The Layer-1 Chain Rotation Thesis: A Retrospective Analysis

Opinions and commentary are my own, this is not financial advice.

A game of musical chairs

Bull markets optimize for narratives, bear markets optimize for fundamentals. While this statement is an overgeneralization, it serves as foundational logic for how participants think and react in different market environments. It’s true for most any financial market, but can be seen most clearly within crypto, which operates at a speed and acceleration 100x that of any other current or historical market.

2022 is clearly in a bear market, not just because most crypto tokens are down 80–90% from their previous all-time-highs, but because the attention of market participants has shifted from hype-fueled ponzinomics to sustainable revenue, sound economics, and the need for crypto to solve real-world problems. Bear markets are when the free-flowing money stops and the question “why are we building all of this again” starts to creep back up. Look no further than the engagement on my recent thread about real-world assets and the general sentiment.

While the cyclical nature of bull market narratives and bear market fundamentals is truly nothing new — for neither crypto nor any other financial markets — it’s worth exploring what exactly happened during the previous bull market exuberance. In this blog, I’ll provide my perspective on the reflexive nature of capital rotation games and the largely unsustainable growth strategies employed by blockchain projects in 2021.

The Supply/Demand Mismatch of Blockchain Bandwidth

It’s clear that one of the most dominant problems facing the crypto industry is the blockchain scalability problem, an inhibitor to any future growth that crypto may have. “The internet of money should not cost five cents per transaction” after all, something which Vitalik still affirms to this day. A throughput of 15 transactions per second with $xx — $x,xxx in transaction fees is clearly not suitable for the vast majority of people.

While this issue has reared its head in various ways over the years, with it initially being the Ethereum community dunking on the Bitcoin community for their network’s high transaction fees in 2017, the script has since been flipped. After DeFi summer in 2020 and going into early 2021, the issue of network congestion and high gas costs became clear as Ethereum became increasingly unusable for the masses.

Zhu Su Tweet about Ethereum abandoning its users
Zhu Su, Co-Founder of Three Arrows Capital, a now-bankrupt crypto hedge fund.

The above tweet perfectly encapsulates the core sentiment and frustrations that many had with Ethereum during 2021. They were priced out and felt that the Ethereum community didn’t care about them, but rather cared more about the ideals around decentralization, self-verification, and monetary premiums. Depending on your frame of reference, some would call this “out of touch with reality” while others would call it “differing priorities.”

In an ideal world, scaling a blockchain is as easy as simply increasing the size of blocks, reducing the time between blocks, and calling it a day. Here’s Elon Musk eloquently stating his scaling roadmap for reducing transaction fees 100x on the Dogecoin blockchain.

Elon Musk explaining his scaling roadmap for the Dogecoin blockchain
Elon Musk, educating the world on the simplicity of scaling blockchains.

Just make the blockchain faster, tune the parameters to eleven, who knew it was this easy! Of course, in reality, it’s not this simple as such an approach leads to centralization due to the increased hardware requirements to run a full node, which breaks the security model of blockchains. Scaling while maintaining the properties that make blockchains useful is a difficult problem.

How Ethereum Was Going to Meet the Retail Demand

Ethereum’s roadmap to scalability is an ever-shifting one. But in 2021, with execution sharding and Plasma obliterated from the roadmap, an all-in focus on rollups was taken in order to meet the demand for blockspace, while still maintaining Ethereum’s decentralization. Rollups separate execution from consensus and data availability, allowing an existing layer-1 blockchain like Ethereum to settle a higher volume of transactions without increasing the hardware requirements of running a full node.

Vitalik Buterin’s diagram of rollup transaction compression
Rollups batch transactions together in a compressed format to increase throughput.

However, the guesstimations about how long it would take for rollups to rollout and reach scale were widely out of sync with the difficulties of the problem at hand. This misaligned messaging around timelines occurred from both the teams developing rollups as well as the Ethereum community at large (yours truly included). Rollups were in fact not at all ready to meet retail user demand in 2021. Even as of writing, in mid-2022, rollups are still not quite ready to meet the level of demand that comes along with global scale.

