All you need to know about the Fat Protocol Debate to date

As many of you know, one of the most anticipated panels at the Penn Blockchain Conference 2023, "Value Accrual in Web3: A Refresh on Fat Protocol Thesis," will gather the leading thinkers on the web3 value accrual to debate such a directional topic in person at the?Penn Blockchain Conference?on 2/10, featuring

• Joel Monegro, GP at Placeholder VC (who coined the term Fat Protocol in his?original thesis?while at USV)
• Aleks Larsen, GP at Blockchain Capital
• Jason Choi, Co-founder at Tangent, founder at Blockcrunch
• Chia Jeng Yang, Investor at Pantera, and author of?Cracks in the Fat Protocol Theory
• moderated by myself

Value accrual has been a long-term topic of interest since I started in web3 VC in 2021, and it's a dream come true to have assembled the four leading thinkers to riff on the topic live on stage.

Ahead of the conference, I revisited the writings of our panelists on the topic and TLDR-ed them into a?one-pager primer of “All you need to know about Fat Protocol Thesis to date.”?In addition to what’s already been argued by Jason, Chia, and Joel (and you can find the TLDR of their main points at the bottom), I have three additional reasons why I stand with Fat Protocol even today.

Why I Stand with Fat Protocol in 2023:

1. Blurred Definitions & Assumptions

The definition of what’s a “dapp” vs. what’s a “protocol” has really blurred and is not as cut and dry as before. Examples of such as

• middleware or dev platforms like Lens Protocol (that builds on a base layer/Polygon and AR but still serves as a developer platform to attract other dapps to build on top)
• app chain thesis (Cosmos 2.0, Avalanche Subnets, Filecoin ICP): the idea of dapps and chains are merging - potentially to eventually converge on value accrual

If a dapp?launches its token, is it a protocol now? What about if this dapp becomes a?developer platform?(like Lens) that others to build on top? Is it a protocol then? Or,?does a dapp only stays a dapp if it accrues value to equity?aka token?

The corollary is a debate over whether value accrual should happen on the equity vs. token side, and whether or not dapps should tokenize. This warrant a whole separate debate but for?app chains & "rightfully tokenizable" dapps, value accrual should accrue to token and token only to align incentives of investors, community, and founding team -?hence Fat Protocol wins here.

2. Aggregator Theory’s Applicability to Web3 (per JV from Protocol Labs)

Per aggregator theory (full credit to JV from Protocol Labs for pointing it out), whoever owns the relationship with users has the ultimate power to monetize and accrue value (Wechat, DYDX example). Along this vein, I stand with the Fat Protocol Thesis as an investment approach because Dapps will eventually want to become protocols/their own chain, if not begin with it.

Once a dapp garners sufficient user reaction like DYDX, it will want to become a “protocol” to

1. enter into an ecosystem play by encouraging other dapps to build on top of and capture additional fees (hence kicking off the positive feedback loop mentioned by Joel in his original thesis)
2. have full control over activities on its own app chain vs. has gas fee affected by other dapps’ activates on chain
3. cater to its own use-case based idiosyncrasy

3. Exit Horizon (Investor Angle)

To put on my VC hat & prioritize the fiduciary duty to maximize return to LP within the shortest amount of time (assuming close-ended fund), Fat Protocol wins again. The obvious assumption here is that

• Protocol = liquid token readily available on secondary market, which also means if a dapp has tokenized, it becomes a “protocol” and hence falls under this bucket
• Dapps = yet to be TGE applications on primary market

I’ve long argued that in a bear market market, it makes a ton of sense to purchase liquid token and long it as venture investment for 4 reasons

1. lower product risk: you already know more or less what the product is and whether it can successfully launch
2. flexible exit route: usually liquid token purchases have a much shorter, if at all, lock up period compared to SAFE deal (need to exit through IPO or M&A) and SAFT deal (with uncertainty around the success of tokenization and additional lock-up period on top)
3. low touch compared to SAFE/SAFT:?generally speaking, good investors tend to be more hands-on with venture deals (SAFE/SAFT) than with liquid token deals, as the latter tend to be more mature and require less handholding. If a VC runs a small shop with limited bandwidth, liquid token might be the more tenable route
4. liquid token aren’t necessarily more expensive than SAFE/SAFT:?unless a venture deal project is raising at sub 20 valuation, there are many liquid token alternatives under 100M FDV for purchase at the moment with minimal lockup

In all fairness,?evaluating SAFE/SAFT deals against straight-out liquid token using the same criteria is not a best practice. If everyone use the above four criteria to evaluate startups, no venture deals will be done and in the future there will be no new tokens. After all, you can have a ton of failed tokens on the liquid market, and have un-launched token in high-growth green-field new sectors (like MEV, ZK). Ultimately it will have to return to the fundamental analysis around the growth & adoption of the project and its value accrual (hey full circle, back to Fat Protocol again)!

TLDR-ing Fat Protocol debate to date

Original Fat Protocol Thesis

by Joel Monegro, written in Aug, 2016

The market cap of protocols will always grow faster than the combined value of dapps because

1. Protocol provides a shared data layer & remove data access gatekeepers in web2
2. Positive feedback loop?from token appreciation -> more speculation -> builders and investors join & existing holders hoard tokens-> more security/network -> more token appreciation

Additionally, protocols are?less forkable?than dapps, and protocols will?capture value out of dapps’s?demand for native tokens

The Case for Cracked Fat Protocol Thesis

by Chia Jen Yang, written in Mar, 2022

Evidenced by the dampened magnitude of the increase in Eth’s market cap compared to those of ERC20 stablecoins, Fat Protocol is getting invalidated because of?

1. Multi-chain?dapps & increasing brand equity (like Uniswap expanding to AVAX)
2. Long-term protocol?competition?leading to lower fees
3. Rollups?reducing total demand for block space
4. Protocols should be evaluated as?Currency vs. Nations?(if viewed like money supply vs. GDP, market cap of L1s does not have to exceed the market cap of dapps)
5. Success of Fat Protocol has been due to a lack of alternative L1s and lackluster Dapp tractions?
6. Dapp values are understated due to centralized entities like Coinbase & Opensea

Forget Fat Protocols

by Jason Choi, written in Jan, 2023

The era of Fat protocol & monolithic blockchains may be over as web3 transitions to a modular architecture that separates execution, settlement, and DA layers to compete for fees. Specifically,

1. Modular blockchain?thesis splits the protocol layer to execution, settlement, and data availability
2. Rising?L2 scaling?solutions curtail value accrual to base layer
3. Future data availability sampling?will reduce DA costs via lessening workload from verifying full blocks
4. EIP4844?will make L2 rollup fees much cheaper
5. High usage ->congestion?-> high fee -> thwart growth
6. Other innovative pricing?for base layer (like ImmutableX to not charge gas fee at all

Below are the high-level topics I plan to ask the panelists

• Definition of dapps vs. protocol in recent days
• How will a modular future of blockchain change the thesis
• Where does the App Chain Trend fit into the Fat Protocol thesis
• Given the rise of new alt L1s, what are the true moat, or scarcity of a L1 that makes it valuable and hard to replace?
• Do you think the base layer winner has emerged yet?
• Alpha Leak