Web3: A Paradigm Shift for Value Investing

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Evolution is the most powerful force in the universe, the only thing that is eternal, and the driving force behind everything. ——Ray Dalio of Bridgewater Fund

As time goes on, evolution is the main theme of human beings. In the past, changes in the environment were the main cause of evolution.

Advances in technology are now playing an increasingly important role. The advancement of technology can allow quantum mechanics to impact classical theories, complex economics to subvert traditional economics, and digital gold BTC to shake the belief in physical gold for thousands of years. There is every reason to believe that the web 3 revolution driven by blockchain technology is a major evolutionary journey that will subvert many inherent models and concepts, but today we mainly discuss the impact of web 3 on value investing.

Looking back at history will allow us to better find our coordinates today. Therefore, to discuss the impact of technology on value investing, we still start with the change of technology.

1. Paradigm shift of technology

The term "paradigm shift" has been misused now, but if you trace the origin of the term, you will find that there should be very few innovations worthy of the term. Paradigm shift first appeared in the book "The Structure of Scientific Revolutions", which describes the huge changes in the basic theoretical system that can trigger scientific revolutions. What he describes is the long-term and far-reaching changes brought about by the upgrading of basic science and technology.

Since the industrial revolution, the basic technological revolution every few decades has dominated value creation, and has also profoundly affected all aspects of society, such as politics, economy, and lifestyle. This is a very typical paradigm shift:

1) Beginning around 1770: steam engine textile machinery;

2) Started around 1830: steam engine railway;

3) Started around 1875: electric steel;

4) Started around 1910: Petroleum cars;

5) Started around 1970: communication computer;

6) Started around 2000: Chip Internet;

In the process of every major technological change, those industrial groups derived from the core technology will become the main body of value creation at that time. Just look at these giants with the highest market capitalization in our technology cycle: Apple, Google, Amazon, Ali, Tencent..., without exception, are built on chips and Internet technology.

2. Evolution of value investing

Since the technological revolution dominates the creation of value and affects all aspects of society, it will naturally affect investment. If the process of technological change mentioned above is simply classified into: the past (before the maturity of the Internet) and the present (after the maturity of the Internet around 2000), we can see that technology also affects value investing.

brand effect

Brand effect is usually seen in consumer goods, basically to meet the needs of different levels of people (Maslow model), brand effect can play different roles: convenience (reduce search costs), safety, differentiation (show different personalities), Affective attributes (social, self-satisfaction), addictiveness, etc.

A strong brand can bring very high customer stickiness, which can generate continuous growth in cash flow. This type of enterprise is very favored by Buffett-style value investing. Open Buffett's investment list, and you will see a bunch of investment targets based on brand effects: Coca-Cola, McDonald's, See's Candy, DQ... From the final results, we also know how much brand effect can contribute to the return on investment.

Implications for web 3:

If you understand the different levels of brand connotation, then you can easily distinguish the combination of NFT and brand that many people currently admire. Most brands and NFT will not collide with sparks, only those that can bring differentiation and emotion Brands with attributes (social) are likely to have a good interaction with NFT.

scale effect

Before the Internet, another driver of value creation was scale. Different from the brand effect, the scale effect is often brought about by technological progress. After the technology is continuously upgraded, the marginal cost will decrease after the efficiency is improved. We can personally feel that the best examples are cars, TVs, and air conditioners, and the product performance is getting better and better. But the price keeps getting lower and lower until it is cheaply owned by everyone.

Compared with brand effect, scale effect has higher technical content and greater social value (improving people's living standards), but unfortunately, it is not as important as brand effect in terms of investment. Because technology will continue to be upgraded iteratively, it is often difficult for a leading company to maintain its leading edge. A failure of technology upgrade may destroy the past success. From Huawei's road to the top, we can see that many giants have died. In the war of technological upgrading. Therefore, there is a phenomenon that is counterintuitive to ordinary people. Leading technology cannot create a long-term moat. This is why Buffett hardly invests in technology stocks.

Implications for web 3:

The technological leadership of the project is only the beginning of the story. Technology alone is not enough to stand out from the competition.

network effect

The fundamental reason why network effects can surpass scale effects and brand effects is that the way it creates value is exponential growth, rather than the linear growth of the past. Every time a node is added to the network, the value of the network not only increases the value of this node, but also increases the value of all nodes. Therefore, Metcalfe's law uses an index of N^ 2 to measure the growth of network value. Moreover, each network will have a critical point of scale. After breaking through this critical point of scale, the growth curve of the value index will become steeper.

When will the critical point of web 3 for the entire industry come?

In the period dominated by brand effect and scale effect, cash flow has become a very important indicator in value investment. For this type of investment method, there is a sentence that highly summarizes "free cash flow growth driven by high ROE and high ROIC".

But in the era of network effects, cash flow is no longer the most important indicator, and network nodes, links, clusters, etc. have become more important indicators.

Those investors who deeply understand network effects become new investment stars, such as Bill Miller. A 16 Z, a well-known investment institution in web 3, also has deep research on network effects. They even wrote an article listing 13 specific indicators to measure network effects.

Involve

As mentioned above, once the network effect crosses the critical point, the growth curve will be very steep, and there will be a huge first-mover advantage. If you are a few months ahead, the scale of your business may be several times ahead. eBay entered the Japanese e-commerce market only two months later than Yahoo. The time gap between these two months has become a hurdle that eBay will never be able to overcome, and finally surrendered the Japanese market.

At the same time, the phenomenon of the network effect that the winner takes all or eats more will make the market share of the ultimate leader far ahead or even complete monopoly. The most typical example is the monopoly position of WeChat in social networks. Such a huge market is monopolized by one company. , There is almost no living space for the second place.

