Crypto and the Consumer: The Road Ahead
From Bitcoin to NFTs and social tokens, here’s how crypto is changing the future of consumer behavior.
September 24, 2021
Our role at M13 is to understand the future of consumer behavior and support the entrepreneurs who are powering those changes. We focus both on direct applications and the infrastructure layers that power them. Along the way, there are emerging technologies that represent a paradigm shift around how businesses operate and how consumers live. Think technologies like the internet, mobile, and cloud, which have given rise to the likes of Airbnb, Amazon, Apple, Facebook, Google, and Uber.
We believe crypto is poised to follow suit. By now, crypto—let’s use this as a catchall for blockchains, cryptocurrencies/tokens/commodities, decentralized applications (“Dapps”), and wallets and other on-ramps/off-ramps—is a regular part of our Twitter feeds and dinner table conversations. Since Satoshi’s bitcoin white paper in 2008, the space has grown to a $1.82.1 trillion* market cap industry.
The bear market of 2018 and 2019—when BTC and ETH dropped 85% and 95%, respectively—tested even the strongest supporters. During this time, we made our first investment into the market with Lightning Labs, which provides the rails to applications leveraging bitcoin for a variety of digitally native use cases. Beyond Lightning, we have made four additional crypto investments: two in the bitcoin space (Fold, River), one in the Flow ecosystem (The NFT Company) and a soon-to-be disclosed company building atop Ethereum.
All the while, the adoption in the NFT and DeFi markets and the increasing prevalence of bitcoin on the global macro backdrop has dramatically reduced the existential risk around crypto. We believe there is no going back. As investors, now the focus is about timing, market adoption, and risk/reward. We expect continued volatility, which is inherent to nascent token-driven economies that are transparent and global in nature.
We have spent a considerable amount of time over the last 18 months in the NFT and creator economy markets. OpenSea alone recorded $3.4 billion in transaction volume on Ethereum in August—this has represented a watershed moment for crypto as it proved the breakthrough potential, business model innovation, and real demand side adoption. More than 4.1 million Americans have bought an NFT!
It also demonstrated some of the issues including unsustainable gas fees and onboarding challenges, but the market has continued to be resilient.
Our focus will be comparing Web 2.0 versus Web3 and the impacts on both the supply (creators) and demand sides (consumers). The investment thesis that we outline is predicated on two trends within Web3:
New ownership models
The rise of microbehaviors
How we got here
How we got here
It’s worth first reviewing the foundations that Web 1.0 and 2.0 laid in order to understand where we are today. Web 1.0, loosely defined as the period from the 1970s to the dot-com bust, enabled the creation of the modern internet’s infrastructure and early applications—some that are still integral (Microsoft) and many that have faded (Netscape).
Following the dot-com era emerged Web 2.0, which was characterized by the large, centralized organizations that harnessed technologies like cloud and mobile to build applications that are integral to our daily lives. In the words of Ben Thompson, the shift to Web 2.0 prioritized “the economics of zero friction” with aggregators like Google and Facebook controlling consumer demand, consolidating their respective categories, and creating the consumer applications that we all use in our regular lives.
The tradeoff that consumers have made, whether implicitly or explicitly, is extreme convenience in exchange for sharing their personal data within these ecosystems. And developers have paid in the form of platform take rates (e.g., the Apple Store and Google Play Store’s 30% cuts) in order to distribute within these ecosystems.
Web3 represents a return to open protocols and a course correction from the centralization seen since the dot-com bust. Innovations in security, artificial intelligence, and more all have implications here, but for our sake we will use the term “Web3” to refer to projects with a crypto focus.
Below is a simplified evolution of the three phases of the web:
Nurture curiosity beyond ourselves to learn about ourselves
We host intimate gatherings around the country, and they are effective and fun ways to convene founders and investors with shared goals. As an established firm with a long and well-known presence in LA, we are active across the best of what the city offers and collaborate with local partners to host an annual program called M13 field trips.
