This piece was first published on Substack May 2023, and has now been minted on Mirror to celebrate web3 Spring. No edits has been made to keep the authenticity of the content, and a new piece that covers latest developments will be published soon
In the previous blog post, I gave a general intro to web3 social. I covered the problems in web2 social networks and explained how open source social networks are looking to solve those. You can read more why we are ready for web3 social. I also covered the app vs. protocol dilemma. the question builders and investors alike are asking: where's the moat?
In this piece, I’d like to take this question one step further. I'd like to suggest a thesis that examines this question through the lens of unit economics. (spoiler alert - some number crunching and assumptions involved). Let’s get right into it!
First i’d like to look at the current TAM of social networks.
Observation: Top 5 Giant tech companies control majority of web2 social networks. (in $ mcap and user base). They hold strong user lockup driven by them controlling the data and users social graphs. That means that these platform are able to capture 100% of the value generated in these platforms.
This value is driven from sales (ad-based revenue, IP and data). This give us a good start to estimate the total pie of economic value created from social networks.
For reference, here are the numbers. (I used ChatGPT where I got numbers based on Q4’21, and Google Bard results dated to January 2023). I used the later in this analysis, reflecting more updated market valuations. I any case the exercise is aimed to be a ballpark and not accurate analysis.
Assumption: In a web3 centric social network world, we can expect a different distribution of value, based on the nature of the tech stack. The social graph is open source, while the applications built on top of them are closed source.
Platforms cannot monetize the entire value to themself. Rather they have to split between the participants
Lets explore some basic assumption:
In web2 social, gravity drives a consolidation of the user base into handful of platforms. Value concentrates into top 5 leading platforms with strong moats and network effects.
This is changing.
Web3 opens the opportunity for any app developer to launch their own front end application on top of open social graphs. Users or creators can sign in with their wallet and skip the cold start problem of joining a new social network app.
That also means users are free to come and leave, which makes it a highly competitive space for applications.
It is safe to assume that the same value (probably greater) will be created and distributed across not 10, rather 100’s or 1000’s of apps. The same value will be captured by multiples layers of the stack:
Protocols
Users
Applications
Protocols - by nature, open source protocols are fork-able. Their moat is derived from the ecosystem built on top of them. Users, integration partners, validators and other ecosystem partners They are also expected to be charging the least % fee. Whatever is necessary to secure or provide financial stability and incentive for the network to work properly.
Web2 social networks take rate is at 100%. We will expect to see low single digit % take rate, spread between the protocols. This assume it is not a winner-take-all case (similar to what we see today between different L1’s at the consenus layer)
Worth noting the protocol layer in this case is not limited to web3 social protocols only. Any integration and utility offered via the app will be charged by underlying protocols. (and offer greater value and utility to the user on the application layer (DeFi, Identity, etc…)
Users - the entire promise of web3 is about more value to creators. I would assume that over time economics will find steady state in users receiving the majority share of the value they create. What are the main reasons ? Competion at the application layer prevents any single app from charging anything above market price. Competition over consumers or creators consolidates into equilibrium steady state. Applications will differentiate in the experience level they offer. They will also be very careful not to extract too much value and be perceived as rent-seeking.
Applications - So we assume that majority of value stays at the hands of the creators. That means applications are fighting over retaining their users. They will try to offer premium and unique experiences, build brands and offer relationships that are beyond just the economics. Apps have the stickiest and closest relationship with the users. They will seek to offer a “Wechat” type of experience that serve the user in everything they need in a single app. Here the game is about UX, building brand and user loyalty.
Let's try to compare to an industry where application and infra are separated. We can compare the cloud infra providers and compare to applications using cloud service as an example. The market cap of the top 3 leading players (AWS, GCP, Azure) is at $2.5T. It's almost equal to the market cap of the top 100 applications using it (Netflix, dropbox etc…) [quote from Tomasz Tungus from Theory Ventures, on 20vc podcast].
Based on this case, we can imagine a world where hundreds of applications built on top of social graph networks. Each one highly specializing in specific domains and use cases.
In web3, protocols start as open-source networks which look to extract minimal rent from users. I’ll assume the protocol layer is the one extracting minimal value (in %). Then I'll split the rest between users and applications. Notice that doesn't mean a protocol cannot be super valuable in total market cap value. In case we end up with a single winner or handful of protocols serving billion of users and hundreds of app. the potential is huge.
Lets try 4 scenarios for a possible split between the players:
In the previous blog I covered potential monetization paths for web3 social applications. That’s just giving some ideas for different biz models these apps can implement. As a guiding principal - any app that is able to capture users attention and demonstrate engagement, could offer various paths to translate that into revenues, which is no different from the existing model in web2. The only difference I believe is that in a web3 social world, more value will have to be distributed vs. captured by the platform.
Let’s try to get a sense of how valuable can a single app become.
Numbers Crunching:
Assuming the above scenarios, what could be a possible valuation in this future if there are leading 10/ 100/ 1000 applications splitting the value currently captured by top 5 social networks ?
Market Cap
Key Take aways:
If we assume similar split of value as seen today in the example i gave of cloud / applications , we could expect that an average app could capture value between $1B to $13B (in average Mcap), in a world that has leading 100 social applications leverage open source social graphs.
Annual Revenue
Key Take aways:
Under the same assumption as above, those apps could see revenue capture of hundreds of millions per year, and that is before we assume they are able to expand the revenue streams enabled on today’s social networks
Web3 further opens the long tail….
This is aligned with the vision of web3 - democratizing access and leveling the playing field, which today mostly controlled by big-tech.
Do you think this can be the trend of the next era of social networks?
Open questions
While it is clear web3 open source protocols spur innovation and encourage the development of applications on top, it is yet to be proven that social applications are able to compete with the incumbents and offer better user experience and capture market share in a highly competitive market that is highly defensible via network effects.
It is important to tackle the questions that are still pending before we can claim web3 social applications are disrupting the existing:
Can web3 social actually challenge and eventually replace web2 to capture that share of value?
Will mainstream users that do not care about ownership make the move to try out new social apps?
What are the innovative new use cases and new forms of social applications powered by web3 that are not just another twitter copy?
Will incumbents be able to transform and adopt a web3 vision (we see Substack doing it, we’ve seen Elon announcing giving up on creators income)
Can web3 applications bypass the closed garden of distribution currently controlled by apple / google stores ?
Will true ownership value could be granted when social apps are dependent on existing platforms that take 30% cut of revenue ?
Will the regulatory unclarity serve as a head wind to newly launched apps that do not hold the resource to handle a legal battle
My next piece will try to address some of the open questions.
Closing notes:
I’ll start with a quote from fellow investor:
"The history told us alpha emerged before the industrial consensus. Uniswap, Curve, AAVE all started before DeFi summer(Q2 2020) OpenSea and Flow started before NFT Q4 2020"
It is clear traditional web2 social networks are not going to disappear anytime soon. But it is also clear an alternative model is rising, offering some compelling advantages to what exist today. As web3 applications adoption become easier and faster, it could be that the killer app for web3 adoption is among this vertical. Since social is embedded in any aspects of our digital life today, it is pretty safe to assume it will be a key component in any use case that will find its way into mainstream adoption.
Stay tuned, it’s going to be an exciting ride for sure!
If you are building a social application, protocol or the combination of them, i’d love to chat ! reach out via lens protocol, Twitter, linkedin or XMTP messaging
Disclaimer: None of the above is intended to serve as an investment advice, nor reflects the opinion of anyone or any entity but my own.
Thanks to the team at Superscrypt (Jacob, Jad, Kishore) for a fun brainstorming session that led to the idea and creation of this post.
Lior