But this explanation is so nuanced and retail users don’t really care. Decentralization? Full node hardware requirements? Multi-year scaling roadmaps? Retail users in 2021 just wanted faster and cheaper transactions so they could continue gambling on speculative tokens with ease. Not meeting this very real (at the time) market demand would mean leaving a lot of money on the table. Were these users simply to stop using blockchains and wait for Ethereum to scale? Of course not, demand simply needed to be offloaded somewhere in the meanwhile.

The Mass Exodus of Retail to Greener (Cheaper) Pastures

Scaling Ethereum is akin to replacing both engines of a 747 in mid-flight with the population of a moderate-sized country and the capital value of a mid-sized US bank on board. But what if we didn’t have to scale Ethereum at all or care about that whole “maintaining decentralization” thing? It would sure make the problem a whole lot simpler, wouldn’t it? All of Ethereum’s code is open-source, the DeFi primitives have mostly all been established, and plus people are bidding on all these largely valueless governance tokens…

And thus, the Layer-1 Chain Rotation Thesis™️ was born. It was remarkably simple: fork Ethereum’s code, make the blocks bigger and faster (thanks Elon), fork all the core DeFi dApps, pay people to use it, and wow you got yourself a cutting-edge next-generation blockchain that is both cheaper and faster than Ethereum! If the timing aligns, then you’ll see an influx of capital and all the speculation that comes along with hyper-growth.

This approach was so simple and effective, that it was done again and again and again. Each time a new deployment with a money printer popped up, retail users, mercenary capital, and other market participants happily rotated to the new chain to collect the free money. Each chain usually had a new trick up its sleeve, commonly in the form of a different narrative or a slight technical improvement, but fundamentally the same thesis was at play.

During a crypto bull run mania, this dynamic was a win-win for all participants. Blockchain core devs could bootstrap the adoption of their chain (and profit in the process), retail users were once again able to interact with DeFi applications (and profit in the process), and mercenary capital was able to put their assets to work (and profit in the process). If everyone making a profit with there being no losers sounds unsustainable to you, well that’s because it was. The L1 chain rotation thesis was crypto hyper-reflexivity to the max. What goes up must come down, but more on that later.

The 12 Easy Steps To Joining the L1 Chain Rotation Cycle

To understand how and why this blockchain growth strategy was so effective, let’s look at the steps involved. If we were still in a bull market, this explanation could have served as a playbook, but for now, it’s relevant to view these steps in the framing of a post-mortem retrospective analysis.

The first step is the most obvious; fork the Go implementation of the Ethereum protocol known as geth. Geth is not only free and open-source software but has also been extensively battle-hardened via years of in-production usage. Why reinvent the wheel where there’s already an underpaid development team that has built the core technical foundation for you?

Go Ethereum GitHub Commit History since 2014
Go Ethereum commit history, free and open-source public good software with 14.4k+ forks.

Naturally, this new deployment of Geth needs a native coin that users can use to pay transaction fees and to support block producers via block rewards. A native coin is also needed to fund the money printer you’ll eventually turn on to attract users and to support the core development team who needs to get paid for the hard work of forking Geth.

Thus you can’t just fork Geth, but you need to initiate a token sale in order to distribute the initial native coin supply to yourself (free), VC investors (~100x lower than public sale price), and maybe some users as well (whatever is left over). Regulators are generally too caught up with their busy work of virtue signaling about “investor protection” and poking at legitimate projects to pay attention to you.

To be perfectly clear, there isn’t anything inherently wrong with forking free and open-source software or initiating a token sale, but these are simply required steps in joining the layer-1 chain rotation cycle that can hopefully accelerate your blockchain’s growth and make you, your investors, retail users, and everyone else some money in the process.