Therefore, under the blessing of "first-mover advantage" and "winner takes all", players in the Internet industry can only pursue the ultimate speed and try their best to make themselves the leader. This kind of fierce competition is especially obvious in China. 996 has become the standard in the Internet industry.

The gap between rich and poor

The winner-take-all network effect allows the leaders to capture the vast majority of the industry's value, which is only shared by a few stakeholders. At the same time, the rapidly growing network economy has given birth to an increasingly radical financial system, and the currency is going through the entire cycle faster and faster from the central bank to venture capital institutions and then to the capital market.

SPAC allows the shell company to be listed first and then acquire the entity, which accelerates the cash-out of start-ups.

While the Internet elites are rapidly creating value and sharing value, what is even more fatal is that the entire currency cycle has left most of the people behind, and most people simply cannot participate in this cycle of currency and value distribution. And if the government does not have more wealth transfer policies, as in the United States, the gap between the rich and the poor will only intensify, laying the groundwork for social unrest.

Future Paradigm: AI Blockchain

The gap between rich and poor brought about by network effects will become more serious in the case of economic slowdown. There is a very apt analogy. If a tunnel has two lanes, fast and slow, when the overall speed of the tunnel is okay, the gap in the perception of the slow lane (the poor) is not so obvious, but when the overall speed of the tunnel drops, the slow lane (the poor) The perceived gap will become more obvious, and the contradictions between the two lanes (classes) will become increasingly irreconcilable.

Perhaps many people's attention is attracted by more eye-catching issues such as epidemics, wars, and racial conflicts, but the gap between the rich and the poor is the biggest disease of this era. If the above are severe outbreaks, then the gap between the rich and the poor is cancer, which is slow but the most difficult to cure.

To eradicate the dilemma caused by the gap between the rich and the poor, there are only two ways: speed up the tunnel as a whole (increase productivity) and reduce the gap between lanes (value decentralization), and the technologies that can undertake this task are: AI and district Block chain; the industrial clusters derived from the two major technologies of AI block chain in the future will be the next paradigm of economic development.

Ecological Effect VS Network Effect

Although the network effect has been extremely powerful in the past 20 years and has dominated value creation, it is playing a limited game. It naturally has a strong desire for monopoly and pursues becoming the king of the game, thus ending the game. Based on the ecological effect generated by web 3, the reason why it can surpass the network effect in the future is that it is playing an infinite game. What the ecological effect pursues is to allow the ecological prosperity and the game to continue, not to end the game.

The characteristics of infinite games: no boundaries, encourage innovation, no audience, everyone is a participant. These features will promote web 3 to transform more scenarios, create a more prosperous ecology, and allow more people to participate in value sharing on the basis of the past Internet.

However, this upgrading process does not happen overnight. The ecological effect of web 3 is still built on the network effect, that is to say, the web 3 project begins with the network effect and ends with the ecological effect.

BTC Network Effects

BTC, the original species in the Crypto world, has a very strong network effect: the network effect of consensus. The consensus of one person is insignificant, and the consensus of a group of people becomes belief. The consensus network effect is like a desert. A few sands are easily blown away by the wind, but when countless sands gather into a desert, no amount of wind can shake it. This is why the BTC moat is so strong.

If we compare other species (such as: religion, gold) that also have consensus network effects, we will find that they have some things in common: the coverage is extremely wide, the duration is extremely long, and if you can’t kill him at once, it will be very difficult. Difficult to eliminate. From these common points, we can also vaguely see the future of BTC.

Ecological effects of ETH

The best case for the ecological effect of web 3 is ETH. If we analyze the ecological effect of ETH with the framework of infinite games:

a) Boundless, all project owners can participate in the ETH ecology;

b) Encourage innovation. Every innovation outbreak of the application will bring a substantial increase in the value of ETH, and even ETH is absorbing innovative technologies from other public chains to complete its own upgrade;

c) Without an audience, everyone can participate in the construction of the ETH ecosystem, not just users.

If the ecological effect of ETH is analyzed with the frame class of dissipative structure:

a) An open system that continuously exchanges assets, energy, and information with the outside world. Defi exchanges financial assets, NFT represented by PFP exchanges social assets, DAO allows outsiders to come in to do work to exchange energy, and oracles exchange information. The more assets, energy, and information interaction scenarios that can be created, the stronger the ecosystem.

b) Positive feedback. The application ecology grows, the price of ETH currency rises, and more and more stakeholders participate in the construction. The security and performance of ETH continue to improve, which can support more application ecology.

c) Non-linear mutation. The value growth of ETH cannot only be expected from the continuous growth of DeFi, but more from the sudden growth and more composability brought about by new innovations on the new track.

V. Conclusion

Human society is always overcoming difficulties one by one, thus entering the next cycle of prosperity. When the current cycle has come to an end, and all problems can no longer be solved by the original methods (money release, fiscal stimulus), subversive changes must be carried out. The development paradigm dominated by AI and blockchain is not the choice of a person or an organization, but a necessity of the times.

Just as Ren Zhengfei said, "Don't be opportunistic in front of the big era." Faced with such a historical opportunity, any timing is short-sighted and speculative. Only early investment and embrace of construction is the right choice.

Buffett-style traditional value investing has formed a very complete system after decades of research by countless people, and many people have a deep understanding of it, but the downside is that it is difficult for you to earn the recognition Money is more about the game of information and trading psychology; only a few people have thoroughly studied the modern value investment of network effects, but at least you can find a formed framework.

During the development of the web 3 industry, the ecological effect will become the most important moat in value investing. Everything is still in a state of chaos and fuzziness, and more ambitious people are still waiting to dig and build.