In August of 2020, Ali Yahya authored a great thread on what he termed the “network flywheel”. Given that blockchains are open and permissionless, they cannot really create defensibility the way traditional companies do (via the privileged access to some resource or the pseudo-ownership over one side of the network (Ben Thompson & super aggregators)). However, they can create defensibility through the proliferation of a vibrant community, set of miners / validators, contributors, and some investors / speculators. Overall, Yahya details the construction of the following network flywheel, which is paramount to a blockchain’s success:

As one can see above, the network flywheel runs off the interaction of contribution from multiple parties. First, the founders create the protocol with a powerful vision, which they communicate to the world. This vision should be compelling enough that some community starts to form around the vision— these are the first dev contributors, advocates, and users. This should create some investor interest as early momentum makes it accretive to generate monetary value. Now, there is a token that has value, which presents a profitable opportunity for miners or validators. These start to mobilize equipment / stakes to secure the network. With this, somewhat of a functional platform arises. A functional platform then means opportunity for developers and other founders to build on top — a true ecosystem is starting to evolve! However, their projects cannot exist in isolation… they need to be useful and present some form of value. With this, end users come in and they bolster the community around the founding team. The cycle is complete and positive reinforcement can create momentum to power this flywheel over time. So much momentum can be created that the founding team can move on, and the flywheel still runs. A decentralized ecosystem has been nurtured.

While Yayha’s framework was used to shed light on blockchain networks, I am of the opinion that one can apply it, or at least parts of it, to tokenized protocols that exist on top of these blockchains. Zooming in on the ‘useful applications’ part of the network flywheel, we have another inner flywheel that exists.

Applying that same model to protocols atop blockchains, we see similar components. In certain protocol economies, you have the founders and their vision, the investors / speculators that help catalyze some value, the stakers / security providers that can empower platform functionality, the devs / contributors that build out the protocol or build on top of it, and the users that find value in using it and help build the community. Where can one see this in DeFi, for example? Say you have a lending or options protocol — founders come in with the vision and beta version, token is dropped and investors create some price action, in addition to holding it some token holders stake it in a security module, this lowers the cost of capital on the network / makes it more viable so contributors keep building it out along with more users finding it useful, and community starts to strengthen. There are some slight creases in the analogy, but it still makes sense. Now, the analogy does not apply to every tokenized protocol. However, this analogy could definitely be informative as a guide for long-term protocol success. Currently, the craziness of the market may obfuscate lacking components of the network flywheel. The token price or community hype provides illusions of success when in the current form the flywheel may not ever kickstart. So, what are the most common pitfalls out there?

It may be that the token has no real value. At first, things seem great at launch, however, if the token is just used as a medium of transaction in the protocol or some type of pure reward mechanism, etc. then its long-term value proposition is weak, and over time more selling than buying will lead to a negative spiral caused by price decline. This can be seen in secondary P2E gaming tokens or pure marketplace currency tokens. A defensible ecosystem should have a token that has real utility, some value accrual, or provides value to the ecosystem’s functioning. This is why tokenomics is so important. As I have stated in the past, brainstorming tokenomics and constantly revising / testing them is crucial in the process of launching a protocol and managing it. A failed token design could explode in one’s face directly, however, most of the times it actually boils up over time and then suddenly fails as certain variables trigger a negative spiral. Thus, designing a token with value is key. Whether it is a staking security model, a utility model enhancing platform usage, or a model that drives liquidity in the protocol, a worthy token model can make a big difference in the success of the network flywheel.

Sometimes there can be a great vision, the investors are there, and there is an interesting token model… but there is no real functionality. This one is obvious, but it can be missed by so many in the moment of excitement, promises, and bubbly markets. Making sure that there is real functionality in the network is key — a working, secure protocol makes it worthy for real contributors to come and build. Some drivers of functionality are the following: great integrations, logical platform security systems, controllable parameters / processes, among others. The good talent won’t come to build on a protocol that lacks the ability to actually function. Now, do there always need to be stakers, per the diagram? No, governance comes into this component nicely. Systems for controlling parameters (i.e. lending protocols) or an expensive governance token for security purposes (i.e. oracles) are applicable here.

