Examining the encryption industry from first principles: How to break the deadlock of nihilism

Original Title: First Principles - Compounders, L1s, IR, Buybacks

Original author: 0x kyle__, DeFiance Capital member

Original translation: ChatGPT

Editor’s note: The author believes that the biggest problem in the encryption field is not talent or capital, but the lack of first-principles thinking, leading to the industry being deeply mired in short-termism, extractive culture, and low trust. The author analyzes the reasons why compounding is difficult to achieve, and proposes the need for top-down promotion of long-term thinking and focus on creating revenue-generating products. At the same time, criticism of the inefficiency of general Layer 1 blockchains is put forward, with the suggestion to focus on specific areas and build their own ecosystems to give tokens value. Additionally, it emphasizes that liquidity token projects should establish investor relations roles to enhance transparency, rather than relying solely on buybacks and burns, and advocates for the use of funds to expand products and consolidate long-term competitive advantages, in order to break the current nihilistic impasse and achieve sustainable growth.

The original content is as follows (for ease of reading comprehension, the original content has been slightly reorganized):

The biggest problem in this field is neither talent nor capital. Simply put, it is a lack of first principles thinking. This is a culture that must be changed. The 1% of people need to start driving this field forward.

If you have been following my Twitter recently, you will find that I have been shouting frantically for some extremely low-hanging fruits, which seem to have a high leverage effect and appear very easy to achieve, but it seems that no one “understands” or executes it very well. Here are some points I have made:

• The real question is: why don’t more chains use their funding programs to incubate their own dapps and build dapps that are clearly in line with the chain? Instead of hoping that these dapps will not abandon the chain within two years.
• The reason why the industry has the current price trend is largely because everyone has this idea: ‘You must sell, because one day it will return to zero.’ The reason is that no one has truly built a good product that people want to continue to invest in regularly. Cryptocurrency needs compounding enthusiasts.
• In most cases, “marketing” in the field of encryption is not consistent with the product. If you are not a consumer-facing product—such as a revenue platform, why are you even marketing to retail users. The best marketing is often price increases. And the best at this are liquidity funds.

I will discuss each topic in this article, namely:

Compound interest, culture, short-termism

• Universal L1 is dead, change is necessary
• Liquidity Tokens and Investor Relations
• Repurchasing and destruction are the least bad, not the best

I will name this article “first principles” because all these points are what I came up with during a simple thought exercise of how to change today’s industry with common sense.

This is not profound. Madness is doing the same thing over and over again, but expecting different results.

We have gone through three cycles, doing the same thing over and over again - creating basically nothing, zero-value accumulation, squeezing tokens and applications to the maximum extent, because for some stupid reason, we have decided to open the casino in this fervent way every four years, attracting capital from all over the world to gamble.

Guess what? After three cycles, ten years later, people finally realize that the market makers, scammers, those who manipulate machines, and those who sell you overpriced food and drinks in the casino are taking away all your money. After several months of hard work, the only thing you can show is how you lost all your history on the chain. An area built on the foundation of ‘I’ll come in, make my money, and then leave’ will not lead to the establishment of any long-term compounding beneficiaries.

This place used to be better, once a legal place for financial innovation and cool technology. We used to be excited about novel and interesting applications, new technologies, and ‘changing the future of (finance) in France’.

However, due to extreme short-termism, a culture of maximum extraction, and low integrity individuals, we have fallen into this permanent financial nihilism self-devouring cycle, when everyone thinks that continuously investing in random scam tokens is a good idea, this cycle collectively triggers itself, because ‘I will sell before he scams me.’ (To be honest, I saw someone saying they knew that ‘SBF token’ is a scam, but they would sell before being cut to ‘quickly profit’.)

You can say that I have no construction experience - that’s right. But this is a small field, and it has not existed for a long time; I have been working in this field for four years, and working with some of the best and smartest funds has given me a deep understanding of what is effective and what is ineffective.

I reiterate: insanity is doing the same thing over and over again and expecting different results. As a sector, we go through the same things year after year - feeling nihilistic after the inevitable crash in prices, thinking it’s all worthless. When NFTs crashed, I had this feeling (oh my, it’s all a scam), and now people feel the same after the recent meme coin debacle, just as they did during the ICO era.

Changing the status quo is simple: we just need to start doing things differently.

