Original title: A New Framework For Identifying Moats In Crypto Markets

Original author: Robbie Petersen, Delphi Digital analyst

Original translation: Ismay, BlockBeats

Editor's note: In the current competitive crypto market, the concept of moat is no longer limited to traditional liquidity and TVL. With the rapid development of DeFi applications, relying solely on liquidity advantages is no longer enough to remain invincible in the long run. This article delves into how crypto applications can build truly defensible moats through branding, user experience differentiation, and the continuous introduction of new features. By analyzing cases such as Uniswap and Hyperliquid, we reveal that in this uncertain industry, continuous innovation is the key to resisting competition and achieving value capture.

The success of every company - whether it is a tech giant or a century-old store - can be attributed to its moat. Whether it’s network effects, user migration costs, or economies of scale, moats ultimately allow companies to evade the natural laws of competition and sustainably capture value.

While defensibility is often an afterthought for cryptocurrency investors, I believe the concept of moats is even more important in the current market context. This is because there are three unique structural differences in crypto applications:

· Forkability: The forkability of applications means that the barriers to entry in the crypto market are lower.

· Composability: Because applications and protocols are interoperable, the switching costs for users are inherently lower.

· Token-based user acquisition: Using token incentives as an effective user acquisition tool means that the customer acquisition cost (CAC) of crypto projects is structurally lower.

Together, these unique properties accelerate the laws of competition in crypto applications. Once an application turns on the “fee switch”, not only will there be countless other indistinguishable applications that provide similar but cheaper user experiences, but there may even be some applications that subsidize users through token subsidies and points.

Logically, without a moat, 99% of applications will inevitably fall into a "price war" and will be unable to avoid the fate of commoditization.

While we have many precedents and inspirations for understanding moats in traditional markets, we lack a corresponding framework that can explain these structural differences. This article aims to fill this gap, deeply explore the fundamental elements that constitute a sustainable moat, and thereby identify a small number of applications that can sustainably capture value.

A New Framework for Evaluating Application Defensibility

Warren Buffett, the “King of Defensibility,” has a simple but effective way to identify defensible companies by asking himself, “If I had a billion dollars and built a business that competed with this one, could I capture a significant amount of market share?”

With a few tweaks to this framework, we can apply the same logic to crypto markets, taking into account the structural differences mentioned earlier: “If I fork this app and invest $50 million in a token subsidy, can I capture and maintain market share?”

When you answer this question, you are essentially modeling the laws of competition. If the answer is “yes,” then it’s likely only a matter of time before an emerging fork or undifferentiated competitor will erode the app’s market share. Conversely, if the answer is “no,” then the app likely possesses the qualities that I believe are common to all defensible crypto apps.

“Unforkable” and “Unsubsidizable” Properties

To better understand what I mean, take Aave as an example. If I fork Aave today, no one will use my forked version because it will not have enough liquidity for users to lend, and there will not be enough users to borrow this liquidity. Therefore, TVL and two-sided network effects are “unforkable” characteristics in lending markets like Aave.

However, while TVL does provide a certain degree of defensibility to lending markets, the key is whether these characteristics are also immune to subsidies. Imagine that a well-funded team not only forked Aave, but also designed an incentive plan of up to $50 million to acquire Aave users. If competitors can reach a competitive liquidity threshold, then users may not have much motivation to switch back to Aave because the lending market is essentially undifferentiated.

To be clear, I do not foresee any team successfully bleeding Aave anytime soon, and subsidizing $12 billion in TVL is no small task. However, I do believe that there is a risk of losing significant market share to other lending markets that have not yet reached this scale. Kamino recently provided a precedent in the Solana ecosystem.

Also, it is worth noting that while large lending markets like Aave may be able to fend off the threat of emerging competitors, they may not be fully able to defend against lateral integration from adjacent applications. For example, MakerDAO's lending arm Spark has taken over 18% of market share from Aave since its Aave fork in August 2023. Given Maker's market position, they have been able to effectively attract and retain users as a logical extension of the Maker protocol.

So, in the absence of other features that cannot be easily subsidized (such as CDPs embedded in the DeFi market structure), the structural defensibility of lending protocols may not be as strong as people think. Ask yourself again - if I fork this application and invest $50 million in token subsidies, can I seize and maintain market share? - I think the answer is actually yes for most lending markets.