This year, field trips for investors included volunteering at a maximum security prison, sailing to tour the largest port of the western hemisphere and meet blue economy entrepreneurs, and a guided hike with wildlife advocate Beth Pratt to learn why LA is the home of what will be the world’s largest wildlife crossing.
Connection happens when you experience things together. Riding on a coach bus with other investors, sharing peanut butter sandwiches in a prison rec room, and standing together on the edge of a protective migration path for at-risk wildlife set a tone of humility, awe, and connection that no algorithm can engineer.
“The emotional intelligence in the men we spoke to during our day together floored me. May the world be so lucky to know men of this depth. Sometimes the school of life really is the best education.”
Investor about Defy Ventures
Macro impacts will drive the great build back.
2023 will be a year of building back up after the great reset of 2022, which was driven by significant macro factors, black swan events (in crypto), and a bull run that probably lasted a couple years too long.
In 2023, tourist investors will continue to retreat from the late-stage growth markets—this will require us to work a little harder for our companies as they continue to scale. Reaching a unicorn valuation will once again become a significant milestone for early-stage companies, and we’ll see significant M&A activity as corporates become more opportunistic and VCs look to return capital.
Tourist investors will retreat from web3, which will stay flat to down over the course of the year. As contagion risk dissipates and better regulation is put in place, there will be generational opportunities to invest in open-sourced protocols and the applications built on top of them. We’ll start to see real utility crowd out speculation—a necessary prerequisite given the low levels of liquidity in the market.
Start with your why
There is something deeply powerful about in-person gatherings. Connecting with others in real life helps us use our senses to express curiosity, ask better questions and listen, and build empathy and trust essential for lasting relationships. Being open to serendipity and meeting others help break us out of our echo chambers and stay humble in the vastness of the universe.
At M13, to be good citizens and investors is to be active stakeholders in our local and global communities. That work enables us to facilitate intimate and meaningful experiences with our investors, founders, talent, and partners. The resulting dialogue, insights, and personal growth ultimately help us lead and build better. That’s our why. What’s yours?
“I always leave M13 events thinking they are much more hip than typical VC events. Lots of interesting people are always in attendance outside of just founders and VCs. It was a fruitful event.”
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Joel Monegro’s 2016 Fat Protocols is a foundational piece that outlines the opportunity in crypto. Whereas many of the protocols of the current web have largely been commoditized at the expense of value creation at the application layer, Web3 models invert that. That is, a larger portion of the value accrues at the protocol, or network level.
This is crudely analogous to being able to actually invest in the internet—enabled through token economics—which is impossible in the current web architecture. And parties other than institutional private market investors (i.e., developers, miners, consumers) can own a piece of this pie too.
How large will the protocols and application layers become? That remains unknown. In his post, Monegro outlines a shift in value from the application to the protocol layer with the rise of blockchain networks, but we believe both the application and protocol layers will increase in value, increasing the aggregate market values. This is because both layers are now investable, increasing the scope of possibilities—and also because history has taught us each paradigm shift in technology dwarfs the previous in terms of value creation.
Source: Derived from Fat Protocols by Union Square Ventures, Joel Monegro; chart by M13
The overall size of Web 2.0 materially surpassed that of Web 1.0, and we believe Web3 will surpass the size of Web 2.0. We have used the Nasdaq-100 index as a barometer for the current Web 2.0 market cap (this grossly understates the true global size as the index focuses on public, U.S.-based equities). Today, this index is seven times larger than the aggregate market cap of the 280 companies listed in the Bloomberg U.S. Internet Index in 2000, which we can use as a gauge for Web 1.0’s peak market size. We expect a greater pattern to occur with Web3 surpassing Web 2.0 given that these networks are tokenized and measurable.
Where are we in the evolution of crypto?
One can look at global market cap ($1.8 trillion) or invested capital ($20 billion in equity capital invested in H1 2021 alone, three times the previous record set in 2018) as barometers for crypto’s progress, but these are lagging indicators.
