Which Web 3 Protocols Are Most Likely to Succeed? A VC Suggests a Common Thread

The protocols most likely to become valuable are popular but also have features that cannot be replicated.

AccessTimeIconFeb 11, 2022 at 11:27 p.m. UTC
Updated May 11, 2023 at 6:07 p.m. UTC
AccessTimeIconFeb 11, 2022 at 11:27 p.m. UTCUpdated May 11, 2023 at 6:07 p.m. UTCLayer 2
AccessTimeIconFeb 11, 2022 at 11:27 p.m. UTCUpdated May 11, 2023 at 6:07 p.m. UTCLayer 2

The current Web 3 stack is an evolving canvas of composable protocols, each totally open source and susceptible to competitive projects forking their code. The ease of building a look-a-like project in the Web 3 space (a version of the internet that incorporates concepts including decentralization and token-based economics) can make it hard to decipher which protocols will become more valuable in the long term.

Yet, it is not strictly a protocol’s popularity that increases its long-term value but a combination of its popularity and defensibility. While popularity is easy to measure, defensibility is more complicated, presenting itself in various forms. After evaluating dozens of protocols, I believe the most desirable form of defensibility is usefulness that cannot be easily forked by a competitive project.

Parker McKee is a principal at Pillar VC, where he focuses on crypto and Web 3 investments.

I call this quality a project's “unforkable utility.” Unforkable utility reflects the hard-to-replicate value to a protocol user.

To recognize unforkable utility more easily, I identified its six most common forms and paired them with examples for context. Interestingly, all six types fall under the broader umbrella of network effects. I am still developing this framework. Here is my thinking in hopes others can critique or build upon the ideas.

The 6 types of unforkable utility:

  1. Protocol collateral/liquidity (capital)
  2. Protocol liquidity (content)
  3. Critical mass of network participants (app layer)
  4. Scaled value + critical mass of network participants (security)
  5. Asset acceptance
  6. Asset liquidity

Collateral/liquidity Capital

The first type of unforkable utility is collateral and liquidity in the form of capital. By capital, I mean assets on-chain that help make a market operate efficiently. For example, the lend/borrow protocol Aave’s front end and smart contract functionality can be forked easily, while the project's collateral and liquidity are much harder to replicate.

The borrowers’ collateral on the protocol forms one side of the marketplace. The liquidity from the supply side forms the other side of the market. Both collateral capital and liquidity capital are unforkable, and paired together they create unforkable utility to the user.

At the time of writing, Aave, the best-known lend-borrow protocol, had the most collateral/liquidity of all lending protocols, with $11 billion in total value locked (TVL). As a result, a user that takes out a loan will in theory be using the best, most efficient market for executing large transactions. The efficiency of scaled collateral/liquidity serves as the protocol's unforkable utility.

Content liquidity

Similar to capital liquidity, a protocol can also see liquidity in the form of content. Similar to Aave, LBRY (Web 3 Youtube) is a two-sided marketplace, but instead of borrowers and lenders, LBRY connects content creators and viewers.

Unlike Aave, though, LBRY’s unforkable state is only found on one side of the marketplace with the content creators and their content. A mirror copy of the LBRY protocol and GUI could be created but the new project would need to convince the content creators to publish their content on the new protocol.

History shows that viewers favor platforms with the most content and as a result, the deep library of content acts as the unforkable utility. There is also a positive loop at play with more content leading to more creators, who produce even more content. Other examples of Web 3 content liquidity are Mirror and Audius.

Critical mass of network participants (app layer)

A famous computer engineer named Bob Metcalfe once surmised that the value of a networked device is proportional to the square of the number of its users. Hence, the more participants on a common network, the more valuable network access is to each user.

The best example of this in Web 3 is a hypothetical decentralized messaging protocol (someone please build this!!). As the number of participants on this protocol grows, so does the utility to each user. After a given network reaches a critical mass, even if an incrementally better protocol is created, the delta in utility between the network with all the participants and the protocol with no participants is so great it’s unlikely a migration will occur.

In the case of the messaging protocol, the unforkable utility is in the collective group of network participants. Another example of this would be a decentralized payments network.

Critical mass of network participants (consensus/security layer)

Another type of unforkable utility is the network security spurred by scaled network value and a critical mass of network consensus participants. Whether it is a proof-of-work (POW) layer 1 (base) chain like Bitcoin or a proof-of-stake chain (POS) like Algorand, the network becomes more secure as value increases due to the growing cost of executing a 51% attack. Moreover, the more consensus participating users there are on the network, the more complicated it becomes for any single user or group of users to execute such an attack.

As Kyle Samani, highlighted in his piece on L1 value capture, “The more secure [a layer 1] is, the easier it becomes for the next marginal user to justify storing their wealth in that chain.” The logical inference from this positive loop (more value leads to more users leading to more value) suggests there should only be a few layer 1 chains that are highly valuable and exceptionally secure.

Asset acceptance

Similar to the definition of “currency,” an asset can have unforkable utility if it’s “generally accepted at its face value as a method of payment.” In the crypto space there are numerous assets like USDC, USDT, etc. that meet this definition. Their project teams and communities have scaled their distribution and acceptance to the point where most people will accept the asset without questioning its value.

For example, if someone is given Solana USDC, it is more useful to the user if they can find an exchange that will take the asset or a merchant who will accept it. This challenge is even more acute for new project tokens. In the case of an asset, unforkable utility can be found in its acceptance by other parties, ecosystems and applications.

Asset liquidity

The more ecosystems and applications in which an asset is liquid, the more useful that asset becomes. Using the Wormhole Solana-Ethereum bridge as the example, when a user brings an Ethereum ERC-20 token to Solana using Wormhole, they are given Wormhole wrapped ether (wwWETH). This is a Solana native asset that represents ETH on Solana. This new asset, weWETH, is neat but a key factor in its utility is whether or not there is liquidity for it.

If there is little liquidity for the asset, a user is limited in how they can use it. When launching a new asset like weWETH, creating liquidity is critical in the early days, even if that involves partnerships and reward incentives. For an asset, unforkable utility is in its depth of liquidity and the number of locations where that deep liquidity can be found.

I hope the examples above prove that entirely open Web 3 protocols can achieve significant long-term value despite frequent forking attempts. Unforkable utility is hard to achieve, but has an enormous potential upside.

Still, soft forms of defensibility like community and brand that frequently have proven successful in generating value are also important to highlight. There are numerous Web 2 and Web 3 examples of this phenomenon. I believe that over the coming years we will see the very best projects use these soft forms of defensibility paired with the more mechanistic forms of defensibility above to create extremely valuable protocols.

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Parker McKee

Parker McKee is a principal at Pillar VC, where he focuses on crypto and Web3 investments. McKee has recently worked on investments in Algofi, Friktion, CipherMode, and Tinyman.