After forking Geth, there’s little need to keep the blocksize and blocktime parameters the same as Ethereum Mainnet. After all, the reason this new chain exists is to be cheaper and faster than Ethereum. After thanking Elon for his infinite blockchain scalability wisdom, there are also some other neat marketing tricks you can employ.

When your new blockchain is launched, the blocks will be empty and so will the state trie. This means transactions will cost next to nothing (sub-cent) and they’ll be included on-chain with the next block (confirmations in seconds). You can now make some comparison charts between your new chain and Ethereum, showcasing someone would have to be a masochist to still be using Ethereum.

Never mind that demand for blockspace will eventually exceed supply (which is when the fee market for transactions kicks in), or that state bloat will eventually grind your chain to a halt if not checked (due to the growing disk IO bottleneck). Those are future problems, for future you, but for now, it is technically true that your blockchain is faster and cheaper than Ethereum.

Similarly, because blocks and the state trie are empty, the hardware requirements for running a full node will be low, even lower than Ethereum. Naturally, this will change over time as blocks fill up and the state trie grows faster than Ethereum, but in the meantime, you can say you’ve solved scalability without compromising decentralization and self-verification.

Etherscan Charts
Ethereum only became expensive after blocks began to fill up (left side), which were limited in size (right side) to help prevent runaway state growth and its centralizing effects.

Naturally, some people will try to call out your shortcuts to increasing throughput, but they can be easily dismissed as “maximalists” or simply ignored because they’re clearly NGMI. If that doesn’t work, then some more advanced tactics are needed. This is when marketing becomes more akin to gaslighting and Twitter becomes the primary battleground.

Find and own a catchphrase such as “Consensus is the bottleneck, scalability is a lesser engineering problem,” “Decentralization is the cost to destroy all replicas,” or just call those who do not align with you “poor” and that “their size is not size.” Throw in a “The future is multi-chain” for good measure as well.

Congrats, you’ve successfully solved the blockchain scalability problem with zero trade-offs! Also, because you’ve launched and distributed a token, you now have a community of financially incentivized token holders who will parrot your narratives and defend your blockchain against FUDsters at any costs. Don’t forget to regularly point out how expensive Ethereum is.

By this point, you’ve probably grown a niche community, but so far there isn’t actually much to do on your new blockchain. Retail users want applications they can use to speculate on tokens, requiring key DeFi primitives like non-custodial exchanges, money markets, overcollateralized stablecoins, derivative platforms, and so on. Once again, look towards Ethereum where there is a growing ecosystem of free and open-source smart contracts that can be easily forked and deployed on your new chain.

DeFi applications across the multi-chain ecosystem
DeFi applications across the multi-chain ecosystem, can you tell which are forks?

However, a blockchain core dev team deploying their own forked dApps to their own forked blockchain doesn’t look like much of an ecosystem, so you’ll want other teams to deploy these dApps. This can be easily achieved in one of two ways. The first is awarding grants to opportunist developers whose innovative idea is to create the “The [XYZ] dApp of chain [ABC]”.

To give some credit, forking and improving an open-source protocol can indeed be a net positive for the industry by pushing the boundaries of what’s possible. But oftentimes, the idea is as simple as forking an established protocol, deploying it on a new chain, and then calling it a whole new thing because the branding is different.

The second approach is a bit more subtle but is usually more time and cost-efficient. Fork those dApps yourself and hire a dev team to pose as the founders and maintainers. If you can’t find any devs to act the part, play the role yourself but under a pseudonym so nobody is any the wiser.

The net result and goal are the same, emulating the Ethereum ecosystem but on your blockchain and with new dApp tokens that retail users can speculate upon. This allows for sentiment such as “If this new dApp token reaches just [x]% of the market capitalization of its counterpart on Ethereum…” You get the idea.

The nice advantage of forking geth is that your blockchain is running the EVM, meaning all of the tooling built around Ethereum and Solidity smart contracts work just the same. Importantly, this means Metamask (which your target audience already has downloaded) will work just as it does on Ethereum, just needing an additional RPC connection. The developer community can also use Hardhat, Truffle, and all the other dev tools they need to (hopefully) create new dApps on your chain.

