The continued development of the application layer in the cryptocurrency space will generate significant real-world value for digital assets.
Table of Contents
Application Layer
Bitcoin
Ethereum
Positive Reflexivity
Breaking Down the Application Layer
Application Matrix
Blockchain Use Cases in the Top 3 Quadrants
Quadrant 1: On-chain Economies
Quadrant 2: Programmable Finance
Quadrant 3: Off-chain Applications
Developing the Application Layer
Ending the Era of Reflexivity
(Preface:
AI’s Transformation into “First-Class Citizen” in the Cryptocurrency Field, the Advantages of Cryptocurrency Robot Agents, and Front-end Applications
)
(Background:
The Rise of the Application Layer: Exploring the Next Frontiers of Blockchain Scalability
)
A general blockchain stores and provides logic for the state, which we commonly refer to as assets, and the logic as applications. For example, Ethereum stores assets such as Ether and Dai in its state, which can be used in applications like Uniswap and Aave. The state and logic together form what we call the application layer.
The cryptocurrency economy began with the introduction of Bitcoin in 2009. Bitcoin is a simple blockchain with limited state, inflexible logic, and inefficient infrastructure, which limits its applications.
Then came Ethereum, which introduced a flexible logic layer through a new blockchain-native virtual machine. It also allows anyone to create their own digital assets on the same network. Ethereum thus expanded the state and logic layers.
However, Ethereum’s infrastructure is still limited.
Since its establishment in 2015, most of the Ethereum research community’s efforts have been focused on improving its infrastructure to support the application layer. Rollup and Danksharding have increased throughput, and account abstraction has enhanced user experience. MEV infrastructure can provide better price execution. However, after 8 years, many are still unsure about what we have built at the application layer. Sure, we can trade AAVE on Uniswap or borrow UNI on Aave. But where are the real-world demands? Where are the use cases?
To date, blockchains have exhibited strong reflexivity. There is a wall between the cryptocurrency economy and the real world, making it difficult for cryptocurrencies to attract the real world apart from speculation. Previous bull markets, such as the DeFi boom from 2020 to 2021, were driven by speculation, and the explosive growth of new native tokens and protocols fueled reflexivity: speculation drove activity, which then drove more speculation.
Reflexivity refers to a circular relationship between cause and effect. Reflexive relationships are bidirectional, meaning that the cause and effect mutually influence each other, making it difficult to determine which is the cause or the effect.
It is foreseeable that this loop cannot continue indefinitely.
Eventually, the party must end, and positive reflexivity turns into negative reflexivity. Speculation is mistaken for product-market fit, while exploration of real-world use cases remains. Two years later, many are still searching for ways to scale on-chain activities. To understand how to develop the application layer, we need to examine it more closely.
The application layer consists of two components: state and logic. The state represents data, while the logic represents computation. Both state and logic can be on-chain or off-chain. We provide a four-quadrant matrix:
Each quadrant represents different applications. So far, most blockchain applications fall into Quadrant 1, which represents the use of native cryptographic assets in on-chain protocols. Quadrant 2 involves bringing real-world assets into the chain and using them in protocols. Quadrant 3 covers the use of native cryptographic assets outside of the chain. Everything else falls into Quadrant 4. If both the state and the logic are not on-chain, then it is not a blockchain application.
Focus on the fully on-chain economy surrounding native applications. Currently, most on-chain activities belong to this quadrant. These endogenous applications are inherently reflexive, which is one of the reasons for the cryptocurrency market’s volatility and speculative nature.
On the positive side, this incentivizes users and developers to enter the cryptocurrency economy. Additionally, although these applications are cyclical, they do contain some real value.
While speculation and gambling are controversial, they are indeed real use cases. However, we all hope that the cryptocurrency economy is not just an on-chain casino. Peer-to-peer payments can also be facilitated using native cryptographic assets, but stability and scalability remain challenges.
To move beyond speculation and inefficient financial services, we need to go beyond Quadrant 1.
Another category of blockchain applications involves bringing real-world assets (RWAs) onto the chain. These assets can benefit from the global, programmable, and composable nature of the cryptocurrency market. Those who question the value of native cryptographic assets often understand this quadrant, as summarized by phrases like “blockchain, not crypto” or the meme of “tokenization.”
