Building A Competitive Advantage in Web3
How to build a moat in a post "Network Effect" era.
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Web3 is reinventing every aspect of businesses as we know them today. Data portability in Web3 might represent the most significant social shift in years, turning power from platforms to users.
This new paradigm creates enormous opportunities for new entrants that will challenge well-established businesses more easily, but also new challenges for big companies that will have to create new moats beyond data lock-in and network effect.
As the Head of Community at Coinvise, this is a new paradigm I often think about. How could Coinvise get the most out of data interoperability? And what moat can we build to keep our users over the long term?
Because these questions will only become more important over the years for thousands of Web3 startups, I'd like to bring you through my reflection here and explore the few perspectives we already have on how those challenges will play out.
Without further ado, let's get into it.
1 - The Three Pillars of Competitiveness in Collaborative Economies
Before starting, and because we’ll use this term often in this essay, what's a "moat"?
A moat is defined as:
"The ability for a business to maintain the competitive advantages that are expected to help it fend off competition and maintain profitability into the future."
And let me tell you, building a moat in Web3 is much more complex than in Web2.
In Web2, the world's most successful companies all had a competitive advantage. The most famous competitive advantage being the concept of “Network effect”, which consists of keeping the data behind a walled garden, making the more users coming on the platform, the more valuable the platform.
But as Jad Esber and Scott Kominers explained in Why Build in Web3, Network Effect doesn't really work anymore in Web3:
Users' ability to take their data from one platform to another introduces new sources of competitive pressure and likely requires firms to update their business strategies.
Ones might argue that with Web3 comes tokens, and that this new variable can help create a network effect by driving new users to reach the inflection point where application utility will surpass the economic utility. Still, I doubt it allows new entrants to create real defensibility through network effect over the long term.
The Token Network Effect can help overcome the cold-start problem but won't change the structure of Web3 that is interoperable and composable by nature.
Building a moat in Web3 is more difficult than in Web2 because we've never had digital currencies before, nor digital property rights or digital organizations built natively for the internet. Everything needs to be re-think, and there are so many more (and new) dimensions and possibilities that it's hard to know where to start.
So is there anything out there that can replace the so-loved Web2 Network effect by leveraging Web3’s new capabilities?
Well, I'm not smart enough to answer this question simply by myself, but luckily enough we have Twitter, and some brilliant minds have already taken the time to explore a few possibilities.
In a (not so recent) tweet, David Phelps shared his vision of the different things Web3 companies could leverage to create a moat:
For him, there are three main options:
Liquidity - Having ample liquidity enables faster transactions with more balanced prices. Liquidity is a flywheel that draws users, provides more liquidity, and draws more users in turn.
Community - Some people say, "technology isn't the moat. Community is." They're right - you can replicate the technology, but you can't replicate people.
Composability - If you create a module that can plug into 1000 products easily, you'll get attention, validation, and auditing verification that will draw more demand.
I've been admiring David's thoughts for a while (and he is well-respected in the space), so we'll dive into these three principles as a guide for competitiveness in a space that's defined by an open and collaborative nature and see what we can get out of it.
2 - Liquidity As a Pillars of Competitiveness
While in theory, having large liquidity seems like a good competitive advantage, in practice, history has shown that liquidity (alone) is not enough to retain users over the long term.
DeFi exchanges such as Uniswap have been incentivizing users to pool liquidity, meaning depositing money, in their exchanges by offering them high APY (Annual Percentage Yield - aka High Return On Investments).
But, as soon as there was better yield elsewhere, users left…
Don't get me wrong. I completely get that deep liquidity means price stability and fewer risks for users and that DEX (Decentralized exchanges) have all interest in retaining liquidity providers. But unfortunately, incentives aren't aligned here, and this is not what liquidity providers are looking for.
Liquidity providers are, as Ian Lee said it so well, "Emotionless, yield-hungry savages who put their capital to work in the highest returning opportunity."
For those reasons, I highly doubt the possibility of new companies creating a moat solely from liquidity.
Lucky us, David has a trick up each of its countless sleeves, and we still have two potential competitive advantages to explore: Community & Composability.
3 - Community As a Pillars of Competitiveness
In a recent tweet, Alex Masmej stated that "Liquidity is undifferentiated, social experiences are not."
