Dialogue with Syncracy Capital Co-founder: The valuation of crypto infrastructure projects will decline over time, but the valuation of application projects will not increase.

In this episode, Chris Burniske and Ryan Watkins discuss the evolving relationship between applications and infrastructure in the cryptocurrency space.

Compiled & Edited by: Deep Tide TechFlow

Guests: Ryan Watkins, Co-founder of Syncracy Capital; Chris Burniske, Partner at Placeholder VC

Host: Michael Ippolito

Podcast Source: Expansion

Original Title: L1 Valuations and the Rise of Apps | Chris Burniske & Ryan Watkins

Release Date: November 6, 2024

Background Information

In this episode, Chris Burniske and Ryan Watkins explore the changing relationship between applications and infrastructure in the cryptocurrency space. They analyze the current premium situation of infrastructure, examine how ETFs are changing market dynamics, and discuss the new opportunities brought by the fusion of decentralized finance (DeFi) and artificial intelligence (AI). Thank you for listening!

Syncracy Capital is an investment firm focused on cryptocurrency and blockchain technology. The firm typically implements its investment strategy by investing in blockchain projects, cryptocurrency assets, and related technology companies. Syncracy Capital aims to leverage its deep understanding of blockchain technology and market insights to provide high-return investment opportunities for investors.

Placeholder VC is a venture capital firm that focuses on investing in startups in the blockchain and cryptocurrency space. Founded by Chris Burniske and Joel Monegro, the firm aims to support and promote the development of decentralized technologies. Placeholder VC helps early-stage projects and companies grow by providing funding, resources, and expertise. The firm typically invests in blockchain projects and cryptocurrency-related businesses with innovative potential and long-term growth prospects.

Comparison of Applications and Blockchain

Ryan mentioned that after the market enters a bear phase, there is a viewpoint that all assets other than Bitcoin are worthless. This situation is familiar to long-term practitioners, as people often lose confidence when prices drop.
However, Ryan emphasized that internal data shows many applications are actually achieving historical revenue highs, with annual revenues reaching fifty million, one hundred million, or even three hundred million dollars, and growing rapidly. The revenues of these applications sometimes even exceed those of many infrastructure projects, despite the latter having much higher valuations.
Ryan further analyzed applications on Ethereum and Solana, finding that their combined revenues may be comparable to Ethereum's revenue. This trend indicates that applications are starting to capture an increasingly larger share of the overall fee pool in blockchain, and their revenues are gradually surpassing those of infrastructure.
Chris added to this by discussing the valuation differences between infrastructure and applications. He pointed out that infrastructure valuations are typically several orders of magnitude higher than those of applications, partly due to the market's perception of "currency" affecting infrastructure valuations. He believes that currently in the crypto space, only Bitcoin, Ethereum, and Solana are seen as credible currencies, and the valuations of these currencies are not based on cash flow but rather on the market's perception of them as currencies.
Chris further explained that in the future, some cryptocurrencies may continue to maintain high valuations, while most infrastructure projects may become commoditized, with valuations falling closer to their actual utility levels.

Capital Inflows and Infrastructure Valuations

Michael expressed a viewpoint similar to Chris's, stating that the main capital driver in cryptocurrency is currency devaluation. He noted that people flee devalued fiat currencies in search of more robust commodity currencies.
Michael also mentioned that while it is difficult to perform discounted cash flow (DCF) analysis on the U.S., other proxy indicators can be sought to understand global investor demand. He compared Ethereum and Solana to U.S. Treasury bonds, arguing that they have high liquidity as currency assets, although future revenue growth may slow.
Ryan then discussed the historical context of Ethereum, noting that Ethereum was initially viewed as a programmable commodity currency rather than an asset like stocks. With the launch of Ethereum, many competitors emerged, and the market began to compare them to Ethereum, leading to inflated valuations for these infrastructures. Ryan believes that investors may not realize the driving factors behind these valuations, resulting in misunderstandings about infrastructure.
Ryan emphasized that infrastructure valuations should not simply be compared to Bitcoin and Ethereum, as many infrastructure projects are actually more like businesses rather than currencies. He pointed out that projects like bridging and middleware do not possess currency attributes and therefore should not be valued by the same standards. Chris agreed with this viewpoint and predicted that infrastructure valuations may collapse in the future, especially for those non-currency infrastructures.