We refer to this quadrant as programmable finance. It involves developers bringing bonds, stocks, commodities, or other traditional financial instruments into programmable markets, thereby unlocking more accessibility, expressiveness, and efficiency.
The most successful RWAs to date are centralized stablecoins. Stablecoins provide a globally accessible and affordable way to obtain US dollars and have been described as the “killer app” of cryptocurrencies. The total market value of USDC and USDT has reached $114 billion.
Programmable finance has been widely discussed in other areas as well. These applications have attracted institutional interest in blockchain technology and will be a major driver of its growth. However, we believe they are just a part of a more expansive cryptocurrency economy.
The last category of applications is those with on-chain state and off-chain logic. These digital-native assets with off-chain applications are the most overlooked category of cryptocurrencies.
The simplest example is social assets. In the previous NFT craze, many NFTs were treated as representations of identity. Bored Apes, Punks, and other well-known NFTs allow their owners to showcase their status or indicate membership in exclusive communities. The challenge with these NFTs is that their social value is closely tied to price and novelty, which can quickly erode. Fortunately, this flaw is characteristic of those specific NFTs and not necessarily an inherent attribute of all social assets. A more mature cryptocurrency economy will provide more robust social assets.
The off-chain logic of social assets is how we behave off-chain. In this way, social assets serve as coordination tools. Since everyone agrees on the state of the Ethereum blockchain, we can coordinate our actions in the real world around that state. For example, we can use social assets to provide opportunities to attend concerts or prove membership in communities like Zuzalu. The value of storing these social assets on the blockchain instead of a centralized database depends on the specific case, but it may benefit from the blockchain’s trust neutrality, sovereignty, permanence, censorship resistance, financialization, or interoperability with other parts of the cryptocurrency economy.
Applications in Quadrant 3 can also offer advantages of cryptographic technology. Consider gaming, where traditional games can support certain on-chain states while keeping most of the game logic off-chain. Then, these assets gain external demand based on their in-game utility or social value.
Token gating unlocks more use cases. Friend.tech, despite its flaws, has demonstrated directional success in showcasing the intersection of social assets and token gating. We suspect many exciting applications can be built in this category. Another recent example is Orb Land. Orb is an NFT that provides exclusive access to certain celebrities. Orb owners have the right to ask questions to the respective celebrity at a certain cadence, such as every 7 days. Orb also has an additional feature, the Orb Market, which is a radical market that allows anyone to buy any Orb from another person at a fixed price at any time.
The dePIN project, which focuses on decentralized physical infrastructure, also falls into Quadrant 3. These tokens incentivize real-world activities such as mapping roads or installing hotspots, solving the cold-start problem.
Not everything neatly fits into one of these quadrants. Each application has some degree of external purpose. Again, there must be some real-world use case (some “off-chain logic”) to be considered useful. And in practice, most applications have their logic partially on-chain and partially off-chain. Nevertheless, as a mental model, we find this framework helpful for reasoning about the application layer.
Based on the latest developments in the ecosystem, we have formed two reverse perspectives on how to develop the application layer.
Our first reverse perspective is that, for the time being, asset innovation is more important than application innovation. Yes, we need better decentralized exchanges. But more importantly, we need to create assets that are truly worth exchanging. The latter is a more easily scalable path for on-chain activities that are sustainably expandable. We encourage more teams to bring novel assets onto the chain.
Our second reverse perspective is that, in the medium to short term, Quadrant 3 is more important than Quadrant 2. RWAs have broad prospects in the cryptocurrency economy. However, for now, we believe it is more important to bring native cryptographic assets into the real world than to bring RWAs onto the chain. The former are “real-world assets” in their own right and have more unexplored, unconstrained design space.
As Quadrant 2 and Quadrant 3 become a larger proportion of the cryptocurrency economy, reflexivity in the market will decrease. Once we have external demand for cryptographic assets and protocols, Quadrant 1 will become less cyclical. Suddenly, Uniswap is no longer just a speculative engine but also a decentralized business with relatively stable demand.
Real-world use cases weaken reflexivity in the cryptocurrency economy, and over time, the market will become more non-causal. By “non-causal,” we mean that the demand for blockchain applications does not come from the blockchain itself, which we believe is the closest antonym to “reflexive” that we can find.
The ultimate state of the application layer will be far less reflexive than it is today and will generate significant real-world value. We will ultimately achieve this.
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Tags:
bitcoin
ETH
RWA
Blockchain Applications