“A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital.”
— Warren Buffett
Crypto’s Cage Match: Users vs. Investors
In 1996, Pierre Omidyar, the founder of eBay, hired his first employee.
He did so reluctantly, unsure if the website he had coded up could turn into a real business.
But he desperately needed someone to collect all the money customers were sending him.
Envelopes full of checks and cash were piling up in his apartment, all from happy sellers anxious to pay their fees.
Oftentimes it was just quarters, dimes and nickels taped to a piece of paper with the seller's name on it.
Keeping track of it all was no fun. But if your first hire is someone to count money, you know you’re onto something.
eBay progressed to counting money so quickly because being a middleman can be good — especially an online middleman: There were no factories to build or products to develop. eBay didn’t hold any inventory, so there were no warehouses to build.
They only had to put up a website and start collecting the money.
Good businesses attract competitors, of course, and AOL, Amazon and Yahoo! soon developed their own online auction sites.
eBay was not given much of a chance against those behemoths of the early internet, each of which had far bigger user bases and offered lower selling fees.
None of them caught on, however.
Some combination of network effects, innovation and community allowed eBay to see off all of its challengers.
Much to everyone’s surprise eBay had a moat.
It Takes a Village
I’ve made the case previously that moats in crypto will be shallow and difficult to defend. And, so far, I don’t see many defensible profit margins in crypto being built.
But OpenSea has been a counter-example.
The leading NFT trading platform has already withstood a credible vampire attack: Despite the token incentives and lower fees available on LooksRare, OpenSea still has 85%+ of the NFT market.
As an online marketplace, OpenSea is a lot like eBay, of course.
But in many ways even better: Sellers don’t have to put their NFTs in the mail and fees are deducted straight from the transaction — the founders don’t have to collect change from envelopes.
A marketplace for digital goods is about as close as it gets to a frictionless business. But less friction means shallower moats.
Consider, for example, that sellers can use the NFT aggregator gem.xyz to list their wares on both OpenSea and LooksRare at the same time.
This suggests that marketplaces for NFTs will have lower network effects than marketplaces for, say, beanie babies and yard sale finds.
Which means that, to build a moat, OpenSea will have to lean into the other aspects of eBay’s successful mix: innovation and community.
Yesterday’s news I think is evidence they are going in that direction: OpenSea bought gem.xyz.
The acquisition suggests to me that OpenSea recognizes it cannot just sit in its castle and collect rents protected by a wide moat.
It’s going to have to innovate and build a community.
That is great news for users.
Is it good news for investors, as well?
Racing to the Bottom
I’ve traded all of about four NFTs (all on OpenSea), so I’m hardly an expert.
But Gem is effectively a trading algorithm, and I have plenty of experience with those, so my opinion here is maybe more informed than is usually the case. (An admittedly low bar.)
One nice thing about being on an equities trading desk was that every six months or so a new provider would come around to offer their more recently developed and therefore faster, smarter trading algorithms — they’d also be half the price.
The decline in algo fees was as steep and predictable as Moore’s Law: Over the course of about 15 years, they fell from 30 bips (0.30%) per trade, to 15, to 10, to 5, to 0 … to negative even. Depending on the strategy you use, algos will pay you for your equities-trading business.
That same process may already be underway in NFTs: LooksRare has undercut OpenSea on fees and, announced just yesterday, are now paying sellers to list on their platform.
There’s more of this to come: It’s always been a race to the bottom for trading fees in traditional finance, and I don’t see why it would be any different in decentralized finance.
The only real winner in that race is users.
So why is OpenSea buying into this algo business?
I don’t think it’s to make money.
Instead, I think it’s an effort to build the mix of sticky factors that allowed eBay to see off Amazon, AOL and Yahoo!.
It won’t be easy — despite OpenSea’s early success, I expect their task will be harder than eBay’s.
But that’s not specific to OpenSea, it’s a crypto thing.
Can “truly great businesses,” as per Warren Buffett, be built in crypto?
For users, yes. We already have lots of examples of that.
For investors? That remains to be seen.
Structurally lower profit margins are a feature, not a flaw, of crypto.
The profit motive, however, is generally the reason that cool things get built, and we want more cool things. So, ultimately, we want investors to make a good return, too.
But not too good: Rent-seeking behavior is bad for everyone except investors.
OpenSea’s purchase of Gem suggests to me that their focus is already on building a community, rather than collecting rents.
If they succeed, it’ll mean that, in crypto, users and investors can both win.