Fear of crypto copycats
Copying is rampant in crypto projects1.
Every week, I get a message from someone building “Decentraland for AR” or “Decentraland for China” or, my favorite, “Decentraland with a different name.”
Consider crypto games. An entire category of game is the Cryptocelebrities smart contract with a renamed variable2.
One of the most blatant examples of copying comes from a project called TRON. The body of its white paper was copied from IPFS and Filecoin.
Juan Benet, founder of Filecoin, posted this damning analysis, leading to widespread ridicule from the community.
The result? TRON is a top ten coin.
In this upside-down world, we have project leads asking other projects to take their code. Recently, Vitalik commented on a proposal for the EOS consensus model, worried that their proposal was unsafe.
“This does not seem to actually be safe.”
He goes on to outline a case where two conflicting blocks get finalized, and ends with the following suggestion:
“If you want an intuitive and good way of doing this, I recommend just using the algorithm in our Casper FFG paper: https://arxiv.org/abs/1710.09437”
Vitalik asks Larimer to “copy” the algorithm developed by the Ethereum foundation.
In an environment where projects are open source, copying is, like blockchains, unstoppable. Some think this means crypto projects have no defenses against competitors, and that the projects that win will have the best go-to-market strategies3.
What would Warren Buffet say?
“In business, I look for economic castles protected by unbreakable ‘moats’” - Warren Buffett4
Projects should build moats: sustainable competitive advantages that defend against competitors.
Sources of economic moats and do crypto projects have any?
There are five sources of economic moats5:
Cost advantage (e.g. economies of scale): when a company uses its scale or unique assets to undercut competitors on cost.
Intangible assets (e.g. patents, brands, trade secrets): when a company holds intangible assets like patents or brands that lead to monopolies or pricing power in the market.
Efficient scale: when the market of limited size is best served by one or a small handful of companies (e.g. utilities, airports) and a competitor is discouraged from entering because the returns in the market would fall below the cost of capital.
Switching costs: when a customer would have to incur an expense or inconvenience in order to switch from one supplier to another.
Network effects: when the value of the network increases for both new and existing users as more people join.
Do crypto projects have any of these?
Defending with cost advantage
Let’s say we’re the largest smart contract protocol, Ethereum. In a business with cost advantage, we would use our superior scale to undercut competitors. Can we do that?
Absolutely not. We will toil and toil to come up with innovations like Casper FFG only to have our fearless leader offer it to EOS.
In open source, being biggest tends to mean you can’t wait around for someone else to develop a solution for you. For the copycat, the cost effective solution is to wait, spend no resources on R&D, and take what you need from the innovators.
Defending with intangible assets
There are good examples of projects defending with intangible assets. Let’s go through each of patents, brands, and trade secrets.
Patents: Hashgraph is a new smart contract protocol that has its underlying technology patented. We’ll see how defensible the patent is and how the community will react to a patented public blockchain.
Brand: Brand matters but it’s hard to tell how much. It seems like Bitcoin benefits from being the first coin people think of. Ethereum benefits similarly. 0x and Aragon have halo effects. One might expect brand to play a meaningful role in attracting and retaining members of the network, but it’s too early to tell.
Trade secrets: Starkware is a new project focused on STARK technology (a privacy and scalability technology that few have expertise in). They plan to offer their expertise to projects in exchange for tokens. For this model to work, their expertise must be virtually impossible to replicate. This strategy is even more interesting than Hashgraph’s.
We’re seeing attempts to defend with intangible assets, but we’ll have to wait to see if these defenses are effective.
Defending with efficient scale
Efficient scale means that a given market is unprofitable for new companies to enter. A new company would drive down profits and make it unprofitable for everybody.
Does this mean that crypto projects should pick niche markets? Instead of building a smart contract protocol, should we build a prediction market for cats?
This may deter competitors for a period of time where our idea looks dumb or trivial to would-be competitors, but because of the near-zero cost of copying, efficient scale doesn’t matter much for crypto projects. If there’s any proof that the market has value, copycats can enter for virtually no cost.