And I must admit, I absolutely agree with him. "Social experiences", which we could translate by "community", are everything in Web3.
3.1- You can replicate technology…
Because Web3 data is on open ledgers, new entrants can see the people part of competitor's projects by looking at the NFTs they hold or how much they're involved in it by looking at the number of social tokens they have, making the surface area for attack by new networks much higher.
Because of this principle of composability - meaning data is interoperable and allows any apps to communicate and work with each other - new projects can easily incentivize specific users to move over to them through a "Vampire attack" strategy. Basically, identifying power users of competitors' projects through accessible data and creating a *somewhat* similar project, adding strong enough incentives to "suck" power users out of your platforms.
That's what LooksRare did to Opensea (NFT marketplaces), SushiSwap to Uniswap (crypto exchanges), and we'll see more and more Vampire attacks in the future. This is inevitable.
3.2 - …but you can't replicate people.
And for those reasons, new Web3 startups have to double down on community.
Community and culture are what make the real difference and what can lead to a moat. Without strong social experiences, your existing user base can just pick up and leave whenever a more exciting protocol pops up, taking their tokens and patronage along with them.
Web3, despite facilitating new entrants to copy established companies, also provides those companies new powers.
Indeed, in Web3 networks, users participate in the economic upside of the network. They are rewarded for the time invested in helping build it. With the platform's utility increasing over time, more people will want to participate in its digital economy, and the token will gain value, rewarding early contributors for their hard work. Web3 is about profit-sharing and revenue tokenization.
New entrants must leverage those new tools at their disposal to share ownership and create trust at scale, attracting new members keen to help accomplish ambitious goals. In this new Web3 world where community is everything, retaining active members will become one of the most important skills to have.
4 - Composability As a Pillars of Competitiveness
Finally, composability may be the root of the feared vampire attacks, but it's also the best way to create a moat. In Web3, it's simply much easier for users to move from one platform to the other.
In Web2, two concepts allow companies to create network effects.
The Switching costs - which describe how difficult or expensive it is for a user to switch from one product to another,
The Multihoming costs - which describe how easy (or likely) it is to use multiple competing networks simultaneously.
The thing is, in Web3, those costs are almost 0. The all-in-one DAO tools that would attract all users, such as Meta, didn't really work because we don't live in this "all-or-nothing" space anymore. Web3 users can take their data from one platform to another at almost no cost, and using multiple platforms is actually encouraged.
Web3 is a modular space where users have certain purposes and needs and where they find the tool to do it and piece those together. Everything in Web3 is already interrelated, and there's no problem with reprocessing data from one platform to another.
And so, Web3 startups shouldn't fear composability but embrace it.
The community's ability to carry their tokens wherever they go is a feature, not a bug. It will force platform builders to design bridges among protocols and platforms to incentivize a circular economy. Users aren't lost if they're still transacting with you through their new platform of choice.
They aren’t lost if you're already there to meet them wherever they go.
Closing thoughts
As shown in this essay, community & composability are key to creating a moat.
But the concept itself implies restriction of movement. Again, a moat is defined as the ability of a business to maintain the competitive advantages that are expected to help it fend off competition. But if we're building an industry that prides itself in its interoperability, we should also shift our perspective from gatekeeping to bridge-building.
We should focus on offering users the ability to navigate web3 as they please by building bridges while establishing a sustainable data flow among platforms to encourage a circular economy. Web3 is an open-source positive-sum game, and companies simply can't fight with this.
As Jad Esber and Scott Kominers cited:
Web3 is based on the premise that there's an alternative to exploiting users for data to make money — and that instead, building open platforms that share value with users directly will create more value for everyone, including the platform.
For those reasons, building a web3 moat will require companies to redefine their structure and business model from the ground up. They will have to focus on building bridges (composability) and delig But it will result in more value created.
As someone who went through the ups & downs of content creation and Web3 community building, I can assist you in two ways:
The 5 Pillars of Web3 Community Building: If you need help starting & growing your community, I’ve written a free 40-pages guide with all the best practices I've discovered to launch, grow and monetize your Web3 community. Grab a copy here:
The Modern Web3 Community Builder - A Handbook to Collective Symbol System: If you’ve already created a community and are now looking to unlock the next phase of your journey, I’ve created a written course that’ll show you how to arouse a feeling of belonging and expand your community’s culture.