VC's short-sightedness and long-lasting pain: Why does excessive betting on public chains cause the crypto world to fall into an "empty nest" crisis?

Author: Anthony DeMartino

Compiled by: Deep Tide TechFlow

Overinvestment in public chains

Over the past two years, crypto venture capital has overwhelmingly prioritized investment in public chains over other protocols. This shift has led to a surge in new Layer 1 (L1) and Layer 2 (L2) networks, but has left the ecosystem with a lack of high-quality protocols.

From a financial standpoint, this strategy brings significant returns, as many chains have market caps that far exceed their total locked position value (TVL). By comparison, leading protocols are hard to even value 20% of their TVL.

Bottlenecks for basic services

This overinvestment creates bottlenecks for other basic service providers.

Specifically, cross-chain bridges, wallets, oracles, exchange integration, and the ability to attract top stablecoins and protocols are all behind. Therefore, new chains tend to rely on secondary alternatives, increasing friction between developers and users.

Currently, FireBlocks is the only institutional wallet on scale, so the lack of integration makes it difficult to attract institutional capital.

This problem will be even worse when the new public chain is incompatible with EVMs, because FireBlocks will be delivered longer.

This problem is particularly prominent for chains using the MOVE language, and the lack of institutional support is obvious.

Top cross-chain bridges like Layer Zero face the same challenges. A top-level bridge that allows both institutions and users to feel assured to use is crucial to attracting capital and assets in other chains.

As top cross-chain bridges have a large and growing transaction backlog, new chains must use weaker alternatives or pay high fees to increase priorities. Some chains are happy to pay more fees to speed up transactions, while chains with less funds have to use secondary cross-chain bridges, which will limit their upside potential.

Protocol issues

When it comes to agreements, the problem is particularly serious.

Some top new protocols, such as ETHENA and Kamino, have TVLs of 5 to 20 times that of many new chains, but their valuations are pale in comparison.

This has led to underinvestment of available protocols, resulting in a huge shortage.

To cope with this problem, public chain foundations are forced to incubate amateur teams that usually just replicate existing code bases rather than building powerful, practical solutions. This introduces significant risks in two main areas:

1. Attracting capital: Protocols developed by underfunded teams are difficult to gain credibility, investor support and TVL.

2. Security & Stability: It is easy to copy existing protocols like AAVE, but it takes experience and expertise to run it effectively and ensure the security of user funds.

Money market crisis

The Money Market is the lifeblood of any top public chain. However, handing over these key protocols to inexperienced teams has weakened the availability and trust of these chains.

While anyone can use ChatGPT to copy AAVE's code, running a lending protocol successfully requires deep knowledge of risk management.

A major oversight in many of these replicates is the lack of external risk managers (such as Chaos Labs) who are critical to AAVE’s unrivalled security record.

Just copying the code without implementing the same risk controls doom these protocols.

It turns out that during this cycle, we have seen several new money market protocols being attacked.

In addition, when the foundation of the public chain must fund the development of the agreement itself, this means that external investors are less interested. Due to the lack of financial backers who support the new agreement, they have difficulty attracting important LPs in the early stages, which is crucial to success.

DEX Dilemma

Although decentralized exchanges (DEXs) are less important than money markets, their lack or poor quality can hinder the success of public chains. Whether it is spot or perpetual contract DEX, it is difficult to attract capital due to the following reasons:

1. Lack of skilled teams: Many of these exchanges are replicas run by inexperienced teams.

2. Slip and poor UI/UX: The lack of well-designed interface and deep liquidity prevents liquidity providers (LPs) from participating.

The result is poor trading experience, big slippage, slow TVL growth, and weakening of the overall ecosystem.

Change the incentive structure

Despite these challenges, economic incentives remain biased towards investing in new L1 and L2 rather than protocols.

This imbalance can be solved in three ways:

1. Agreement valuation must rise: the market needs to reflect the actual value and utility of top-level agreements.

2. L1/L2 Investment must be reduced: If the chain's valuation drops, capital allocation will naturally turn to the agreement.

3. Protocols become their own chains: This trend began with recent behaviors of HyperLiquid and Uniswap.

While it is obvious that valuation needs to be converged between protocols and chains, it is less clear whether the protocol should become a chain.

This trend is beginning to emerge, partly because of the imbalance in valuation. Not only do top protocols attract TVLs more than most new chains, they also receive exponentially increased fees, but are still not favored by VCs.

While creating a great protocol is complex and rare, building a new chain is becoming easier and more dependent on the quality of the marketing team than the skills of the developer.

Furthermore, these teams may be distracted by building low-value technologies to boost valuations, thus neglecting the construction of the protocol layer.

If this trend is driven by external forces, it will only exacerbate the lack of protocol quality and continue this cycle.

The key question is whether VCs recognize and correct this imbalance before it is too late,

The industry's future is in danger

If these problems are not resolved, the entire crypto industry will face the risk of stagnation.

Without a strong, well-funded protocol, new chains will struggle to provide the seamless user experience required for mainstream adoption.

Institutional players entering the field quickly will be forced to retreat or fund their own agreements, forcing the industry to become more centralized.

Ultimately, VCs need to re-prioritize investments to break the stagnation, otherwise the future of cryptocurrencies will be at stake.

— Anthony DeMartino, CEO and Founder of Trident Digital, Istari Ventures GP.