may no longer be a subsidiary of the public chain ecosystem, but rather giant applications establishing their own foundations. The interoperability and composability emphasized by Web3 will truly be realized at this time. We anticipate such a scenario: users own their data and can switch between applications at a very low cost, enjoying free social interactions and seamless gaming, without worrying about high barriers and fees, nor about asset security. Such a Web3 will undoubtedly carry more beautiful aspirations of humanity, and people will spend more time on the internet and in the metaverse, realizing more ideas in this virtual world. At this point, Web3 will unleash its unparalleled value.