Recruiting high-quality infrastructure providers and thus bootstrapping the network decentralization and performance is considered by many protocol teams and projects in the space as one of the most challenging tasks.
In this Blockchain Infrastructure Thesis we will look at the blockchain use-case adoption today, look what is needed for its further advancement as well as into its technological, social and economic drivers. We will figure out why building infrastructure and its provision matters for the long-term success of the blockchain space and how these are connected.
We will argue why at the current stage of blockchain maturity we believe that building and providing the blockchain infrastructure is the most important and arguably most strategically sound way for traditional enterprise players to participate in the ecosystem growth and in the blockchain space overall.
So what exactly is the role of infrastructure providers? Which use cases come next and what are the different infrastructure-requirements?
1. Blockchains Today
Blockchain has yet to become the game-changer some expected […] given the amount of money and time spent, […] little of substance has been achieved. – “Blockchain’s Occam problem“, McKinsey, Jan 2019
McKinsey, BCG and Co. are not so widely quoted in the space due to their arguable distance from blockchain grassroots movement, but this time their observation is correct… sort of.
In order to understand where the McKinsey guys are right and wrong, let’s take a look at the adoption timeline of blockchain technology, which looks something like this:
Cypherpunks -> Developers -> End-Users -> Corporates -> Nation States
We have successfully passed the first stage, where cypherpunks were the only users of crypto. We are currently still at the “developers” stage. We are building various components of the Web3 stack, composable tools and modular frameworks for developers, working on privacy, standardization, UI/UX and last but not least interoperability. Until these are in place, this makes little sense to talk about mass adoptions with end-users and corporations. We see a great deal of work being done across all of these areas in the background, which means it goes largely unseen for an average consulting company’s analyst.
First steps and attempts to get the technology to the End-Users and Corporates are being made, but there are still several key puzzle pieces missing before we can aspire to claim real adoption for these segments.
2. Blockchain Infrastructure Definition
What is the main reason we have seemingly slowed down at the “developers” stage on the adoption timeline? Lack of robust, efficient and secure infrastructure to prepare for wider adoption. Infrastructure is a pretty abstract term and can mean various things based on the angle it is looked at, so it makes sense to break it down further.
Financial Infrastructure – one of the pre-requisites of building any sort of meaningful blockchain application is the financial foundation (money) which is borderless, censorship-resistant, neutral, global and publicly verifiable. This is relevant to anything from governance to “bananas on the blockchain” as highlighted by Andreas Antonopoulos. These basic functionalities are largely enhanced by cross-chain interoperability and DeFi built on top. Without these, we will end up with centralized, siloed, censorable networks, which won’t be open APIs and would just replicate the systems of today. In that case the use of blockchain as underlying technology of choice is rather questionable.
And even if for some reason we do want to pursue those use-cases where censorship-resistant money is not required, we still need a reliable, robust digital token of value to fuel our applications and smart contracts in form of a stablecoin for instance (mostly relevant in enterprise setting).
This is why it is so important to get money/finance right first. This is however not the only thing we need to get right.
Decentralized networks in their general form need hardware to provision them, software to secure them, public stakeholders to govern them and a long list of supply-side services to enable them to function in a trustless and distributed manner within a business domain. – Jake Brukhman, Coinfund
Technological Infrastructure – while financial infrastructure is mostly software- and protocol-driven, with certain social and economic aspects to it, hardware-driven infrastructure provision is equally important. Here we are talking about classical PoW mining (solely hardware), as well as more interesting to us generalized mining, mostly present in PoS and hybrid consensus settings. We focus on the nodes of a given network and their categories, their general architecture and set-ups as well as a long tail of supply-side services. Here are just a few examples of the form generalized mining can take:
· Polkadot / Kusama – Validators, Collators, Nominators and Fishermen (both on the relay chain, as well as parachains like Edgeware)
· Layer 2 / State Channels – Hubs, Watchers, Routers, Dispute Resolvers
· Coda / MatterLabs – SNARKers, Verifiers, etc.
· Livepeer – Transcoders, Merkle Miners
· Steemit – Witnesses, Content Creators and Curators
· … and many others
All of these are needed to be provided to the network to ensure it is functioning in a trustless, secure, efficient and distributed manner. So what does it mean to be infrastructure or supply-side service provider to a network and what does it take?