Ethereum Virtual Machine Layer Diagram
The Ethereum Virtual Machine (EVM) is an abstraction between the code and the physical hardware.

However, it’s essential to make sure your other dependencies are in check as well. You’ll need a block explorer, so either fork an existing one or pay Etherscan to make a clone. You’ll need oracles for your forked DeFi apps, so get into contact with Chainlink. You’ll need liquidity and a fiat on-ramp for your coin, so work with exchanges to get listed. You want the experience to feel like Ethereum (but cheaper and faster).

Lastly, you need a way for people to onboard onto your new chain from existing ecosystems such as Ethereum. A siloed garden is no fun for anyone and significantly limits your growth potential. Therefore, you’ll need to create a cross-chain token bridge, which will take the form of a multi-sig managed by a small handful of trusted validators. Cross-chain bridges can be tricky to get right, as well over a billion dollars worth of crypto has been stolen from bridges in the past year alone.

Largest DeFi Exploits by The Block Research
Some of the largest exploits in DeFi have been cross-chain bridges.

Deploying a cross-chain bridge is simply a necessary risk to take to join the chain rotation cycle. Once deployed, make sure to let users know you have a bridge to sell them and that it’s the most seamless and secure bridge that they’ve ever seen before.

By this point, you’ve created (forked) a new blockchain and you’ve managed to convince a number of community members into believing and/or echoing the narrative that your blockchain is faster and cheaper than Ethereum. But why should users switch over from the other “faster and cheaper than Ethereum” alt-L1 blockchains they’re already using? Your blockchain will likely have less liquidity, users, traction, and mindshare than existing solutions.

There is but one clear answer: to make money.

This next step is the key ingredient to making the L1 chain rotation thesis what it is. Deploy, endorse, and market a massive token subsidy program, where users can earn rewards by simply deploying their capital into your blockchain’s dApp ecosystem — commonly known as yield farming. These token subsidies can take the form of the chain’s native coin (of which you minted yourself a portion of the supply allocated for this purpose) and/or governance tokens deployed by the dApps themselves.

Yield Farming academic paper diagram
Examples of how yield farmers can earn “native token” subsidy rewards.

During a bull market where retail participants will speculate on anything that moves, the tokens used for subsidizing rewards will inevitably have a value above zero, even on day one, which is enough to kick-start the ensuing virtuous cycle. Make sure to give the subsidy program a catchy name and focus on how this program will enable growth and that your ecosystem is growing and that growth is good. Welcome to the world of printing money.

When token subsidies are employed, the “yield” offered by dApps on your blockchain will look quite alluring. Lending rates on money markets will be higher, returns on provisioning liquidity in DEXs will be higher, and the ROI on depositing tokens into a contract that doesn’t do anything will be higher. As long as the money printer is still giving out tokens and people are willing to purchase these tokens, then the “yield” will continue to flow. However, most people don’t question where the yield actually comes from, and even for those who do, it doesn’t matter as the “yield” will still exist.

This increased “yield” from the token subsidy program will attract both retail users and mercenary capital to deploy their assets into your blockchain ecosystem via your cross-chain bridge. This capital deployment from yield-chasers will result in an increase in the Total Value Locked (TVL) of your blockchain and its dApps, a prime metric that signals to users and speculators that your blockchain is healthy and growing. The “fundamentals” of your blockchain are increasing and TVL is going to be used as proof of that.

DeFiLlama TVL growth
Total DeFi Total Value Locked (TVL), notice how TVL grew from $18B to a peak of $252B in 2021 (+1,300%).

Naturally, this increase in TVL will be very exciting, and now is the time to market your success. Multi-channel marketing campaigns, promoted tweets, and sponsored media articles are the fuel you need to accelerate this virtuous cycle. You won’t be alone either as your core dev team (who double as marketers), VC investors, token holders, dApp dev teams, and influencers will all be promoting how amazing the growth of this new chain is.