Future Asset Classes and Value

Chris further explored the concept of Ethereum and Solana as new types of government bonds, suggesting that they possess characteristics of both currency and cash flow assets to some extent. He mentioned that Bitcoin, as a commodity currency, has characteristics similar to gold and emphasized the importance of understanding the fundamental workings of Bitcoin.
Ryan concluded by stating that the complexity of valuing these assets lies in their diversity, akin to blind men touching an elephant, where different perspectives may lead to different understandings. He pointed out that due to the lack of clear comparison standards, smart individuals may arrive at different conclusions regarding the valuation of these assets, reflecting the market's varying views and understandings of them.

Challenges in Infrastructure and Application Development

Michael mentioned that one of the challenges in the cryptocurrency space is recognizing the uniqueness of these new entities. He noted that Bitcoin, as a completely new asset, has return characteristics similar to other assets but is fundamentally different. Many entering the crypto space attempt to impose their existing worldviews onto it, leading to different understandings of "currency" and "applications." He mentioned that Bitcoin supporters often view applications as useless, while traditional venture capitalists tend to adopt cash flow discount models, overlooking the uniqueness of currency.
Next, Michael raised questions about the different strategies of L1 (Layer 1) protocols in infrastructure development, particularly comparing Ethereum and Solana. He pointed out that Ethereum has adopted a more minimalist design philosophy, allowing the market to develop freely, resulting in a rich ecosystem of infrastructure. In contrast, Solana is a more integrated protocol that provides many built-in features, reducing reliance on external providers.

Impact of Application Developers

Chris responded by emphasizing the impact of infrastructure design on application developers. He mentioned that Placeholder focused on Ethereum investments in 2018 and 2019, but shifted to Solana during the bear market of 2022 and 2023. He noted that Solana's design allows application developers to build efficient applications more quickly, citing the successful NFT marketplace Tensor as an example, highlighting that Solana developers were still able to succeed during difficult times.
Ryan also added that Solana's integrated design allows developers to spend less time on infrastructure issues, enabling them to focus more on user experience and retention strategies. He mentioned that Solana's application development teams typically spend only 20% to 30% of their time on infrastructure, while Ethereum teams may need to spend 50%, and Cosmos teams may need to spend 80%.

Fragmentation Issues in the Ecosystem

Ryan further pointed out that as independent teams build extensively on infrastructure, the issue of ecosystem fragmentation arises. He noted that the lack of unified standards between different ecosystems leads to challenges in asset transfer and interoperability. This competition and differing viewpoints make it difficult to establish consensus.
Chris added that these changes often take a long time to manifest their effects, and market participants should not rush to declare victory. He mentioned the historical competition and mutual accusations between Bitcoin and Ethereum, as well as the changes in performance across different market cycles, which complicate the understanding of the market.

Relative Performance of Ethereum and Solana

Chris discussed the challenges of Ethereum's relative performance, noting that although he personally still holds and stakes Ethereum, he believes Solana has performed better during this period. He mentioned that market complacency and the accumulation of wealth may lead to laziness, ultimately requiring some setbacks to regain momentum. Chris believes Bitcoin has gone through similar cycles and is currently in a revival phase. He speculated that Ethereum may also experience a similar transformation by the end of this decade, facing different directional choices, including those of Celestia, Bitcoin, and Solana.

Comparison of Design Philosophies

Michael then inquired about Ethereum's design philosophy, suggesting that it adopts a very minimalist design, allowing the free market to solve many problems. For example, the sharding issue that Ethereum initially sought to address ultimately led the market to develop a roadmap based on aggregation. He pointed out that Solana, on the other hand, has taken a different approach, attempting to incorporate complexity into its infrastructure design so that application and product developers can build more smoothly.