3. The Role of Infrastructure Providers
The genius of Bitcoin is that for the first time, it has managed to align the incentives of a distributed pool of infrastructure providers (miners) who don’t know one another, who could even represent opposite commercial interests and be competitors in their line of business, to contribute resources to the shared network. Attracting high-quality infrastructure providers (e.g. validators) is vital to bootstrap the networks stability, performance and decentralization. Especially for newer protocols without the network effects of Bitcoin, this has been named the most challenging task for any protocol team and project in the space.
The most capitalized PoW-based Layer 1 networks like Bitcoin and Ethereum in its current form, rely on miners to maintain the network. With PoS and most of the Layer 2 technologies, as well as with garden variety permissioned networks, the role of miners is fulfilled by Validators (names vary based on the network), which comprise the core infrastructure of a given network.
With most new blockchain protocols, it is a challenge to bootstrap the network initially, as most start with mostly centralized set-ups, with a goal, or at best a set of incentives, to gradually decentralize.
Note: the term “validator” is used rather loosely here as every network has its own definition of one, from Block Producers (BPs), Delegators, Supernodes, etc.
There are a few main features validators have to possess:
· Efficiency – uptime and availability has to be maximized so that a validator is not missing on any blocks and block rewards.
· Resilience – can be expressed with geographic distribution (geopolitical resilience) as well as heterogeneous set-up, with validators having different resource providers (e.g. cloud, datacenter co-location) and architecture to avoid a potential single validator breach to potentially be able to bring down most of the network.
· Low concentration of voting power – to avoid the 33% attack (PoS equivalent for the 51% attack in PoW) and cartelization of the validator set. A lot of PoS networks have this issue as the initial token distributions between large funds and ecosystem players might not have been so uniform. Some Validators might charge zero fees, thus attracting large share of retail delegations, which can represent a major problem in the long run.
· Reputation – expressed with a brand and/or track record and is especially relevant with the networks with slashing conditions (e.g. Cosmos, Polkadot). In such networks, token holder is seeding trust in a validator to do its job well and will be financially punished if the validator commits a “slashable” offence. These are defined by the protocol and mostly involve downtime and double-signing.
Having validators which fulfill requirements above is a very important point for any blockchain project/protocol. Some major protocol teams are even willing to subsidize said infrastructure (hardware and resources) themselves and/or provide very favorable validator incentives to bootstrap the network and kick-start respective network effects (e.g. Hedera Hashgraph).
Robust infrastructure is a pre-requisite for the network being able to accommodate future adoption at scale.
4. Market for Infrastructure Provision is Growing
The Proof-of-Stake security model space is growing rapidly with some projections indicating a 15-20% share of PoS by the end of 2019. With that, we are seeing the market share of hardware-intensive PoW declining and a more efficiency-focused infrastructure provisioning in form of Validators in their general form getting into the spotlight.
This market share is expected to significantly grow in the next 2-3 years fueled by public chain PoS growth, as well as growth of permissioned blockchain space and the interoperability of both. Here are the key drivers of that growth:
· Major PoS protocols are launching (e.g. Polkadot, Dfinity, Hedera Hashgraph, Ton, Near, Solana, etc.)
· Shift of Ethereum and several other currently PoW-based protocols to Proof-of-Stake (e.g. Cardano, Wanchain, etc.)
· Interoperability and application-specific blockchain vision coming to fruition (mostly driven by Cosmos and Polkadot) with various Zones and Parachains being spun off (Iris Network, Terra, Kava, Alethio, Edgeware, Regen Network, Sentinel, etc.)
· Corporate coins are launching like Libra, Walmart, Allianz, Goldman Sachs
· Public Chain (e.g. Ethereum) adoption by Enterprises, which is now more likely with various privacy layers like Nightfall, Enigma, etc.
· Development of Layer 2 technologies, most of which implement some form of staking mechanism (e.g. Bitcoin Lightning Network, Raiden Network, etc.)
· Large Funds, Exchanges and Custodians are starting to enter the space, offering own staking services to their clients (Binance, Poloniex, Coinbase, etc.)
· Central bank and fiat-like tokens (China’s BPoC, EU, IMF, E-money, etc.)
· This does not account for private/permissioned infrastructure provision for industrial consortia based on Hyperledger, Corda, Ethereum PoA chains, which is also a growing space, albeit harder to measure due to its private nature.