Compounder, Culture, Short-termism

Simply put, compounders are assets that only rise and do not fall over many years—think of Amazon, Coca-Cola, Google, etc. Compounders are companies with the potential to achieve sustainable and long-term growth.

Why haven’t we seen compounding in the field of encryption?

The answer is more subtle than this, but basically - extreme short-termism and misalignment of incentives. Indeed, there are many issues with the structure of incentives, as Cobie’s private capture and phantom pricing articles cover well. I won’t delve into this because the focus of this article is, as individuals, what can we really do now?

For investors, the answer is obvious - Cobie points out here: you can choose to exit (you may want to do so)

Indeed, people have chosen to opt out: in this cycle, we have seen the decline of “CEX tokens” as retail participants choose not to buy these tokens; although individuals may not have the ability to change this systemic issue at the system level, the good news is that the financial markets are quite efficient—people want to make money, and when existing mechanisms do not yield profits, they do not invest, making the whole process unprofitable and forcing a change in the mechanism.

However, this is just the first step of the process - to truly build a compounder, the company needs to start instilling long-term thinking in this area. It’s not just that the “private market capture” is bad, but the entire chain of thinking that led us to this point - like a self-fulfilling prophecy, founders collectively seem to believe “I will make my money and then leave”, no one is really interested in playing the long game - which means charts always look like a McDonald’s M shape.

The top level must change: a company is only as good as its leaders. Most projects fail not because of a lack of developers, but because of senior decisions to leave. This industry must start to regard those founders with high integrity, high energy, and long-term thinking as role models, rather than idealizing founders who engage in ‘short-term ramping up and smashing down’.

The founders in this field are generally of low quality, which is not news anymore. After all, it is a field that calls those who bind the pumpfun token as ‘developers’ - the threshold is really not high. As long as you have a vision that surpasses the first two months before the token is launched, you are already ahead of others.

I also believe that the market will begin to economically incentivize this long-termism, and we have already started to see this. Despite recent sell-offs, Hyperliquid has still risen fourfold from its initial issuance price, something that few projects can boast about in this cycle. It is usually easier to make the argument for ‘long-term holding’ when you know that the founder’s vision aligns with the long-term growth of the product.

The natural conclusion is that founders with high integrity and high energy will start to occupy a large share of the market, because frankly, when everyone is tired of scams, they just want to work for someone with vision and who won’t quit the game—and there are too few people doing this.

In addition to having a good leader, the establishment of a compound interest also depends on whether the product is based on good assumptions. In my opinion, this issue is easier to solve than finding a good founder. The reason why there are so many empty products in the field of encryption is because the people who create these empty products also have the mentality of ‘earn money and leave’—so they choose not to take on new problems, but only fork popular things and try to make money from them.

However, the fact is that the industry does reward this kind of illusory idea - such as the AI agent frenzy in the fourth quarter of 2024. In this case, after the dust settles, we will see the usual McDonald’s M-shaped pattern - therefore, companies must also start focusing on building profitable products.

No income path = No long-term believers/holders = No buyers of assets, because there is no future to bet on.

This is not an impossible task - businesses in the field of encryption do make money. Jito’s annual revenue is 9 billion, Uniswap’s is 7 billion, Hyperliquid’s is 5 billion, Aave’s is 4.88 billion - in a bear market, they continue to make money (just not as much).

Looking ahead, I believe that the transient and narrative-driven speculative bubbles will become smaller and smaller. We have seen this already - in 2021, games and NFTs were priced in the hundreds of billions, but this cycle, the peak of memes and AI agents is only in the tens of billions. This is a macro-level euthanasia roller coaster.

I believe everyone should be free to invest in what they want. But I also believe people want their investments to pay off—when the game is so clearly marked as ‘this is a hot potato, I have to get rid of it before it goes to zero,’ the roller coaster will go faster and faster, the market will shrink, because people choose to exit, or lose all their money.

Income solves this problem - it makes you as an investor understand that people are willing to pay for the product, therefore, there is a certain long-term growth prospect. When something has no revenue path, it is almost uninvestable in the long term. On the other hand, the revenue path leads to the growth path, attracting buyers willing to bet on the continued growth of assets.

In conclusion, building a compounder requires:

• Top-level infusion of long-term thinking
• Focus on building profitable products

Universal L1 is dead, change is necessary

If you sort the Coingecko homepage by market value, you will find that blockchain accounts for more than half of it; apart from stablecoins, Layer 1 occupies a considerable value in our industry.