Instead, we focus on three macro signals to assess the space’s evolution:
1. Network security
Bitcoin and Ethereum continue to improve in security through their increasing hash rates (the combined mining power of their networks), which is key for maintaining decentralization. While Bitcoin’s hash rate dropped with China’s recent mining crackdown, it has since rebounded to its January 2021 range and become less concentrated (with zero dependency on China), which we view as positive in the long term.
In many ways, Bitcoin and Ethereum are becoming massive brands that attract developers and consumers—in part due to their resiliency, which is driven first and foremost by their security (Bitcoin has survived over a decade of regulatory battles, government shutdowns, forks, etc.!).
Source: NYDIG Research Weekly, July 23, 2021
2. Developer activity
In its 2020 developer activity report, Electric Capital highlights the flight to quality and consolidation among the ~8,000 blockchains. The below chart shows two trends:
An increase in developer activity for Ethereum, Bitcoin (excluding Lightning Network activity), and the other top 200 networks; Ethereum developer activity more than doubled from 2018 to 2020.
A decrease of nearly 60% in developer activity for networks outside the top 200, which suggests a consolidation among Layer 1 blockchains.
Source: Original chart from Electric Capital Developer Report, 2020; redesigned by M13
We believe it will become increasingly difficult for new Layer 1s to break out unless they have a specific focus or differentiated value prop. Two examples are Solana and Flow. With its Proof of History consensus mechanism, Solana is rapidly proving its value prop of speed (can handle 50,000 transactions per second vs. Ethereum’s ~30) and low transaction costs for DeFi and increasingly NFTs. Similarly, we are bullish on Flow—designed by the Dapper Labs team—for its performance around NFTs and games.
The most important indicator of success is consumer adoption, which we view through two lenses:
Valuing crypto as a financial asset
Embracing crypto-native applications
Crypto as a financial asset
Emerging markets are increasingly adopting crypto on the basis of its utility. El Salvador’s decision to accept bitcoin as legal tender is a perfect example, and we expect to see continued adoption in economies with histories of inflation. Adoption is not just limited to emerging markets—an estimated 46 million Americans own bitcoin. As the chart below shows, we are seeing real global adoption across both emerging and developed/tech markets. And while China’s central bank today declared crypto illegal, we believe that we are past the tipping point in adoption.
Source: Chainalysis. Only includes countries listed in the Chainalysis index.
Crypto Native Applications
The rise of DeFi and NFTs suggest that crypto adoption has not just centered around bitcoin’s use case as a store of value. Richard Chen from 1Confirmation estimates there are 3.4 million DeFi addresses and the aggregate DeFi market cap is $116 billion. Given DeFi’s practical applications, this is a particularly strong barometer for adoption.
On the NFT side, as of May 2021 an estimated 4.1 million Americans have bought or sold an NFT. As a comp, it took 12 years for 46 million Americans to own bitcoin, yet NFTs have reached 4.1 million people within six months. And contrary to popular belief, most consumers are not flipping them on secondary markets for a quick buck—in fact, less than 10% of NFTs are sold within a week after their primary sale, and only 22% are sold within a year. This suggests that consumers are primarily purchasing them for other reasons (e.g., long-term financial gain, emotional connection, personal interest).
The NFT space as a whole has continued to increase in recent months, driven by a rebound in digital art sales and the rise of play-to-earn games like Axie Infinity.
Source: Cryptoslam via The Block; chart redesigned by M13
It is also important to point out the rate of acceleration of consumer adoption in crypto. The growth of the NFT space is a perfect example. A few data points to consider:
- NFT marketplace OpenSea recorded $3.4 billion in August transaction volume, and for reference, Etsy generated $3.6 billion in Q4 2020 GMV. This adoption is real!
- The top 10 NFTs (Axie Infinity, CryptoPunks, ArtBlocks, TopShot, Bored Ape Yacht Club, etc.) have generated over $6 billion in aggregate lifetime sales, and it only took 315 days for this group’s total sales to grow from $10 million to $6 billion!
- Bored Ape Yacht Club launched on April 30, 2021 and has generated nearly $480 million in sales. Loot reached $240 million in sales within 19 days!