Unique Direction of Celestia

When discussing Celestia, Ryan drew an analogy, suggesting that Celestia's construction direction is akin to a Bitcoin with ZK opcodes, aimed at providing low-cost user verification. He emphasized that Celestia offers greater flexibility than Bitcoin, allowing developers to build more complex applications. He explained that Celestia's design enables developers to have greater control within an optimized blockchain ecosystem, thereby creating the best user experience.
Ryan further illustrated this by mentioning projects like Uniswap, which can enhance user experience by controlling multiple layers (such as wallets, front ends, protocols, etc.). This flexibility is a core advantage provided by Celestia, allowing applications to better adapt to user needs. He pointed out that Celestia's design philosophy treats applications as chains rather than traditional smart contracts, thus offering more possibilities in application development.
Finally, Michael mentioned the short-term challenges Celestia faces, including its recent unlocking events and price volatility, reflecting the market's sensitivity to investor sentiment. His comments highlighted how investors seek opportunities and risks within the rapidly changing crypto market.

The Endgame of Value Accumulation

Chris began discussing the current market's focus on crypto assets, particularly concerns regarding large-scale unlocking events. He mentioned that once the market's worries about these unlockings dissipate, there could be unexpected positive reactions. Michael summarized their discussion, mentioning the relationship between infrastructure and applications, and how value might accumulate at different levels in the future.

Overview of the Fat Protocol Theory

Michael referenced a famous article, the "Fat Protocol Theory," and invited Chris to summarize its core points. Chris pointed out that the basic idea of the fat protocol theory is that the protocol layer of the internet (such as TCP/IP, HTTP, SSL, etc.) has little economic value, while the real value comes from the applications built on top of these protocols (like Facebook and Google). In the context of blockchain, the situation is different, as the protocol layer (like Bitcoin and Ethereum) possesses significant economic value, while the value of the application layer is relatively low.
Chris further explained that Joel's theory emphasizes that in the early days of blockchain, the value of the protocol layer was much higher than that of the application layer. However, over time, this situation may change, especially as new applications continue to emerge.

Value and Challenges of the Application Layer

Chris also mentioned that although the value of the protocol layer is significant, the application layer has its own value. The application layer faces some challenges in value accumulation because the characteristics of blockchain allow user data to be shared across multiple applications, contrasting with the monopolistic lock-in mechanisms of Web 2.0. For example, users can use the same data across different applications, intensifying competition among applications.
He cited Coinbase as an example, noting that the company bears many regulatory costs and compliance requirements, thereby establishing its own moat in the market. Chris emphasized that the success of investments depends not only on market opportunities but also on the timing of entry and the scale of investment.

Capital Flows Between Infrastructure and Applications

Michael agreed with Chris's viewpoint, mentioning that there may currently be too much capital flowing into infrastructure, while applications could be the next significant opportunity area. He believes that as the market evolves, investors and developers need to reassess the value relationship between infrastructure and applications to find new growth points.
Michael noted that many fund managers are confident about the market's transition but feel uncertain about the specific timing. He asked Chris and Ryan if they also sensed a cautious attitude among funds when considering this value shift.
Ryan stated that from his perspective, any relative value trade typically has two factors: either overvalued assets decline or undervalued assets rise. He believes that the valuation gap for infrastructure will narrow over time, but he leans towards the idea that the multiples for infrastructure will decrease rather than those for applications increasing.

Valuation of Applications and Infrastructure

Ryan continued to analyze the current market valuations of applications, pointing out that while some applications are generating substantial revenue, their multiples are not cheap. He compared the valuations of software companies, finding that many high-growth, high-profit companies trade at multiples between 10 and 20, while some DeFi protocols have average multiples as high as 44, which is not cheap in absolute terms. He questioned why investors would be willing to purchase these applications at such high valuations, especially when many applications have yet to prove their stability in the crypto economy.

