How to Analyse a Web3 Protocol
Understanding the Web3 Value Stack 🧱
A blockchain network is only the base layer in the crypto value stack. These blockchain networks are referred to as Layer 1 blockchains. They are known as Layer 1 (or L1) because they allow other types of crypto protocols to be built on top of them. Some of the most common L1’s today include Ethereum, Solana, Avalanche, etc. There are two different types of L1s:
- Asset Ledger — The blockchain network’s ledger’s function is to track who owns how much of the native blockchain coin and what they are using it for, e.g., Ethereum, Solana, Avalanche.
- Storage Ledger — The blockchain network’s ledger’s function is to track who is storing data on the blockchain and how much they are storing, e.g., Filecoin, Arweave, Sia.
So L1’s like Ethereum have a ledger of transactions that essentially tell us who owns how much ETH.
But what is ETH used for? To access computing power.
Through something known as a smart contract (this property is available on other Layer 1 blockchains as well in slightly varied forms). A smart contract is basically code or a program that can be written to the blockchain and executed. Once written to the blockchain it will live on the blockchain forever or until the underlying blockchain itself somehow shuts down. This allows developers to create decentralized applications (dApps) that run on the blockchain instead of a traditional centralized server. The dApps can be created such that they have their own unique standardized token (currency) to operate their protocol. dApps can then be used to create more dApps on top of them if they have useful properties. This concept is known as composability and introduces us to the power of open-source software that can, in parallel, accrue value as well via crypto tokens. The primary applications have been seen in a new form of finance called decentralized finance or ‘DeFi’.
The below image demonstrates the Web3 Value Stack with its different layers:
Analysis of a Crypto Protocol 💡
A crypto protocol is a network just like Facebook. Hence it experiences network effects which grow the value of the protocol exponentially as users grow and hence the token itself grows in value. Therefore, we need to analyse different types of metrics and intangibles to ensure that network effects flywheel is in full flow.
Firstly, we need to understand where the protocol is in the value stack. It is likely that the protocol will be an iteration of one of the concepts covered above. Is it a dApp? Is it an infrastructure product or a Web3 social media play? What blockchain is it built on? These are all key concepts to assess right off the bat. Below is a non-exhaustive list of the different types of protocols:
- Layer 1 / Layer 2 Protocols
- Media / Social Media
This information will be available in the whitepaper of the project which can be found on its website.