Ah, the hot topic in many facets of crypto — is this protocol actually useful? Why will end users come to use the protocol? Why will they increase their usage and expand to using other features? These are important questions. While they could be answered easily, their performance in reality can be dismal. Perhaps a protocol has an interesting idea, but the use case is too early or is not really there. Perhaps it is a good idea, but there is a competitor that just does it better for cheaper and with more features. I don’t believe that founders fail to answer this, it is rather just that it can be hard to achieve the answers in reality. Driving useful applications comes down to a great vision, a deep understanding of the space and the target market, being knowledgeable on competitors and their performance / their gaps, and, best of all, understanding the user. This last one can be the toughest at times — am I going after the DeFi degen? The institution? The new web3 user? I am a firm believer that creating useful applications is derived from maintaining a ‘customer first’ mentality. Now, it is totally fair for your customer to change over time; in fact, recalibrating your network flywheel to a more suitable customer can be a great action that enhances the longevity and strength of the flywheel. Bottom line: make sure there is real use for the protocol.

There is a lot going on in the network flywheel. While Yayha did a phenomenal job at creating an understandable framework, it did have the byproduct of obscuring the tough details behind both making all the key components work themselves and making them work interdependently. At the end of the day, a protocol could have all the components in the short-term, but if they are not operating well together, then the flywheel won’t get to the point of acceleration it needs and decay may settle in. The truth of the matter is that the network flywheel can sometimes be more like a Swiss watch — there are several gears turning concurrently and for a founding team and community to manage that can be tough. This is where the softer qualities can be very important — proper communication, openness and community, inspiration, and thoughtfulness can be the oil to getting the gears turning.

As a founder, community contributor, or investor, knowing your flywheel, how to monitor each part of it, and where the opportunities lie for improvement are crucial in determining the long-term success of the protocol. Another point to note is that flywheels can change over time, and this is totally okay, in fact sometimes really needed. Network flywheels build defensibility and generate value for an ecosystem… understand your flywheel closely.

Disclosure:* This blog series is strictly personal/ educational and is not investment advice nor a solicitation to buy or sell any assets. It does not represent any views from where the author is working — all views, opinions, and arguments are the author’s. Please always do your own research.*

In August of 2020, Ali Yahya authored a great thread on what he termed the “network flywheel”. Given that blockchains are open and permissionless, they cannot really create defensibility the way traditional companies do (via the privileged access to some resource or the pseudo-ownership over one side of the network (Ben Thompson & super aggregators)). However, they can create defensibility through the proliferation of a vibrant community, set of miners / validators, contributors, and some investors / speculators. Overall, Yahya details the construction of the following network flywheel, which is paramount to a blockchain’s success:

As one can see above, the network flywheel runs off the interaction of contribution from multiple parties. First, the founders create the protocol with a powerful vision, which they communicate to the world. This vision should be compelling enough that some community starts to form around the vision— these are the first dev contributors, advocates, and users. This should create some investor interest as early momentum makes it accretive to generate monetary value. Now, there is a token that has value, which presents a profitable opportunity for miners or validators. These start to mobilize equipment / stakes to secure the network. With this, somewhat of a functional platform arises. A functional platform then means opportunity for developers and other founders to build on top — a true ecosystem is starting to evolve! However, their projects cannot exist in isolation… they need to be useful and present some form of value. With this, end users come in and they bolster the community around the founding team. The cycle is complete and positive reinforcement can create momentum to power this flywheel over time. So much momentum can be created that the founding team can move on, and the flywheel still runs. A decentralized ecosystem has been nurtured.

While Yayha’s framework was used to shed light on blockchain networks, I am of the opinion that one can apply it, or at least parts of it, to tokenized protocols that exist on top of these blockchains. Zooming in on the ‘useful applications’ part of the network flywheel, we have another inner flywheel that exists.

Applying that same model to protocols atop blockchains, we see similar components. In certain protocol economies, you have the founders and their vision, the investors / speculators that help catalyze some value, the stakers / security providers that can empower platform functionality, the devs / contributors that build out the protocol or build on top of it, and the users that find value in using it and help build the community. Where can one see this in DeFi, for example? Say you have a lending or options protocol — founders come in with the vision and beta version, token is dropped and investors create some price action, in addition to holding it some token holders stake it in a security module, this lowers the cost of capital on the network / makes it more viable so contributors keep building it out along with more users finding it useful, and community starts to strengthen. There are some slight creases in the analogy, but it still makes sense. Now, the analogy does not apply to every tokenized protocol. However, this analogy could definitely be informative as a guide for long-term protocol success. Currently, the craziness of the market may obfuscate lacking components of the network flywheel. The token price or community hype provides illusions of success when in the current form the flywheel may not ever kickstart. So, what are the most common pitfalls out there?