There’s no reason to stop at TVL either, as a whole host of metrics will be increasing as users chase subsidized yields. Active address count, daily transaction count, protocol revenue, market capitalization, and pretty much any metric that benefits from subsidized yields can be promoted as proof that your chain is the future.

Do Kwon tweet about UST’s growth
Do Kwon promoting the growth of UST, an algorithmic stablecoin fueled by subsidized rewards, which later collapsed in early 2022 at a peak of ~$20B.

The one metric you don’t want to highlight, however, is how much is being spent on token subsidies or the resulting inflation rate. The big number was impressive for the initial announcement, but after deployment, you want to focus on promoting yield, TVL, and growth. The goal is to incite FOMO and WAGMI energy. If you don’t have your capital deployed to this new chain and you’re not speculating on these hot new tokens, then sorry fren you’re missing out.

This is the stage where things really start to accelerate. The retail masses will see this marketing blitz on their social media timeline and feel they have to jump in, just think of the opportunity cost otherwise! The impressive growing TVL and other growth metrics will look too strong to ignore. As a result, retail will feel that these tokens are undervalued and begin to increasingly speculate and bid up their value. The token’s inflation rate, lack of value capture, or unsustainable economics is irrelevant, the TVL is going up and that is good!

Crypto speculation growth
Speculation increased exponentially in 2021, helping fuel the growth cycles of blockchains.

People who speculate on tokens, tend to not only defend their investment but actively promote it as well, accelerating the cycle even further via word-of-mouth marketing. The amount of Koolaid being drunk at this point will be intoxicating, but with their portfolio value going up, they’ll feel validated in their thesis.

Anyone calling out the cycle for what it is, an unsustainable hype cycle, is just simply fudding because they missed out and didn’t make money like everyone else. The market has spoken and these valueless governance tokens are actually very valuable because the price is going up. Never mind the circular logic, look at the TVL growth!

The L1 chain rotation thesis flywheel is now in full effect. When the price of a token used to subsidize yield increases in value, thanks to market speculation, then the rate of subsidized yield provided to users also increases. These increased yields attract even more capital to be deposited into your dApp ecosystem, improving the growth metrics such as TVL even further. These growth metrics can be repromoted on social media, leading to more speculation on those tokens, leading to increasing yield, leading to an increase in TVL, leading to… and the cycle accelerates.

L1 Chain Rotation Thesis flywheel
This virtuous cycle flywheel effect is at the heart of the L1 chain rotation thesis.

Speculation on the fundamentals of your blockchain’s ecosystem has suddenly made the fundamentals even better. Can you see where this can start to go wrong?

At a certain point, the underlying blockchain reaches its breaking point. Blocks begin to fill up, which causes transaction fees to increase and confirmation times to take longer. This was the very thing your chain was supposed to solve, no good! Thankfully, you can simply kick the can down the road by increasing the blocksize. Yes, this increases the hardware requirements of running a full node and yes this is unsustainable as eventually, disk IO will become so saturated that even the beefiest server-farm nodes cannot stay synced to the tip of the chain.

BSC is a lost cause GitHub Issue
An infamous GitHub issue raised about the experience of running a BSC full node.

But don’t worry, these are just “growing pains” that every blockchain like yours runs into at some point. As it turns out, blockchain scalability is actually quite nuanced and a hard problem to solve. It always was, but now you need to convince your audience of this as well who are likely questioning if you really solved anything at all. It’s time for a pivot.

The cycle has been so profitable thus far, it would be a shame to just let it end like that. Thankfully, you don’t have to, because you are now an interoperability blockchain. Your blockchain isn’t a singular chain, no, it’s now an ecosystem of sidechains that interconnect via a central hub chain.

Except, you can’t call them sidechains because of the negative connotation around poor network security. The name doesn’t really matter, the point is that you’re now going to solve scalability by extending horizontally. These new chains won’t have the same level of security or decentralization as the first one, but when has that mattered in achieving success thus far?

