With computer and IT engineers around the world debating whether or not the blockchain represents the first serious challenge to the present underlying technological foundation of the internet, there is a more interesting game afoot here.
We’re talking about the relative value between protocols and applications. As it has worked out the first time around, the protocols (SMTP, HTTP, TCP/IP) that provided the internet’s technological foundation yielded comparatively little financial value when compared to the hugely profitable applications that were built on top of them. We’re talking about YouTube, Facebook, Google, etc.
Now with blockchain technology threatening to shake the foundations, it seems that this protocols versus applications idea might be reversed when talking dollars and cents.
Inverted Value in the New Stack
Perhaps nowhere is this inverted relationship between protocols and applications more obvious than in the two big kahuna blockchain networks of Bitcoin and Ethereum.
Let’s take Bitcoin.
This network sports an impressive $10 billion market cap, but the largest companies built atop this foundation – the applications – are worth a relatively paltry few hundred million each, and that’s being generous, because it’s an apples and oranges comparison trying to apply traditional business fundamentals to this new generation of technology.
In the case of Ethereum (market cap of around $1 billion), we have yet to see a single breakout application, and it’s been a couple of years since this blockchain release.
Game Changer #1: The Shared Data Layer
Let’s think about Google for a moment.
How did this company get so goshdarned big? That’s easy. Because it grew out of a system of protocols that allowed a few huge players to control massive amounts of information.
For example, if you’re an online entrepreneur who wants traffic to your website, you must play Google’s search page result game.
But along came blockchain technology, an open and decentralized network that fosters a more welcoming environment to new products and services. Can you imagine trying to mount a serious challenge to Google’s dominance of the search engine industry?
Ain’t gonna happen.
But with blockchain, the cryptocurrency competitors to Bitcoin’s original product now number in the hundreds, and customers are in no way confined to any particular trading exchange like they might feel to Google when they want to conduct an online search.
Maybe you don’t like trading Bitcoin with Coinbase. No biggie. It’s a simple matter to quickly switch to Kraken or any of a hundred others and pick up right where you left off.
This is because everyone has free access to the underlying data and software. The result is that a shared data layer is good news for consumers. Since exchanges can’t cordon off the data, they are forced to fight for market share by providing better services at lower costs.
Perhaps even more importantly, the shared data layer reduces barriers to entry into the market by new players, and there’s no way that’s a bad thing.
Game Changer #2: The Protocol Token
The other part of the equation that has driven the blockchain protocol’s profit potential is called a protocol token. Essentially, this is what you use to participate in the service, whether it be Bitcoin transactions or Ethereum computing power.
In short, protocol tokens are what you want to have. Since Bitcoin has been with us since 2009, and has the longest track record of development to analyze, let’s stick with it.
Though Bitcoin’s value upon creation was miniscule – a single bitcoin could be had for pennies – the moment it began to appreciate entrepreneurs and developers sat up and paid attention. These early stakeholders dove in and now, with Bitcoin price drifting north of $10,000 each, are sitting on fortunes.
The interesting part about all this, and tying back into the original point about inverted protocols and applications values with blockchain, is that a price increase serves to motivate these early investors to create products and services around the protocol, thus making it even more appealing to a larger group of market participants, thereby driving the price up even more.
That’s how the blockchain’s fat protocol has created impressive direct financial rewards and will likely continue to do so in the foreseeable future.
The Bottom Line
Here’s the big takeaway from this discussion.
As presently constructed, the protocol’s market cap will always be more than the combined value of any applications it spawns, because success at the application level serves only to heat up interest in the protocol through speculation.
Whereas the present internet evolved through a winner-take-all process that yielded such behemoth applications (companies) as Facebook and Google, expect that blockchain technology will continue to reverse the business model, resulting in smaller, more responsive applications that don’t seek to corner the market.