Fat vs Thin Protocols

This post I have written explains why the blockchain, which is the protocol layer, will capture most of the value. This understanding of fat vs thin protocols has encouraged me to believe that the market cap of the blockchain will always be greater than the combined market cap of all the applications built upon it.

A protocol is simply a collection of rules, behaviours, and formats that specify a communication standard between two or more nodes on a network [2].

Joel Monegro describes that previous generation of protocols (TCP/IP, HTTP, SMTP, etc.) produced huge amounts of value, but most of this value was captured by the top layer, the applications; such applications include: Google, and Facebook[1]. Therefore, in terms of value distribution, the protocols are ‘thin’ and the applications are ‘fat’. Thus, one may conclude investing in applications produced high returns and investing in protocol technology produced low returns [1].

However, with the advent of blockchain the value captured by the stack is reversed; producing ‘fat’ protocol layers and ‘thin’ application layers. This is clear when looking Bitcoin and Ethereum, the two dominant blockchain networks with market caps of $227B and $70B respectively [3], while the applications built upon them are only worth a fraction of their market cap. According to Joel Monero, there is two things that cause this: shared data layer and cryptographic “access” tokens [1]. Firstly, by replicating and storing user data across an open and decentralized network, and hence a shared data layer, barriers to entry are reduced, creating a more lively competitive ecosystem of applications [1]. Secondly, the crypto tokens, when an application is successful, demand for the protocols token is increased as it is required to access the application. This increases the price per token as they are limited, invites speculators and more investors and developers; further increasing the price. Hence, Joel Monegro believes “the market cap of the protocol always grows faster than the combined value of applications built on top” [1].

To summarise, in the blockchain stack, the protocol is ‘fat’ because a shared data layer is created, and because applications built upon it require the protocol’s token to access the application itself. Therefore the value of the application built upon the blockchain will always be less than the value of the blockchain.

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[1] http://www.usv.com/blog/fat-protocols
[2] https://blog.coinfund.io/fat-protocols-are-not-an-investment-thesis-17c8837c2734
[3] https://coinmarketcap.com/coins/