As discussed in previous chapter, blockchain networks are securing significant amount of value, thereby relying on their infrastructure to be resilient, performant and secure. The market for offering these is already measured in billions, with 4+ multi-million VC investments in 2019 Q1/Q2 alone (Bison Trails, Staked, Figment Networks and Infinity Stones).
Most of the blockchain investments conducted so far (mostly via ICOs) were made on the protocol level and were used for building the underlying network. Given current lack of adoption of various protocols and Dapps and thus lack of value accruing to the native tokens (if that at all were a possibility), most of the monetization happened on the level of crypto funds and ICO investors who “cashed out” early.
However, development of the base PoS layer of certain protocols enabled a large array of infrastructure-related business models like generalized mining and supply side services, which is now starting to attract investments as well as it capturing some of the value which was created on the protocol level.
Most of the project teams and founders we talked to are getting extremely agitated once the topic of validation or infrastructure provision comes up, some are even willing to subsidize it. Having a great track record and brand name is growing on importance in validation space when renown validators start to join newer networks and do not have to win over trust from the new community. The networks can also benefit from the reputable validators participating in them in terms of their image.
5. The Case for Stateless Permissionless Money
Once we have figured out that infrastructure provision is indeed a growing and quite interesting cutting-edge business model, the next logical question is which networks to provide infrastructure to (check this thread for some insights on this topic). There are already a lot of PoS networks and even more are going live soon. This choice is extremely important because as infrastructure provider, getting monetized in the native token (in case of at least keeping some of these), one has to believe in the long-term future of the project and share its vision, as building a stakers community and earning their trust in a network can be pretty tough and a long process, combined with ongoing need to govern the network. Here, PoS networks align the interests of infrastructure providers and token holders significantly better than PoW. In addition to that, as we found out in our recent Case Study, contributions to protocol development, value-added services and governance are extremely important to attract delegators.
There are two main ways to look at Financial Infrastructure:
· Permissioness stateless money
· Permissioned corporate money or central banks’ “crypto-fiat”
For someone in crypto for a while, it is not hard to make a case for permissionless stateless money as the most or even the only acceptable foundation of Web3 (which we will do below). However, looking from a business standpoint, some permissioned networks can also play a very important role in driving adoption in short- to mid-term, Libra arguably being one of the examples thereof (if it takes off).
Below we will look at both to find out where do the opportunities lie and which ones might eventually “win”.
Permissionless Stateless Money – Macroeconomic Case
Looking at the global markets and geopolitics in 2019 feels a lot like the movie Big Short and the pre-crisis vibes are in the air. It might be that the first signs of it are coming right from where we are writing from – EUs economic stronghold, Germany.
In times like these, investors tend to flock to gold as a global macro hedge (which is happening currently), or now Bitcoin, as more people are waking up to the fact that Bitcoin does possess store-of-value characteristics and is in some ways superior to gold in that regard. In his recent work, one of the greatest investment minds, Ray Dalio, in his must-read paper Paradigm Shifts wrote:
“It is a good time to ask what will be the next-best currency or storehold of wealth to have when most reserve currency central bankers want to devalue their currencies in a fiat currency system.”
Even though throughout most of the paper he argues for gold, for anyone familiar with crypto it is hard not to see this as a perfect case for Bitcoin and crypto as a whole. Fiat system, which contrary to popular belief only existed since 50 years starts to give a crack, and we need a solid Financial Infrastructure for the digital age we are living in.
Note: Here we are not just talking about Bitcoin, as we believe in its security characteristics and the notion of “hard money”, however it is not composable enough to build DeFi applications natively on top of it. And even if it was (via e.g. Rootstock, etc.), the trade-offs which come with improved composability on Bitcoin will likely decrease the security of Bitcoin, a trade-off Bitcoin does not want to make. We believe other protocols like Cosmos, Tezos, Polkadot and Etherum 2.0, to name a few, contrary to the Bitcoin maximalist’s views, can actually make Bitcoin more usable without it making the said security trade-offs. Combinations of various open-source protocols is what we mean with Financial Infrastructure.
As written by Alex Lange, there are several very important features of sovereign money as opposed to corporate and central bank money:
· Commercial & political neutrality
· Voluntary adoption
· Deflation or predictable inflation
· Decentralized control
· Censorship Resistance
Having barely scratched the surface, the case made above is strong enough to be able to argue that permissionless and stateless crypto is going to play a dominant role in the future of finance.