However, the chart of the second largest digital asset after Bitcoin looks like this:

If you buy Bitcoin in July 2023, you will increase by 163% based on the current price.

If you buy Ethereum in July 2023, according to the current price, you will increase by 0%.

This is not the worst part yet. The 2021 bubble in everything triggered a wave of ‘Ethereum killers’ - new blockchains intended to surpass Ethereum in some technical way - whether in speed, development language, block space, etc. But despite the hype and massive capital investment, the results did not meet expectations.

Today, it has been four years since 2021, and we are still facing the consequences of that wave - 752 smart contract platforms have launched tokens on Coingecko, and there may be more that have not yet been launched.

Not surprisingly, most of their charts look like this - which makes Ethereum’s charts look decent in comparison:

Therefore, despite four years of effort, billions of dollars in funding, and over 700 different blockchains, only a few L1 have decent activity—and even those have not reached the ‘groundbreaking user adoption level’ that everyone expected four years ago.

Why? Because most of these projects are built on wrong ideas. As Luca Netz pointed out in his article ‘What is Consumer Cryptography,’ many blockchains today follow a common approach, with each blockchain dreaming that they will ‘carry the Internet economy.’

But this requires a huge effort, ultimately leading to fragmentation rather than penetration, because a product that tries to do everything usually cannot do anything well. It is an effort that costs too much money and time - frankly, many blockchains even struggle to answer a simple question: ‘Why should we choose you instead of blockchain number 60?’

Domain L1 is another case where everyone follows the same script but expects different results - they compete for the same limited developer resources, trying to outdo each other in funding, hackathons, developer housing, and now it seems we are still making phones(?)

Let’s assume an L1 succeeded. Every cycle, some L1 can break through. But can this success be sustained? The winner of this cycle is Solana. But here is a perspective that many of you may not like: What if Solana becomes the next Ethereum?

In the last cycle, there was a group of people who were so convinced of Ethereum’s success that they put most of their net worth into Ethereum. Ethereum is still the chain with the highest TVL, and now there is even an ETF—however, the price remains stagnant. This cycle, the same type of people are saying the same things—Solana is the chain of the future, Solana ETF, and so on.

If history has any indication, the real question is - can today’s victory ensure tomorrow’s relevance?

My point of view is simple: instead of building a general-purpose blockchain, L1 is more meaningful to build around a core focus. Blockchain does not need to be all things to all people. It just needs to excel in a specific area. I believe the future is blockchain-agnostic—it just needs to excel, and the technical details won’t be so important.

Today, builders have shown this sign - the founders of building D-app are mainly concerned not with the speed of the chain, but with the distribution of the chain and end-user consumption - is your chain being used? Is it necessary for it to be distributed to make the product attractive?

44% of the web traffic runs on WordPress, but its parent company Automattic is valued at only $7.5 billion. 4% of internet traffic runs on Shopify, but its valuation is $120 billion—16 times that of Automattic! I believe L1 will also have similar end states, with value accumulating to build applications on the blockchain.

Therefore, I believe that L1 should take groundbreaking measures and build its ecosystem. If we use cities as an analogy for blockchain (thanks to Haseeb’s 2022 article), we can see that cities start because certain advantages make them viable economic and social centers, then over time they focus on a dominant industry or function:

• Silicon Valley → Technology
• New York → Finance
• Las Vegas → Entertainment and Hotel
• Hong Kong and Singapore → trade-centric financial centers
• Shenzhen → China’s hardware manufacturing and tech innovation hub
• Paris → fashion, art and luxury goods
• Seoul → K-pop, entertainment, and beauty industry

L1 is the same - demand is driven by the attractiveness and activities they provide; therefore, the team must start to focus more on doing the best in a vertical field - planning the kind of attraction that attracts people into its ecosystem, rather than building various different exhibitions hoping to attract users.

Once you have that kind of attraction that attracts people into the ecosystem, you can build a city around that attraction. Again, Hyperliquid is an example of a team that has done well in this area and iterated on first principles. They have built a local sustainable DEX order book, spot DEX, staking, oracle, multisig—all built internally, and then expanded to HyperEVM, which is a smart contract platform for people to build on.