What you’re attempting to scale is not necessarily transactions per second, but rather the flywheel effect. A new sidechain means a new token for people to speculate on, a new dApp to subsidize with tokens, and a new blockchain with empty blocks and state to be filled up. Eventually, these sidechains will become congested just like the first blockchain deployment did, but thankfully you already solved for that. Just launch another sidechain.

The interoperability blockchain thesis is very nice, but by this point, the gig is usually up. When there becomes more sellers than buyers, which can happen for a number of reasons, the game of musical chairs has come to an end. The flywheel has begun to reverse itself. As the price of the token used to subsidize yield starts to decrease, the yields begin to decrease. Decreasing yields leads to people withdrawing their capital, either to generate more yield in another blockchain ecosystem or simply because the risk is no longer worth the dwindling return.

This causes the ever-important fundamental metrics like TVL to drop, which makes the subsidy token not look as attractive as an investment anymore. With the fundamentals “changed,” those speculating on the token become more bearish and begin to sell off. This causes yields to decrease further, which causes more capital to leave, which causes… and the cycle accelerates.

L1 Chain Rotation Thesis unwinding
The unwinding of reflexive L1 rotation thesis flywheel.

This doesn’t mean your blockchain and its ecosystem is dead, but rather much of the mercenary capital and retail is leaving for greener pastures. What is left are the users who found real utility from your blockchain ecosystem, feel the level of yield offered is still sufficient, or have simply become community members. Tokens never truly go to zero either, even during cases of extreme hyperinflation, so the subsidy will still always have some value to support the ecosystem.

But what exactly triggers the switch to more sellers than buyers in the first place? Most often, it’s a new shiny blockchain that has appeared offering better yield, lower transaction fees, faster transaction speeds, and/or a better narrative overall. This blockchain will probably run into all of the same issues as yours, but that doesn’t matter, the fact remains that they’re faster and cheaper than your blockchain and they’ll let users know.

And thus, the rotation cycle goes on.

Conclusion and Key Takeaways

Crypto in 2021 was largely defined by the jpeg NFT mania and the L1 chain rotation thesis. When money flows freely, projects have to compete on the basis of attention, and nothing attracts the attention of capital holders more than the opportunity to make money, either via speculative tokenized jpegs that can be resold at a higher price or by subsidized DeFi yields on a new blockchain fork.

While this blog post may seem like a pessimistic view on alt-L1 blockchains, the growth tactics I described above were simply the logical route to take given this approach was being actively rewarded by the market, in terms of both attention and capital allocation. It’s clear that not every blockchain other than Ethereum is a blatant unoriginal fork created as a cash grab, as many blockchains have real redeeming qualities and unique value propositions that push the industry forward as a whole. This blog isn’t meant to take shots at any specific blockchain ecosystems, but rather to highlight the capital rotation games that the crypto industry as a whole not only accepted but actively supported.

I’m interested in crypto because this technology presents a viable path towards improving society by re-establishing trust between mutually-distrusting entities by executing agreements on a credibly neutral settlement layer that is viewable to all and tamperable by none. I am not interested in crypto because of the various ways we can print money out of thin air to fake yield, create financial weapons of mass destruction that obliterate retail capital, or because of the highly reflexive and speculative properties. There was simply a systemic malformed incentive structure problem, something which not a single project or entity could solve, but is at the very least worth calling attention to and analyzing.

These days, given the current market conditions, the L1 chain rotation thesis strategy doesn’t work as well as it used to. Narratives of growth are now expected to be matched with sound economics and real defensive moats. I hope when the next bull cycle arrives, whenever that may be, that we have collectively learned our lesson about unsustainable capital rotation games. But to be frank, this is crypto and I have my expectations set accordingly.

Follow me on Twitter @ChainLinkGod and listen to the ChainLinkGod Podcast for more of my ramblings and explanations about the crypto industry.

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