Summary of “Fat Protocols”

This is a summary of the original “Fat Protocols” thesis, covering how financial value is captured on the blockchain at the protocol layer compared to the application layer for the internet.

Protocol vs Application Value Capture

How value is captured for the Internet

Internet protocols (TCP/IP, HTTP, SMTP, etc.) produced immeasurable amounts of value, however, almost all the financial value captured occurred at the applications layer (Google, Facebook, etc.). This leads to investing in applications for high returns instead of investing in protocol technologies.

How value is captured for the Blockchain

The opposite happens for the blockchain where you can see the underlying protocol capturing the majority of the financial value (Bitcoin, Ethereum, Polygon, Binance Smart Chain) even though applications also capture significant value.

Why the difference?

The shared data layer

Many applications require user information to function (Uber, Paypal, etc.) creating a higher barrier to entry where a lot of the value is captured by these data aggregators (Google, Facebook, etc.). The blockchain, which instead replicates and stores user data across an open and decentralized network rather than individual applications reduces the barriers to entry. Competing applications constructed on the protocol are still interoperable with each other just by building their services on the same open protocols.

Ownership of the protocol layer

The protocol layer now can be owned via cryptographic access “tokens” with the value of ownership being the access for the service provided by the network (transfers and smart contract transactions). This turns the protocol from just a technology that supports the application layer to an infrastructure entity owned by stakeholders.

The ownership mechanism also creates a feedback loop that increases the value of the protocol.

1. New protocols draw the attention of early speculators, developers, and entrepreneurs who buy in and become initial stakeholders in the protocol.
2. Then some of these early adopters who are invested in the financial success of the protocol, build products and services on the protocol and market the protocol in hopes to further its value.
3. Some of the applications become successful and the marketing generates further interest in the protocol, attracting new users and more mature investors.
4. This further increases the value of the tokens, which draws more attention from more entrepreneurs, leads to more applications, and so on.