It may be that the token has no real value. At first, things seem great at launch, however, if the token is just used as a medium of transaction in the protocol or some type of pure reward mechanism, etc. then its long-term value proposition is weak, and over time more selling than buying will lead to a negative spiral caused by price decline. This can be seen in secondary P2E gaming tokens or pure marketplace currency tokens. A defensible ecosystem should have a token that has real utility, some value accrual, or provides value to the ecosystem’s functioning. This is why tokenomics is so important. As I have stated in the past, brainstorming tokenomics and constantly revising / testing them is crucial in the process of launching a protocol and managing it. A failed token design could explode in one’s face directly, however, most of the times it actually boils up over time and then suddenly fails as certain variables trigger a negative spiral. Thus, designing a token with value is key. Whether it is a staking security model, a utility model enhancing platform usage, or a model that drives liquidity in the protocol, a worthy token model can make a big difference in the success of the network flywheel.

Sometimes there can be a great vision, the investors are there, and there is an interesting token model… but there is no real functionality. This one is obvious, but it can be missed by so many in the moment of excitement, promises, and bubbly markets. Making sure that there is real functionality in the network is key — a working, secure protocol makes it worthy for real contributors to come and build. Some drivers of functionality are the following: great integrations, logical platform security systems, controllable parameters / processes, among others. The good talent won’t come to build on a protocol that lacks the ability to actually function. Now, do there always need to be stakers, per the diagram? No, governance comes into this component nicely. Systems for controlling parameters (i.e. lending protocols) or an expensive governance token for security purposes (i.e. oracles) are applicable here.

Ah, the hot topic in many facets of crypto — is this protocol actually useful? Why will end users come to use the protocol? Why will they increase their usage and expand to using other features? These are important questions. While they could be answered easily, their performance in reality can be dismal. Perhaps a protocol has an interesting idea, but the use case is too early or is not really there. Perhaps it is a good idea, but there is a competitor that just does it better for cheaper and with more features. I don’t believe that founders fail to answer this, it is rather just that it can be hard to achieve the answers in reality. Driving useful applications comes down to a great vision, a deep understanding of the space and the target market, being knowledgeable on competitors and their performance / their gaps, and, best of all, understanding the user. This last one can be the toughest at times — am I going after the DeFi degen? The institution? The new web3 user? I am a firm believer that creating useful applications is derived from maintaining a ‘customer first’ mentality. Now, it is totally fair for your customer to change over time; in fact, recalibrating your network flywheel to a more suitable customer can be a great action that enhances the longevity and strength of the flywheel. Bottom line: make sure there is real use for the protocol.

There is a lot going on in the network flywheel. While Yayha did a phenomenal job at creating an understandable framework, it did have the byproduct of obscuring the tough details behind both making all the key components work themselves and making them work interdependently. At the end of the day, a protocol could have all the components in the short-term, but if they are not operating well together, then the flywheel won’t get to the point of acceleration it needs and decay may settle in. The truth of the matter is that the network flywheel can sometimes be more like a Swiss watch — there are several gears turning concurrently and for a founding team and community to manage that can be tough. This is where the softer qualities can be very important — proper communication, openness and community, inspiration, and thoughtfulness can be the oil to getting the gears turning.

As a founder, community contributor, or investor, knowing your flywheel, how to monitor each part of it, and where the opportunities lie for improvement are crucial in determining the long-term success of the protocol. Another point to note is that flywheels can change over time, and this is totally okay, in fact sometimes really needed. Network flywheels build defensibility and generate value for an ecosystem… understand your flywheel closely.

Disclosure:* This blog series is strictly personal/ educational and is not investment advice nor a solicitation to buy or sell any assets. It does not represent any views from where the author is working — all views, opinions, and arguments are the author’s. Please always do your own research.*