Defending with switching costs
Take Ethereum. The more projects being built on the platform, the more developers. The more developers, the more tooling and shared knowledge. The more tooling and shared knowledge, the more attractive the platform for other developers. Try asking a developer to switch after they’ve joined the community, learned the language, and adopted the tooling. It’s going to be hard unless they hate the experience and the new platform is twice as good.
Defending with network effects
Bitcoin enjoys the many benefits of being the largest cryptocurrency by market cap.
Because it’s the largest and most secure, Bitcoin is the most likely to be:
The first cryptocurrency someone buys
Accepted by merchants
Held by institutional investors and governments
Trusted by holders as a store of value
Because of its network effects, it is difficult for another cryptocurrency to overtake Bitcoin’s lead.
As an upstart project, how do you establish network effects? Go-to-market and strength of network effect.
The plan for Telegram’s TON token represents a bet on go-to-market. By taking advantage of their hundreds of millions of users, they can instantly bootstrap the size of their network. If you’re starting from zero, you might partner with someone with distribution or raise sufficient capital to pay for distribution.
Strength of network effect is covered well by Samani in “On the network effects of stores of value”. Some networks have more powerful network effects than others.
Moats (and lack thereof) for crypto projects
The figure above compares importance of moat sources for crypto projects with an average non-project. A point at the origin means that that particular moat source does not apply. A point closer to the origin compared to the “Non-crypto project” means that moat source is less applicable than the average project and vice versa.
For crypto projects, network effects are more important, switching costs are equally important, intangible assets and efficient scale are less important, and cost advantage is not important. Overall, there are fewer ways to build a moat, but it’s not true to say crypto projects cannot have economic moats.
Crypto projects have fewer moats to protect against competitors and copycats. As a result, go-to-market is critical. A competitor with deep pockets is an existential risk. Ecosystem funds like the Stable Fund and massive raises like Telegram’s $1.4B token offering are rational.
Once a project reaches scale, it becomes much harder to simply copy and merge changes into the protocol (while maintaining decentralization)7. As we’ve seen with Bitcoin, Ethereum, Zcash, Monero, and more, protocol governance is slow and messy with the most contentious decisions resulting in hard fork. While a protocol can be bootstrapped by copying features, the ease of deploying copied features is inversely related to its size and decentralization.
Copying reduces overall R&D costs across the industry (and benefits everyone), but disproportionately benefits new projects with deep pockets and distribution. However, copying plus go-to-market is only effective in bootstrapping a protocol. At sufficient scale, copying is no longer as effective. Over a long enough time horizon, the teams with a clearer connection to their constituents and superior execution can win–but having capital and distribution makes it a lot easier.
Are you building a project? I’d love to hear how you’re thinking about defending against competitors.
Basically anything that has a registry of collectible items, each with supply 1, and a Ponzi scheme buy/sell mechanic. ↩
And not, for example, the best tech talent, brand, etc. ↩
This quote is widely attributed to Buffett, and he has made statements along these lines, but I can’t find a source for this particular quote. ↩
While different industries tend to emphasize specific sources of economic moat–network effects are particularly important in social media–there is general consensus on the five sources listed in this investopedia article. Some takes on moats use different names, but these sources appear to be the superset. ↩
The argument goes, if atomic swaps and interoperability make the cost of transferring value across chains zero, and if smart contracts can run across chains, then there’s no user or developer locking to a specific protocol. While the adoption of WASM across chains should make it easier for developers to switch from one protocol to the other, I expect the switching costs to remain sufficiently high for the foreseeable future. ↩
Vlad Zamfir’s comments on this about halfway through his recent Ethereal panel on governance moderated by Laura Shin. He basically says that when a project is not live, devs have the power, but after a protocol is live and with a community, the devs are terrified and have way less agency than you might think. Listen here. ↩