Market Sentiment and Investor Behavior

Chris agreed with Ryan's viewpoint, believing that market changes may occur more slowly than many expect. He added that infrastructure valuations will ultimately fall below those of applications, while application valuations may align with those of tech stocks. He believes that although meme coins may lack fundamentals, their popularity could force infrastructure and applications to share profits, thereby driving the overall market's maturation.

Market Maturity and Changes in Investor Behavior

Ryan emphasized that as asset classes mature, investor expectations will also become more realistic. He pointed out that while there may have been rapid high returns in the past, the current market environment requires investors to view returns more rationally. He mentioned that although applications have the potential to generate good returns, current investors are more inclined to chase assets that are difficult to evaluate.
Chris added that changes among market participants will also drive this shift. With the introduction of Bitcoin and Ethereum ETFs, Wall Street's research and valuation methods will increasingly penetrate the crypto space. He believes that as market infrastructure continues to overlap, professional investors will begin to focus on applications with stable income bases rather than speculative meme coins.

Impact of ETFs on the Market

Michael raised two questions about ETFs: first, the differences in capital flows between Bitcoin ETFs and Ethereum ETFs, and second, whether ETFs will increase or decrease market volatility. Chris responded that as the asset base increases, volatility typically decreases. He believes that while there may be periods of heightened volatility, overall volatility will decline in the long run.

Capital Flows of Bitcoin and Ethereum

Chris further analyzed the market performance of Bitcoin and Ethereum ETFs. He noted that Bitcoin ETFs have received more support and recognition in traditional finance, while Ethereum lacks similar backing. He mentioned that the narrative around Ethereum in the market is not unified, leading to its relatively weak appeal. Ryan agreed with this viewpoint, stating that the timing of Ethereum's launch and the lack of a clear narrative have caused it to lag behind Bitcoin in terms of capital inflows.
Ryan also mentioned that the valuation approach to Ethereum in the last cycle may have led to erroneous expectations. He believes that valuing Ethereum as an asset similar to stocks is inappropriate, as changes in business models and declining transaction fees have affected Ethereum's attractiveness.

The Duality of Fees

Michael expressed understanding regarding the discussion of fees, believing that to some extent, low transaction fees and high total fees are complementary. He pointed out that while some believe that the level of fees can directly reflect the health of the market, in reality, transaction fees are not the only metric; overall economic activity and value creation are key.

Long-Term Market Outlook

Chris finally emphasized that despite the varying performances of different assets in the market, he remains optimistic about Ethereum. He suggested that if one does not invest in cryptocurrencies, they should consider diversifying funds across major assets like Bitcoin, Ethereum, and Solana. He believes that over time, these assets will become long-term winners.

Views on DeFi 1.0 and AI

Michael began discussing DeFi 1.0 and the AI field, asking Chris and Ryan for their thoughts on these two areas. He mentioned that some projects in DeFi 1.0 (like Maker and Aave) have performed well within the Ethereum ecosystem, and the market supply situation for these projects has improved, making their market cap to fully diluted market cap (FDV) ratio more robust.

Potential of DeFi 1.0

Ryan expressed a positive view on DeFi 1.0, believing that although the overall application market is overvalued, projects like Maker and Aave still show attractiveness at reasonable multiples. He pointed out that these projects not only grow rapidly but also have significant upgrades on the horizon, and they have established valuable businesses on the blockchain that can generate substantial fees.
Ryan also mentioned that the market's focus on supply dynamics is reasonable, as many token economic structures were poorly designed in the past, even disadvantaging retail investors. However, some assets have fully addressed their supply release issues, making them more attractive in the market. For example, Maker conducted a large number of token buybacks last year, which effectively supported its own token.

The Rise of AI

When discussing AI, Michael expressed a strong interest in the field, believing that AI could become an important narrative theme. Ryan also stated that AI is becoming a genuine field of knowledge, attracting increasing attention and usage. He believes that the applications of AI will continue to expand and may intersect with other technologies (like blockchain), creating new business models and opportunities.