Data sourced Cryptoslam.io; chart designed by M13
Where is M13 focusing? The rise of Web3
We believe that most traditional business models can innovate in Web3 by incorporating the characteristics of crypto-native applications:
Over the last decade, the focus in crypto has been around building the protocol infrastructure and proving out these characteristics. We believe the next decade will be about scaling with a focus on driving demand and optimizing user experiences. The long-term addressable market is anyone with a smartphone, and the protocols today could not handle that type of demand (expanding to the ~4 billion consumers with smartphones).
From a business model perspective, Web3 shifts platform incentives away from typical advertising and subscription models controlled through walled gardens to a paradigm where value is derived from interactions on the network, which directly benefits both creators and consumers. All the more, they both gain ownership in the network and avoid excessive Web 2.0 take rates.
To be more specific, it is worth highlighting a few social and content categories that can benefit from Web3 models.
We believe that the next generation of giant consumer software companies will come from crypto, and the near-term opportunity will be in social and content categories outlined above driven by a combination of network ownership and reduced take rates. There will also be native 3.0 use cases that we cannot yet foresee, and we are excited to see them take hold.
To be more specific, there are two trends that we are focusing on:
New ownership models
The rise of microbehaviors
New Ownership Models
New ownership models through social tokens
Crypto enables new ownership models that use token economics and align incentives among network participants. Social tokens are a great use case of this in action. We believe they will become an increasingly important component of Web3 models, based on their impact on network value accretion and community access.
Rally and Roll are interoperable social tokens with applications in the creator economy. A fan can earn a creator’s own token for engaging with and supporting him or her across platforms (e.g., receiving tokens for subscribing to the creator’s email newsletter, watching videos on Twitch, or purchasing merch.) This allows creators to monetize their communities similarly to Patreon or OnlyFans, but without the risk of a single platform and moderation.
A creator—let’s call her Jane—can tokenize herself through the creation of social tokens that are tethered to her personal brand. Fans purchase $JANE tokens because they have conviction in Jane’s network. That is, if they believe that Jane will become increasingly successful over time, more people will buy $JANE and increase the value of the coin and community (and vice versa if fans’ perceptions sour).
And there is real adoption: Artists like WhaleShark ($WHALE), RAC ($RAC), and Portugal. The Man ($PTM) have all created tokens, and we are beginning to see communities and businesses, not just individual creators, adopt this model with the rise of tokenized communities built atop their own protocols like Friends With Benefits. We believe tokenized communities, where members have access and proof of ownership, will become increasingly popular.
Understanding the token economics
Understanding the token economics and comparing the “cap tables” of Web 2.0 versus Web3
We can use Rally as an example to outline the flow of value for both consumers and creators and compare the differences in value distribution between Web 2.0 and Web3 social networks. (Note: M13 is not an investor in Rally).
Rally offers “unique currencies built around individual creators and their communities” called Creator Coins in addition to a “single currency across all creators” that “ensure[s] the largest possible liquidity pool for the entire network.” This multi-layer token approach allows creators and consumers to trade a currency that is tailored to a given community while providing ample liquidity via the network-level token.
As creators and consumers adopt Creator Coins, this drives value at the main Rally network level, and we can begin to determine what the aggregate network might look like at scale. Per the Rally token supply schedule, 50% of coins will be allocated to network users (creators, consumers), 20.4% to network maintenance (developers, liquidity providers), 15.3% to seed investors, and 14.3% to the team.
Comparing this token allocation to the cap table of a Web 2.0 social platform like Twitter, we can see the differences in where value accrues at scale. We can look at two hypothetical scenarios:
Rally matches Twitter’s 2013 IPO valuation ($14.16 billion)
Rally doubles Twitter’s IPO valuation ($28.32 billion)
Source: Chart by M13; Twitter data sourced from PitchBook; Rally data from RLY Governance Token Supply
Note: Rally’s market cap today is $171M and $8.8B on a fully diluted basis, assuming all tokens are released. Per the supply schedule, it will take another ~7 years for all 15 billion $RLY tokens to be released.
