Recap
Last week, we delved into layers that make up the Blockchain architecture as below :
- Layer 0 - Hardware & Networking
- Layer 1 - Protocol Layer
- Layer 3 - Transaction Layer
- Layer 4 - Application Layer
Internet Protocol
The objective of today's discussion is to understand the underlying structure of the internet and the source of monetary value accrual. This is then compared to the underlying structure & protocols in a Blockchain & the source of its monetary value accrual.
We discussed this briefly in one of my earlier blogs. We will get into more details now.
Image by Thomas Ulrich from Pixabay
First of all, what is the internet?
Very simply, the internet is a global network of billions of computers & other electronic devices. (Source : here)
What happens when billions of computers get connected to each other? There is flow of information across these billions of computers. Information can be text, images, videos etc. Now, how does this information travel across the internet?
This is made possible through something known as Internet Protocols. A protocol is a language that is used between computers & is a set of rules that governs communication of data over the internet.
The data that is transmitted over the internet is broken down into smaller packets at the source computer. These packets then travel from source to destination using the shortest and most efficient path over the network. Once these packets reach the destination computer(s), these packets are then put back together at the destination computer(s) and the data is displayed accordingly. This is all done using the TCP / IP protocols.
There are multiple protocols governing this transfer of data & information like SMTP / POP3 (for emails), TCP / IP (for data transfer), HTTP / HTTPs (for hyperlinks) etc. These protocols are like traffic signals on major highways. The people who drive on the highway are the data. The signals work in alignment to ensure smooth flow of traffic from one location to another. No one "owns" the internet and the underlying protocols. The infrastructure is available to all at no cost.
Companies like Google, Microsoft, Meta, Twitter etc build their applications or software on these protocols & monetize them. In other words, the monetary value is accrued in the application layer rather than the underlying protocols.
Check out the market cap of these companies:
Google - $ 1.56 Trillion
Apple - $ 2.36 Trillion
Amazon - $ 1.18 Trillion
Meta - $ 464.81 Billion
(Source : here)
We can see the application layer taking most of the value space in Web 2.0.
Blockchain Protocols
In a blockchain, this relationship between applications & protocols is reversed. Let us take the example of two big platforms in crypto world - Bitcoin & Ethereum. The market cap of these companies as of date is
Let us see the market cap of some applications on Ethereum :
Dai- $ 6.9 Billion
The Sandbox - $ 1.62 Billion etc
(Source :here)
It can be seen that the market cap of the applications on Ethereum base (We will get into Ethereum soon!) is far less than that of Ethereum itself on which these applications are built. Now, who benefits from this? The investors who invested in Eth (the token or "currency" of Ethereum Blockchain) who will see their investment value increase as more applications are built on the Ethereum platform & usage increases.
In BItcoin Blockchain, customers pay transaction fees for funds transfer which are paid to the validators & miners who maintain the infrastructure for transaction processing & proof of work.
Hence, unlike Web 2, the investors of the protocols also see positive value addition from their investments in the protocol platforms more than the investors of the applications on those platforms.
This can be visualized as below :
It is posited that there are two reasons why the value extraction dynamic got flipped where the protocol layer accrues more value compared to the application layer :
- Shared Data & Network
- Introduction of Tokens
Shared Data & Network
The transactions in a Blockchain are stored in decentralized ledgers maintained by individual nodes and not in centralized servers. Hence, the applications being built on top of these protocols need not worry about data servers or infrastructure for maintaining the data.
However, the above depends on the types of data which can be accessed publicly and those that need to be kept private. That is a discussion for later!!
Introduction of Tokens
Let us take this opportunity to introduce the concept of Tokens or more appropriately protocol tokens which are required to access the services provided by the protocol. Consider an example of any children's park. Normally, we pay fiat money and the park provides us with a token which can be used in various games or sections of the park. This token is called a utility token for using the facilities in the park.
If an application wants to make a funds transfer from one account to another, the funds are held in the Ethereum blockchain and hence some Eth (the protocol token for Ethereum) would be paid as commission to the underlying protocol for data storage, transaction processing, computing power etc).
Thus, more applications mean more services taken from the underlying protocol which increases the network effect for both the application and the underlying protocol.