Continued development of the application layer in the field of cryptocurrency will generate significant real-world value for crypto assets.
Table of Contents:
Application Layer
Bitcoin
Ethereum
Positive reflexivity
Decoupling the application layer
Application matrix
Blockchain use cases in the top 3 quadrants.
Quadrant 1: Fully on-chain economy
Quadrant 2: Programmable finance
Quadrant 3: Off-chain applications
Developing the application layer
The end of reflexivity era
(Preface:
The transformation of AI in the crypto field to “first-class citizens”, the advantages of crypto robot agents, and front-end applications
)
(Supplementary background:
The rise of application chains: Exploring the next frontiers of blockchain scalability
)
A general-purpose blockchain stores the state of the system and provides the logic for that state. We typically refer to the state as assets and the logic as applications. For example, Ethereum stores assets like Ether and Dai (state) and they can be used in applications like Uniswap and Aave (logic). The state and the logic together make up what we call the application layer.
The crypto economy began with the advent of Bitcoin in 2009. Bitcoin is a blockchain with limited state, inflexible logic, and inefficient infrastructure, which restricts its applications.
Then came Ethereum, which introduced a flexible logic layer through its new blockchain-native virtual machine. It also allowed anyone to create their own crypto assets on the same network. Ethereum thus expanded both the state layer and the logic layer.
However, the infrastructure of Ethereum is still limited.
Since its founding in 2015, most of the Ethereum research community’s work has focused on improving its infrastructure to support the application layer. Rollup and Danksharding have increased throughput, and account abstraction has enhanced user experience. MEV infrastructure can provide better price execution. However, after 8 years, many people are still puzzled about what we have built at the application layer. Yes, we can trade AAVE on Uniswap and borrow UNI on Aave. But where are the real-world demands? Where are the use cases?
To date, blockchain has exhibited strong reflexivity. There is a wall between the crypto economy and the real world, and it is difficult for cryptocurrencies to attract the real world beyond speculation. Past bull markets, such as the DeFi boom from 2020 to 2021, were driven by speculation, and the explosive growth of new crypto-native tokens and protocols fueled reflexivity: speculation drove activity, which in turn drove more speculation.
Reflexivity refers to a circular relationship between cause and effect. Reflexive relationships are bidirectional, where the cause and the effect mutually influence each other, making it impossible to determine which is the cause or the effect.
It is foreseeable that this loop will not continue indefinitely.
Eventually, the party must come to an end, and positive reflexivity turns into negative reflexivity. Speculation is mistaken for product-market fit, while exploration of real use cases remains. Two years later, many are still searching for ways to scale on-chain activity. To understand how to develop the application layer, we need to study it more closely.
The application layer consists of two components: state and logic. State refers to data, while logic refers to computation. Both state and logic can be on-chain or off-chain. We present a four-quadrant matrix:
Each quadrant represents different applications. So far, most blockchain applications have been in Quadrant 1, which represents the use of crypto-native assets in on-chain protocols. Quadrant 2 involves bringing real-world assets (RWA) onto the chain and using them in protocols. Quadrant 3 encompasses the use of crypto-native assets off-chain. Everything else falls into Quadrant 4. If both state and logic are not on-chain, then it is not a blockchain application.
The focus is on the fully on-chain economy surrounding crypto-native applications. Currently, most on-chain activities fall into this quadrant. These endogenous applications are inherently reflexive, which is one of the reasons for the volatility and speculative nature of the crypto market.
From a positive perspective, this incentivizes users and developers to enter the crypto economy. Additionally, although these applications are cyclic, they do contain some real value.
While speculation and gambling may be controversial, they are real use cases. However, we all hope that the crypto economy will not just be an on-chain casino. Peer-to-peer payments can also be done using crypto-native assets, but stability and scalability are poor.
To go beyond speculation and inefficient financial services, we need to go beyond Quadrant 1.
Another category of blockchain applications is bringing real-world assets (RWA) onto the chain. These assets can benefit from the global, programmable, and composable nature of the crypto market. Those who question the value of crypto-native assets often understand this quadrant, as summarized by the mantra “blockchain, not crypto” or the meme of “tokenization.”
