Cryptocurrency VC Over-Concentration on Public Chains Leads to Insufficient Investment in Basic Services, Protocols, and Imbalanced Capital Distribution
Author: Anthony DeMartino
Translation: Deep Tide TechFlow
Over-Investment in Public Chains
In the past two years, cryptocurrency venture capital has overwhelmingly prioritized investment in public chains over other protocols. This shift has led to a surge in new Layer 1 (L1) and Layer 2 (L2) networks, but has left the ecosystem lacking in high-quality protocols.
From a financial perspective, this strategy has yielded significant returns, as the market capitalization of many chains far exceeds their Total Value Locked (TVL). In contrast, leading protocol valuations often struggle to reach even 20% of their TVL.
Bottlenecks in Basic Services
This over-investment has created bottlenecks for other basic service providers.
Specifically, cross-chain bridges, wallets, oracles, exchange integrations, and the ability to attract top stablecoins and protocols have lagged behind. As a result, new chains often rely on secondary alternatives, increasing friction for developers and users.
Currently, FireBlocks is the only scalable institutional wallet, making it difficult to attract institutional capital due to the lack of integrations.
This issue is exacerbated when new public chains are not EVM-compatible, as FireBlocks' delivery times become longer.
For chains using the MOVE language, this problem is particularly pronounced, as the lack of institutional support is evident.
Top cross-chain bridges like Layer Zero also face the same challenges. A top bridge that can instill confidence in both institutions and users is crucial for attracting capital and assets from other chains.
Due to a large and growing backlog of transactions at top cross-chain bridges, new chains must either use weaker alternatives or pay high fees to increase their priority. Some chains are willing to pay more to speed up transactions, while those with less funding are forced to use secondary cross-chain bridges, limiting their growth potential.
Protocol Issues
When it comes to protocols, the problems are particularly severe.
Some top new protocols, such as ETHENA and Kamino, have a TVL that is 5 to 20 times that of many new chains, yet their valuations are comparatively modest.
This has led to insufficient investment in available protocols, resulting in a significant shortage.
To address this issue, public chain foundations have been forced to incubate amateur teams, which often merely replicate existing codebases rather than build robust, battle-tested solutions. This introduces significant risks in two main areas:
Attracting Capital: Protocols developed by underfunded teams struggle to gain credibility, investor support, and TVL.
Security and Stability: While it is easy to replicate existing protocols like AAVE, effectively running them and ensuring the safety of user funds requires experience and expertise.
Money Market Crisis
The money market is the lifeblood of any top public chain. However, entrusting these critical protocols to inexperienced teams undermines the usability and trustworthiness of these chains.
While anyone can use ChatGPT to replicate AAVE's code, successfully running a lending protocol requires deep risk management knowledge.
A significant oversight in many of these copycat versions is the lack of external risk managers (such as Chaos Labs), which are crucial for AAVE's unparalleled security record.
Simply copying code without implementing the same risk controls will doom these protocols to failure.
It has been observed that several new money market protocols have been attacked during this cycle.
Moreover, when public chain foundations must self-fund protocol development, it indicates a diminished interest from external investors. The lack of financial backers to support new protocols makes it difficult to attract significant LPs early on, which is critical for success.
DEX Dilemma
While decentralized exchanges (DEXs) are not as critical as money markets, their absence or poor quality can hinder the success of public chains. Whether for spot or perpetual contract DEXs, attracting capital is challenging due to the following reasons:
Lack of Skilled Teams: Many of these exchanges are run by inexperienced teams operating replicas.
Slippage and Poor UI/UX: A lack of well-designed interfaces and deep liquidity prevents liquidity providers (LPs) from participating.
The result is a poor trading experience, high slippage, slow TVL growth, and an overall weakening of the ecosystem.
Changing the Incentive Structure
Despite these challenges, economic incentives still favor investment in new L1s and L2s over protocols.
This imbalance can be addressed in three ways:
Protocol valuations must rise: The market needs to reflect the actual value and utility of top protocols.
L1/L2 investments must decrease: If the valuations of chains decline, capital allocation will naturally shift towards protocols.
Protocols become their own chains: This trend has begun with the recent actions of HyperLiquid and Uniswap.
While it is evident that the valuations between protocols and chains need to converge, whether protocols should become chains is less clear.
This trend is emerging partly in response to valuation imbalances. Not only do top protocols attract TVL that exceeds most new chains, but they also earn exponentially increasing fees, yet still do not receive favor from VCs.
Although creating an excellent protocol is complex and rare, establishing a new chain is becoming increasingly simple, relying more on the quality of marketing teams than on the skills of developers.
Additionally, these teams may become distracted by building low-value technologies to boost valuations, neglecting the construction of the protocol layer.
If this trend gains external momentum, it will only exacerbate the lack of protocol quality and perpetuate this cycle.
The key question is whether VCs will recognize and correct this imbalance before it is too late.
The Future of the Industry is at Risk
If these issues are not addressed, the entire cryptocurrency industry faces the risk of stagnation.
Without strong, well-funded protocols, new chains will struggle to provide the seamless user experience required for mainstream adoption.
Institutional players rushing into the space will be forced to retreat or fund their own protocols, leading to a more centralized industry.
Ultimately, VCs need to realign their investment priorities to break the stagnation, or the future of cryptocurrency will be in jeopardy.
— Anthony DeMartino, CEO and Founder of Trident Digital, GP of Istari Ventures.
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