Experiments with Small L1 and L2

Chris proposed an interesting point, suggesting that small L1 and L2 may "nationalize" their financial infrastructure. He mentioned that projects like Ronin might adopt open-source components to create their own decentralized exchanges (DEX) and lending platforms, thereby returning liquidity and profitability to their own tokens. This model could enable small ecosystems to better support their core teams and drive the value growth of their tokens.

The Intersection of Cryptocurrency and AI

When discussing the intersection of cryptocurrency and AI, Michael expressed his strong interest in the AI field, believing it could represent a "0 to 1" innovation opportunity. He mentioned that although the market is filled with investment enthusiasm for AI, there is no clear investment approach in traditional markets. He feels that the potential in this area is exciting, similar to the scenario during DeFi summer, where unprecedented innovations may emerge.

Analogy of DeFi Summer

Chris agreed with this view, considering DeFi summer a good analogy. He pointed out that while this field has experienced much volatility and misunderstanding, there are also some important truths. For example, blockchain, as an open data structure, can provide rich data sources for AI, making the combination of the two very natural. He mentioned that blockchain is permissionless, allowing various machines and systems to use it, which provides a solid foundation for the development of AI.

Early Experiments and Development

Ryan also shared his perspective, believing that we are currently in the early experimental stage of the intersection between AI and blockchain. He reflected on the early stages of DeFi, noting that the protocols at that time were relatively cumbersome, but there were still reasons to feel excited. He mentioned that projects like BidTensor are rethinking the distribution of block rewards, particularly how to leverage AI-related resources to incentivize and support the construction of GPU infrastructure.

Rise of AI Agents

Ryan further noted that the rise of AI agents is a trend worth paying attention to. He mentioned that some autonomous AI agents have recently emerged, capable of interacting with blockchains through simple natural language commands. This new mode of interaction may attract more people to participate in on-chain development, lowering the technical barrier.

Cultural and Emotional Impact

Chris also emphasized the changing way we interact with AI, suggesting that we are no longer simply commanding machines but are trying to understand and gain the attention of machines. This new mode of interaction may have profound effects on our emotions and change our relationship with technology.

Future Outlook

Ryan added that in the future, we may see some autonomous AI agents that can control their own funds and pay humans for services rendered. This idea raises thoughts about future work and income models, potentially altering our relationship with technology.
Ryan continued to explore the current rise of AI agents, pointing out that although this is still in its early stages, an increasing number of enthusiastic participants are driving the development of this field. He mentioned that he has recently been surprised by the potential of AI agents, especially as the autonomy of on-chain agents has begun to show different levels in recent weeks.

Potential of AI Agents

Ryan illustrated this by noting that Coinbase recently released a new agent development framework that easily connects ChatGPT to its platform. Users can simply input commands in natural language to have the agent perform tasks, such as creating tokens. This simplified process allows more people to participate in on-chain development without needing to delve deeply into programming languages.
He further elaborated on the potential applications of this technology, such as crowdfunding capital to support automated trading bots on-chain. This model could allow different investors to co-fund a project, enabling it to run automatically on-chain. This idea excites him, and he believes it will bring new possibilities to DeFi protocols.

Outlook for the Future

Ryan also mentioned that many friends are experiencing a renewed sense of excitement reminiscent of DeFi summer. He believes that the current market is undergoing a maturation of asset classes and a rationalization of valuations, making this field more attractive. He looks forward to the possibility of new innovations and projects emerging in the coming weeks, similar to the rapid developments during DeFi summer.

Dual Perspectives on AI

Michael added that another interesting aspect of the AI field is the clear divide in opinions within the industry. Some believe AI is full of potential, while others view it as an illusory bubble or scam. This divide often signals opportunities worth paying attention to.
He also mentioned that the rise of AI creators may exceed expectations, becoming pioneers in technological applications. This emerging ecosystem of AI creators could bring many new business models and application scenarios.

New Modes of Interaction

Chris further explored the changing ways we interact with AI, emphasizing that we are no longer simply commanding machines but are establishing a new relationship with them. The emergence of AI agents prompts us to begin viewing them as equals, and this shift may have profound emotional and social implications.

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