Front Ends Will Capture More Value

The prevalence of aggregators and forked front ends complicates the defensibility issue in the DEX market. Historically, if you asked me which model was more defensible - DEXs or aggregators - my answer would obviously be DEXs. At the end of the day, front ends are just different perspectives on the back end, and switching costs between aggregators are inherently lower.

In contrast, decentralized exchanges own the liquidity layer, and the switching costs of using a forked exchange with less liquidity are much higher, which results in more slippage and worse net execution outcomes. Therefore, given that liquidity is unforkable and more difficult to subsidize at scale, I have argued that DEXs are more defensible.

While this view remains true in the long term, I believe the balance may be tipping towards the front end, with more and more value being captured by the front end. My thinking boils down to four reasons:

Liquidity is more of a commodity than you think

Similar to TVL, while liquidity is inherently “unforkable,” it is not immune to subsidies. There are many precedents in DeFi history that seem to confirm this logic (e.g., SushiSwap’s blood-sucking attack). The structural instability of the perpetual contract market also reflects the fact that liquidity alone cannot be a sustainable moat. The rapid pace with which numerous emerging perpetual DEXs have been able to gain market share suggests that the barriers to launching liquidity are inherently low.

In less than 10 months, Hyperliquid has become the highest volume perpetual DEX, surpassing dYdX and GMX, which each held over 50% of the perpetual market.

Front Ends Are Evolving

Today, the most popular “aggregators” are intent-based front ends. These front ends outsource execution to a network of “solvers” who compete to provide the best execution for their users. Importantly, some intent-based DEXs also tap into off-chain sources of liquidity (e.g., centralized exchanges, market makers). This enables these front ends to bypass the liquidity onboarding phase and immediately provide competitive, or even better, execution results. Intuitively, this weakens the role of on-chain liquidity as a defensive moat for existing DEXs.

Front-ends control the relationship with end-users

Front-ends that control user attention have disproportionate bargaining power, which allows them to strike exclusive partnership deals and even achieve vertical integration. Through its intuitive front-end design and control over end-users, Jupiter has become the fourth largest perpetual contract DEX on all chains. In addition, Jupiter has successfully integrated its own launch platform and SOL LST, and plans to build its own RFQ/solver model. Given Jupiter's close connection with end users, the premium of JUP is at least partially justified, although I expect this gap to narrow eventually.

In addition, as the ultimate front-end, no application is closer to the end user than the wallet. By connecting retail investors on the mobile side, the wallet has the most valuable order flow - "fee-insensitive flow". Given that wallet switching costs are inherently high, this has enabled wallet providers like MetaMask to cumulatively earn over $290 million in fees by strategically selling convenience to retail traders instead of best execution.

In addition, while the MEV supply chain will continue to evolve, one thing will become increasingly apparent - value will accumulate disproportionately in the hands of the participants with the most exclusive order flow. In other words, all current initiatives aimed at redistributing MEV - both at the application layer (e.g., DEXs that consider LVR, etc.) and at lower levels (e.g., crypto memory pools, trusted execution environments, etc.) - will disproportionately benefit those actors closest to the origin of order flow, meaning that protocols and applications will become increasingly "thin", while wallets and other front ends will become increasingly "thick" due to their proximity to end users.

I will further elaborate on this point in a future report, titled "The Fat Wallet Theory".

Building Application Moats

To be clear, I expect liquidity network effects to lead to inherent winner-take-all scenarios in large-scale markets, however, we are still a long way from that future. Therefore, relying on liquidity alone may remain an ineffective moat in the short to medium term.

Instead, I believe that liquidity and TVL are more like prerequisites, while true defensibility may come from intangible assets such as brand, differentiation in user experience (UX), and most importantly - the ability to continuously launch new features and products. Just as Uniswap was able to overcome Sushi's blood-sucking attack because they had the ability to "out-innovate Sushi", similarly, Hyperliquid's rapid rise can be attributed to the team building arguably the most intuitive perpetual contract DEX to date and continuously launching new features.

Simply put, while liquidity and TVL can be subsidized by emerging competitors, a team that continuously launches new products cannot be replicated. Therefore, I expect there will be a high correlation between applications that can sustainably capture value and those with teams behind them that never stop innovating. In an industry where moats are almost impossible, this is undoubtedly the strongest source of defense.

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