From an ownership standpoint, there are two parties that appear to be at a disadvantage in a Web3 network:
Non-seed preferred investors (e.g., growth round investors): They are replaced by network maintainers (miners) and the community
Team: They own 14.3% of token supply in the Web3 model versus 23.2% of equity in the Web 2.0 example.
Rise of Microbehaviors
The rise of microbehaviors
Our second area of focus within Web3 is the rise of the microbehavior economy. This is where users earn or pay a creator a nominal amount of money for an action, such as a reader tipping an author $0.10 for a poignant article. That is not so easy today. Existing fiat payment rails carry transaction fees, and U.S. dollars are only divisible up to the cent, meaning that microtransactions today are unfeasible.
A fundamental shift in crypto is its fractionalization, which allows for nominally low amounts of crypto to be transacted—the lowest denomination of a bitcoin is 1 satoshi (“sat”) or 0.00000001 bitcoin. As a result, crypto has enabled the ability to process microtransactions at scale.
An example of microtransactions is the proliferation of the play-to-earn gaming segment, most notably the aforementioned Axie Infinity, which allows gamers to earn its AXS token and participate in network governance by playing. We are closely watching the play-to-earn segment and believe it will have significant ramifications for the global gig economy as more gamers realize they can better support their futures and families through gameplay instead of driving a stranger around town.
We are also interested in microbehaviors leveraging bitcoin via the Lightning network. As mentioned above, we invested in the Lightning Network leader Lightning Labs on the thesis that it would enable bitcoin as a medium of exchange by facilitating the speed and lowering the cost of bitcoin base layer transactions—and enabling transactions in the Web3 economy. Lightning transactions are instant and cost a few satoshis versus base layer bitcoin transactions, which can cost $0.10-$10.00 and take up to 10 minutes.
Our first investment in the Lightning ecosystem came in 2020 with Fold, a financial on-ramp that allows consumers to spend fiat and earn bitcoin as a cashback reward. By building on top of Lightning, the business is able to instantly offer satoshis to users on purchases and can manage a gamified variable rewards strategy.
Our second investment in the Lightning ecosystem was River, a private bank centered around bitcoin. It offers a white-glove exchange product that integrates with Lightning to facilitate the cost of transacting bitcoin, and it is building toward services like bitcoin-based lending and digestible tax reporting.
Beyond these two examples, Lightning’s use cases for microtransactions are widespread, from areas such as gaming to work. The commonality is that these apps enable consumers to earn/spend nominal amounts of crypto for completing tasks, which we believe will open up new users to crypto as a way to earn. Other examples include:
The road ahead
Taking a step back, the new ownership models and microbehaviors that we just discussed have profound implications for both consumers (demand) as well as creators and developers (supply). And these are just two subsets of the broader Web3 movement.
We are strong believers that these models will permeate our daily lives over the next decade. Just as the market cap of Web 2.0 surpassed the peak market cap of Web 1.0, we think Web3 can dwarf Web 2.0 based on the new incentive models that crypto models create and the fact that now both the protocol and application layers are investable.
The crypto experience for the layperson can still be convoluted when compared to the other apps that he or she uses on a daily basis. The most notable issue is that consumer experiences in crypto generally are still lacking relative to Web 2.0 counterparts given they are not hosted in app stores. What does the app store of the future look like given Apple and Google still control our mobile operating systems? There are signs that app stores may be changing and allowing for new payment methods—will this reduce take rates and provide a new distribution channel for crypto? We are looking for solutions and are excited for the new use cases that will be built for Web3.
We at M13 will be doubling down, spending more of our mindshare, and deploying more of our capital into crypto and its impact on the future of consumer behavior. If you are building, investing, writing about, or just curious about the space, we hope you’ll join us on the journey.
How to get in touch
Contact Latif Peracha at firstname.lastname@example.org, and follow him on Twitter at @latifperacha.
Contact Mark Grace at email@example.com, and follow him on Twitter at @markwgrace.
* Data as of September 24, 2021
Special thanks to our colleagues Abigail Snodgrass and Olivia Jensen for their amazing design help!