Permissioned corporate money or central banks’ “crypto-fiat”
Despite the pretty convincing case for stateless money, there are several questions remaining. Could corporate coins like Libra act as stateless crypto on-ramp, eventually strengthening it there where it lacked? USV does actually think so. Is the rather idealistic vision of stateless money becoming The Money to play out, and if so, within which timeframe? What will happen to large players and central banks playing the permissioned card?
We believe it is not an either/or question, as both are very likely to coexist. Corporations still have a major role to play in crypto adoption today. We are here to find out under which circumstances corporate coins can exist and look at the commercial aspects of infrastructure provision regardless of the network’s nature.
Libra, perhaps unintentionally, has drawn a lot of attention to crypto as we have seen from the hearings in US. It could open up more people to digital currency, and given educational effort from our side, realize in which ways is Libra different to Bitcoin and make an educated choice for either of those.
Calibra (Facebook’s wallet for Libra) will most likely have a superb UI/UX, something most of the dapps could learn from. Custody and privacy aspects associated with Libra are still questionable, however most of the people unfortunately care more about convenience and UX, rather than what happens with their data.
Large global players are going to issue own crypto, People’s bank of China (PBoC), Libra, Goldman Sachs, Allianz, Walmart, etc. These players have enough resources and existing users to kick-start network effects.
There has been close to no competition in money with national currencies being run as essentially a monopoly of respective central banks. Rising competition from the tech companies is a sign of healthy development within an industry whose players were enjoying their uncontested positioning for quite a while.
As some estimates show, such permissioned networks like Libra can be a lucrative commercial opportunity for infrastructure providers (discounting potential ethical aspects of such activity). Regardless of the network’s nature, there is a clear need for infrastructure provision which can be satisfied by a variety of actors.
There is an increasing number of start-ups in the staking providers industry (we have interviewed many of them here), however there are other players like corporations, who are currently sleeping through this opportunity. This brings us to the next chapter, given the market and networks at hand, what could corporations actually do about it?
6. Role of Corporates in Today’s Blockchain Space
Coming back to McKinsey statement, “little substance” achieved by blockchain projects in enterprise context and otherwise can be attributed to several key factors. As discussed above, Financial Infrastructure is just not there yet to allow dapps to seamlessly interoperate and move a standardized form of digital value/assets in scalable and privacy-preserving way. In case moving value on-chain is not necessary and the blockchain is utilized solely as an immutable data layer (e.g. for time-stamping) with some scripts on top (smart contracts) one has to seriously question the technology choice.
This is why we see many Proof of Concepts, which get stuck in that stage without going into production. The lack of Financial Infrastructure powered by efficient Technological Infrastructure is what makes it extremely complex for PoCs to move forward along with certain organization-related reasons covered well here. This is true in both B2B and B2C areas.
If we are missing that infrastructure, why not build it?
Financial Infrastructure has to be powered by open-source software in order to stay relevant in the long term (see previous chapter) and there is very little value traditional enterprises can directly extract from it as there is no traditional way to monetize open-source protocol development… except from providing resources to the network in the form of technological infrastructure.
When it comes to infrastructure provision, large enterprises are well-positioned to pursue the Mixed Strategies (see below). These involve running validators in one form or another for a network, taking on various roles like SNARKers, Transcoders, etc. Here, various providers compete based on their efficiency and not on investment-intensive hardware or on proprietary software.
This makes it arguably the most fitting role for more traditional actors to engage with decentralized networks. Germany, where we are writing this from, is famous for its quality and efficiency and we can see its reflection in the number of nodes run for most of the protocols and infrastructure providers based here.
If running an own validator is not an option due to various reasons (regulatory, tax, etc.), providing infrastructure as a service is an alternative. This involves setting up and running managed validators for third parties, as well as potentially providing resources (storage, compute, etc.) as well as additional services (e.g. security audits). This is another option to tap into infrastructure provisioning market without a direct token exposure.
When choosing which networks to provide resources to, the first knee-jerk approach of a corporate looking at infrastructure provision would be to run a permissioned / consortium validator (e.g. Libra), or any other permissioned network coming up (Allianz, etc.). It has well-known brands and companies in the consortium, making a top-management decision about running these easier.
