The Web3.0 Jigsaw: Categorizing Cryptocurrencies
— By StrangeApe
The first humans who harnessed fire probably didn’t know the extent of the impact they would have on Mankind. Sure, they might have thought “This is going to help our tribe! We can use it to stay warm, ward off predators and cook!” but did they have all the future use cases figured out? Doubtful.
Satoshi Nakomoto had an ambitious goal: revolutionizing the global financial system by creating a decentralized digital currency, Bitcoin, which isn’t backed by a central bank and enables peer-to-peer transactions without a trusted 3rd party. But did he envision every use case a Blockchain-based digital currency can have? That they would potentially be building blocks of Web3.0? Probably not.
Whether or not Bitcoin will indeed achieve its creators’ goal remains to be seen. However, it has served as a blueprint for thousands of projects which, while inspired by it, have different visions for what they want to achieve. As of 2021, there are over 8,000 cryptocurrencies and tokens. 89 of them have a market cap of over $1 billion. On one end of the spectrum, they are all lumped together as projects attempting to be “the next Bitcoin” which disparages them as unnecessary or an outright scam. On the other end, they are categorized by names that, while specific, are not the most accessible to new entrants into the space(ex: DeFi Protocols, Blockchain Oracles, DAOs, Layer 1 and Layer 2 solutions).
In the following post, we’ll layout 5 broad categories based on the most common use cases Cryptocurrencies/Tokens are being created for. Within each of these categories, there are potential subdivisions that we will not go into. Before we do so, one helpful concept to keep in mind is the so-called Blockchain Trilemma which states that there are 3 aspects of a Blockchain: Security, Scalability, and Decentralisation.
The trilemma of how to optimize one aspect without compromising the others has been at the root of many of the developments we will discuss.
I. Medium of Exchange/Store of Value
This is what you would use in your National Currency for simple transactions such as remittances or buying goods. But what factors would push you to use Bitcoin or Monero instead of, say, USD to hold and pay with? a-How well, do you believe this cryptocurrency is equipped to preserve its value? Bitcoin as a “digital store of value” has emerged as a dominant narrative for the OG cryptocurrency due to its finite supply. b-How effectively can it transfer value from point A to B. If you’ve ever attempted to send an international bank transfer (especially if you live in certain countries), you’ve probably faced the pain of the payment not arriving for days then finding out it’s stuck in processing at an intermediary. Decentralization becomes a much more important aspect if this is the situation you are in. However, when compared to the speed and cost of using traditional networks like Visa or Mastercard, Cryptocurrencies currently lag (it is noteworthy that solutions are constantly being proposed). This paired with price volatility and potential government crackdowns might dissuade mass adoption, at least in the near future.
II. Ecosystem Enablers
Cryptocurrencies in this category are an “infrastructure” layer for Decentralized Applications with Smart Contracts at the core and the network’s native cryptocurrency being needed to leverage them. They are often referred to as “Layer 1” Solutions and are the base layer of most of the Web3 innovations we have seen over the past few years including DeFi, NFTs, and Metaverses. Most of these developments happened on the Ethereum network giving it a dominant position in the space with an impressive ecosystem of DApps. However, this has put the Network under pressure, driving fees up to and creating urgency to find ways to scale the Network’s ability to handle transactions and drive costs down. Competing Networks with Smart contract capability have recently gained some traction such as Solana and Avalanche though whether they can really achieve scalability without compromising security and decentralization remains to be seen.
III. Scaling Solutions
Instead of competing with the established Blockchains such as Bitcoin and Ethereum mainly on Scalability, Scaling Solutions leverage these Network’s Decentralisation and Security and help scale them. They basically work “on top” of them hence the name “Layer 2”. The debate on how to scale Blockchains is one that is likely to last for years with potentially multiple answers. It is noteworthy that some solutions have their own native currency such as Polygon Network’s Matic, (an Ethereum Layer 2 Solution which is a Blockchain itself) while others, such as Bitcoin’s Lightning Network (a solution type known as a “Channel”), does not (as of December 2021).
IV. DApp Specific
As previously mentioned, Decentralised Apps are built on top of Ecosystem Enablers/Layer 1 or even Scaling Solutions/Layer 2 which allow it. Within the broad category of DApps are multiple Verticals such as DeFi Protocols (ex: Uniswap), Metaverses (ex: Decentraland), and DAOs (ex: Olympus DAO). These DApps might issue their own Token which can serve multiple purposes including governance and rewards. We will cover them in more detail in a separate post.
Web3 is supposed to restore openness to the internet and bring an unprecedented degree of ownership to individuals. However, the above examples all happen within the confines of one Blockchain. Interoperability Blockchains such as Polkadot and Cosmos see the opportunity in enabling cross-blockchain transfers of any type of data or asset and aim to be Web3’s “Layer 0”, connecting Blockchains together. Unless the future of Cryptocurrency lies with one Blockchain monopolizing all activity, interoperability is likely to become more and more prominent. With Crypto moving at breakneck speed, this categorization is very likely to need adjustment or outright reconsideration. However, whatever developments transpire, a “Big Picture” new entrant-friendly categorization is likely to be useful. In our next entry, we will take a deeper look at the different categories of DApps.