We call this quadrant programmable finance. It involves developers bringing bonds, stocks, commodities, or other traditional financial instruments into programmable markets, unlocking more accessibility, expressiveness, and efficiency.
The most successful RWA so far is centralized stablecoins. Stablecoins provide a globally accessible and cheap way to obtain dollars and have been described as the “killer app” of cryptocurrencies. The total market value of USDC and USDT has reached $114 billion.
Programmable finance has been widely discussed in other areas. These applications have piqued institutional interest in blockchain technology and will be a major driver of its growth. However, we believe they are just a part of the broader crypto economy.
The final category of applications is those with on-chain state and off-chain logic. These digital-native assets with off-chain applications are the most overlooked category in crypto assets.
The simplest example is social assets. In the last NFT craze, many NFTs were seen as representations of identity. Bored Apes, Punks, and other well-known NFTs allow their owners to showcase their status or indicate membership in exclusive communities. The challenge these NFTs face is that their social value is closely tied to price and novelty, which quickly erode. Fortunately, this flaw is specific to those NFTs and not an inherent attribute of all social assets. A more mature crypto economy will offer more robust social assets.
The off-chain logic of social assets is how we behave off-chain. In this way, social assets serve as coordination tools. Since everyone agrees on the state of the Ethereum blockchain, we can adjust our actions in the real world around this state. For example, we can use social assets to provide opportunities to attend concerts or prove membership in communities like Zuzalu. The value of storing these social assets on the blockchain instead of a centralized database depends on the specific case, but it may benefit from blockchain’s trust neutrality, sovereignty, permanence, censorship resistance, financialization, or interoperability with other parts of the crypto economy.
Applications in Quadrant 3 can also offer advantages of crypto technology. Consider gaming, where traditional games can support certain on-chain state while keeping most of the game logic off-chain. Then, these assets gain external demand through their in-game utility or social value.
Token gating unlocks more use cases. Friend.tech, despite its flaws, has shown directional success in showcasing the intersection of social assets and token gating. We believe there are many exciting applications that can be built in this category. Another recent example is Orb Land. Orb is an NFT that grants exclusive access to certain celebrities. Orb owners have the right to ask the corresponding celebrity questions at a certain rhythm (e.g., every 7 days). Orb also has an additional feature – the Orb Market is a radical market that allows anyone to buy any Orb from another person at a fixed price at any time.
Decentralized Physical Infrastructure (dePIN) projects also fall into Quadrant 3. These tokens incentivize real-world activities like mapping roads or installing hotspots, solving the cold-start problem.
Not everything neatly fits into one of these quadrants. Every application has some external purpose to some extent. Again, there must be real-world use cases (some “off-chain logic”) for something to be considered useful. And in practice, most applications have their logic partially on-chain and partially off-chain. Nonetheless, as a mental model, we find this framework helpful for reasoning about the application layer.
Based on the latest developments in the ecosystem, we have formed two reverse perspectives on how to develop the application layer.
Our first reverse perspective is that currently, asset innovation is more important than application innovation. Yes, we need better decentralized exchanges, but more importantly, we need to create assets that are truly worth exchanging. The latter is an easier path to sustainable scaling of on-chain activity. We encourage more teams to bring novel assets on-chain.
Our second reverse perspective is that in the medium to short term, Quadrant 3 is more important than Quadrant 2. RWAs have vast prospects in the crypto economy. However, as of now, we believe bringing crypto-native assets into the real world is more important than bringing RWAs onto the chain. The former represents “real-world assets” of their own kind and has more unexplored, unconstrained design space.
As Quadrant 2 and Quadrant 3 make up a larger proportion of the crypto economy, reflexivity in the market will decrease. Once we have external demand for crypto assets and protocols, Quadrant 1 will become less circular. Suddenly, Uniswap is no longer just an engine for facilitating speculation; it is also a decentralized business with relatively stable demand.
Real-world use cases weaken reflexivity in the crypto economy, and over time, the market will become more acausal. By “acausal,” we mean that the demand for blockchain applications does not come solely from the endogenous demand of the blockchain itself – which we believe is the closest antonym to “reflexive” that we can find.
The ultimate state of the application layer will be far less reflexive than it is today and will generate significant real-world value. We will eventually achieve this.
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Tags:
bitcoin
ETH
RWA
Blockchain Applications