Here is why it is effectively broken down:

• First, focus on ‘building attraction’: By first building perpetual trading products, Hyperliquid attracted traders and liquidity before expanding.
• Control Stack: Having critical infrastructure (oracles, staking) reduces vulnerabilities and creates moats.
• Ecological synergy: HyperEVM now serves as a permissionless playground for developers, leveraging Hyperliquid’s existing user base and liquidity.

This ‘attraction-first, city-second’ model reflects the success of web2 platforms (for example, Amazon started with books and then expanded to everything else). Solve an exceptionally good problem, and then let the ecosystem organically expand from that core value.

Therefore, I believe that blockchain should start integrating its own products, building its own attractiveness, having a stack; as a captain, you are a visionary person - this allows you to align your blockchain with your broader, long-term vision of L1; and ensure that the project will not be abandoned immediately when chain activities start to decline, as everything is built internally;

Most importantly, this process brings currency to your tokens - if blockchain is a city, tokens are the currency/commodity that people trade; by using it, the value is driven to the tokens - people need to buy your tokens to do interesting things on the chain. It gives value to your currency and gives people a reason to hold it.

Oh, but it’s important to remember - just because you specialize doesn’t mean there’s a market demand for it. Another hard truth is that L1 must work in the right way at the right opportunities. Blockchain must develop products that people want - sometimes, people don’t really want ‘web3 games’ or ‘more data availability’.

Liquidity Tokens and Investor Relations

The next topic is about how I think liquidity token projects should develop in this field. It’s simple - liquidity token projects need to start establishing Investor Relations (IR) roles and quarterly reports, allowing investors - whether retail or professional, to clearly see what the company is doing. This role is not new or revolutionary - but is severely lacking in this field.

However, very little has been done in the field of IR. I was told by the business development leads of multiple projects that if you have some kind of ‘regular phone calls pitching your liquidity tokens to funds,’ you are doing 99% more in this area than other projects.

Business development is cool in attracting builders and ecosystem funders, but it’s better to tell the public what the token is doing in the role of IR - it’s really that simple. If you are a token that wants to attract buyers, you need to market yourself - and the way you do this is not by renting the largest booth at a conference or advertising at the airport, but by marketing yourself to capital-rich buyers.

By conducting quarterly growth updates, you begin to show investors that the product is legitimate and can accumulate value—enabling investors to speculate on the long-term prospects of the product’s potential good performance in the future.

As for how you should go about it - a good starting list is:

• The report discusses quarterly expenses/income, protocol upgrades, numbers, but no MNPI - released on the blog/website
• Communicate with the liquidity fund manager monthly to discuss your product/promote yourself
• Hold more AMAs

Buybacks and burns are not bad, but they are not the best either

The last thing I want to discuss is the repurchase and destruction in this area. My point of view is: if these funds have no other use, I think repurchase and destruction is a good use. In my opinion, the encryption has not yet reached the scale where the company can be worry-free, and there is still a lot to be done in terms of growth.

The first and most important use of income should always be to expand products, upgrade technology, and enter new markets. This is consistent with driving long-term growth and building competitive advantages; a good example of this is the acquisition frenzy of Jupiter, who has been using cash to buy names to acquire products and key talents in the field.

While I know there are people who prefer buybacks vs. burns and will call for dividends, my view is that most crypto operations are similar to tech stocks in that the investor base is of a similar type: investors looking for high returns want asymmetric returns.

Therefore, it doesn’t make much sense for the company to return value directly to token holders through dividends - they can do so, but it would greatly benefit the product if they use cash reserves to build a larger moat that will serve them in 5 to 10 years.

Cryptocurrency is now at the stage of beginning to enter the mainstream - so now slowing down the momentum makes no sense; instead, cash should be invested to ensure that the next winner leads for a longer period of time, because although all prices are falling, the institutional settings for cryptocurrencies have never been better - the adoption of stablecoins, blockchain technology, tokenization, etc.

Therefore, although repurchasing and destroying is much better than taking the money and leaving, it is still not the most effective way to use capital, considering how much work there is to be done.

Conclusion

This bear market has already begun to make people realize the necessity of building revenue-generating products as a path to profitability, as well as the inevitable need to play a legitimate investor relations role in showcasing token performance.

There is still a lot of work to be done in this field. I remain optimistic about the future of encryption.

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