What makes traditional enterprises fit in infrastructure provision is their size. This can directly translate into economies of scale, the amount of expertise, access to capital, and some value-added services like slashing insurance being more plausible.
Which networks to provide infrastructure to?
With most of the public permissionless networks, we find ourselves in a digital commodity space – these networks can be thought of as public goods. As the name of these suggests, one does not need to ask for permission to participate in the network and provide resources to it, there are no “paying clients” or “partners”, there are only efficient resource provision to the network, track record in doing so and transparent communication to potential delegates to win their trust. Having large partners like funds/custodians/exchanges can help to achieve critical mass and get into the validator set (most networks have a limited number of active validators), but this is not a prerequisite.
There are certain companies offering easy node creation and set-up, which is helpful for decentralization of nodes as a whole, however the security and performance aspect of those, directly translating into slashing risks are mostly not taken into consideration. This makes protocols with larger barriers of entry into validation set or higher technical requirements of nodes themselves more interesting from an enterprise standpoint and where they can exercise the “efficiency” competitive advantage. This can counteract the negative stigma sometimes associated with corporations in blockchain space, which potentially might have a negative effect on attracting retail delegates. Here, institutional investors are a more likely bet in short- to mid-term.
PoS in comparison to PoW has way more aligned incentives between miners (infrastructure providers) and token holders/investors as they are directly interested in long-term success of the network as they have more stake in the network itself, expressed in tokens and are incentivized to increase the value of the network.
There is no shortage of networks to provide infrastructure to based on the company’s strategy, business synergies and industry starting from interoperability (Cosmos and Polkadot), decentralized VPN (Sentinel), cross-chain DeFi (Kava), carbon offsetting (Regen Network), private smart contracts (Enigma) to blockchain scaling via zero-knowledge (Coda, Matter Labs) to name a few. The list can go on and on.
By bootstrapping these networks, as corporate, the goal is to ensure these blockchains are production-ready by providing a secure, robust infrastructure for “developers” to focus on building applications to bring the space to “end user” while simultaneously tapping into a commercially attractive and growing market of infrastructure provision.
We see a robust, secure and performant Financial and Technological Infrastructure as the key missing piece, powering the Web3 technology stack on the way to mass adoption.
Depending on the network, there are certain roles one can take on as infrastructure provider and participate in various generalized mining opportunities. These have various technological and economical requirements.
Decision to provide infrastructure to a given protocol, apart from direct incentive mechanisms, has to take into account the long term prospects of the network, as in some sense, the decision on infrastructure provision to a given network is similar to an investment decision a VC normally takes.
PoS, as well as Staking-as-a-Service market is growing very fast, both in terms of its market cap and the number of protocols in both public and permissioned settings. This means the importance of professional infrastructure provision will only grow, especially once we start seeing some major slashings.
It is thus extremely important for the space to make long-term oriented decisions as building secure, robust infrastructure takes time. Libra has definitely turned the spotlight of the mainstream to crypto, as well as infrastructure provision, which is undoubtedly good, regardless of implications of Libra itself.
Taking into account the long-term validity, as well as privacy aspects of something like Libra, leads us as a space to a rather ethical question whether the infrastructure provider is liable for what happens on the application side of the network. This topic deserves a case study of its own.
Having said that, we should not discriminate any given network and foster competition letting free market and network effects identify the “winning” protocols.
We encourage all ecosystem players, both crypto-native as well as those coming from more traditional industries, to look into the cutting-edge infrastructure provision space, as this helps to really understand the incentive machines we are dealing with, which is just another word for blockchain. By providing infrastructure, one is not betting on the success of any given individual use-case, but bets on the network effects and overall economic activity happening on top of a network. This can be considered a less risky undertaking compared to direct investment in any given dapp or use-case.
We hope with this thesis we managed to provide our readers with a rather unorthodox angle to look at the staking ecosystem, thus further contributing to a much-needed education for the better of the overall blockchain space.
About the Authors
Gleb (Glib) Dudka is a strategic thinker and research analyst. He has bootstrapped the blockchain validator operations of T-Systems (Deutsche Telekom) as the first enterprise player in the space. At Staking Rewards he is leading Content and Research / Development.
Mirko Schmiedl is the Co-Founder, CEO and Product Lead at Staking Rewards. He is researching Proof of Stake Networks and yield-bearing assets since 2013. Prior to Staking Rewards he has led a Bitcoin Mining Operation in Southeast Asia.