With the recent downtrend in crypto markets, it’s a helpful exercise to step back and observe things other than price. How is value in crypto created? Where does it originate?
We can learn a lot about crypto from going straight to the source: the developers that create these systems and networks. The developer activity in a given cryptocurrency ecosystem tells us a lot about the investment potential of the asset.
Developers are ultimately self-interested and will go where they are best incentivized. And while this isn’t always correlated with the price of the protocol they’re building on, most developers won’t work on a project they think is doomed for failure.
A few weeks ago, Electric Capital released a report on developer activity across cryptocurrency Layer One networks. This week, we take a look at how development activity has historically been reflected in price and how it can help us predict the success (or failure) of different crypto assets over time.
Talent has flocked to cryptocurrency and Web3 over the last year, with more than 34,000 developers freshly onboarded to crypto in 2021. Why does this matter? Developers build products, consumers use those products, which generates revenue, generating return for investors, then more investments are made, then more products are built by developers, then more consumers, then…you get it.
On some level, developer activity is the core activity related to the growth of the crypto ecosystem: without unique and talented developers creating in the space, there would be nothing valuable to invest in. The fact that crypto is growing and innovating so quickly is directly due to the talent it can attract.
So, by default, the ecosystems that attract the most innovative talent will be the most successful ones.
Developer Activity and Market Cap
As expected, developer activity is positively related to the total market capitalization of crypto.
As total crypto market cap peaked in late 2017, the monthly active developer count continued to grow for a full year. The two years following the peak held developer count steady, despite markets losing nearly 80% of their value. So developers, in large part, stick around, although it’s a lagging indicator. Most builders who come on have a long-term faith in the technology.
Today, as crypto market cap corrects, we could see a slowing in the growth of active developers into 2022. And while new developers coming to crypto is good for the market, it’s a lagging indicator. New developers getting hired is more reflective of past crypto price than future returns.
Cross-referencing the amount of dApps (decentralized applications) being built on the Ethereum network with price data and developer growth provides some interesting takeaways as well.
The increase in developer count referenced above in late 2017 saw a subsequent massive spike in dApps built during 2018. So, if this generation of Web3 developers sticks around, expect to see more products launch across networks throughout 2022.
Many projects built during that timeframe have become remarkably successful in the last few years: dYdX, Ren, Synthetix, and AAVE are all good examples. As more developers enter the space to build innovative products, more and more successful protocols will pop up. Keep digging, as bear markets produce winners for strong teams and patient investors.
Where are Developers Building?
The top 200 crypto projects (as well as smaller projects) have seen massive developer growth compared to ETH and BTC in market run ups. Although more than 20% of the new developers join the Ethereum ecosystem, many devs are creating on new ecosystems for new projects.
But when markets decline, the growth in those categories slow and developers move from smaller projects back into BTC and ETH. It’s probably reasonable to assume that these protocols provide a more stable, long-term platform to build on. So while bullish conditions foster innovation, bearish ones enforce the strength of Bitcoin and Ethereum.
This trend looks very bullish for Ethereum. Even as we see alt L1’s grow in market cap and usage, the stability in users and underlying functions that ETH provides is advantageous for developers launching new projects.
Granted, many projects from 2018 or earlier that were not related to BTC or ETH ended up failing. If developers continue to work on different chains in downturns, that could be good news for alternative Layer One networks. But if we see developers flock back to ETH and BTC, it could mean smaller protocols have a limited lifespan.
Development and Incentives
The ICO (Initial Coin Offering) boom in 2017-2018 invited unhealthy investment decisions. If a team could write about a groundbreaking idea in a whitepaper and offer a way to buy their token, it was almost guaranteed to raise capital.
Let’s take TravelBlock as an example, a once-promising platform poised to democratize travel using the blockchain. Raising more than $30 million in their ICO, the funds were used for team operations and development before they ran out. Countless other projects in that era showed a quick flash of life before funds ran out (or they were just an outright scam).
Now, VCs and investment groups have come to the space. While some DeFi users see this as a negative, so-called “suits” provide immense capital for projects. This builds a longer runway for operations to kick into high gear even if the protocol is barely generating revenue. Investment allows developers to continue building despite adverse market conditions.
A good example here is Avalanche. Last year, the Avalanche Foundation launched a fund worth over $200 million to stimulate growth and development across their network. Trader Joe, one of the top dexes on AVAX, received $20 million in incentives to accelerate user growth and cement DeFi as one of the main use cases for the network. Capital helps facilitate adoption.
The incentive funds for DEXes are used to incentivize adoption and onboard liquidity. This, in turn, brings more users, and thus the growth of a new protocol commences.
So far, this method has done well at bootstrapping network activity. The following chart shows developer activity across different Layer One protocols. Solana, with substantial funding from VCs, is one example of high developer activity correlated with high investment returns.
However, some alternative Layer 1s don’t have the investor resources to payout incentive funds to developers. Without this catalyst for user growth, their protocols may struggle to generate sustainable adoption. If incentives aren’t there or run out, these developers might go back to building on the Ethereum network, where users are plentiful and consistent.
In this way, bear markets enforce the success of legacy protocols (ETH and BTC), while bull markets incentivize smaller, better-incentivized projects. So keep an eye out for dev activity and innovation sticking around somewhere despite bearish conditions: that might be the sign of a protocol that can weather a bear market.
The Rise of Fundamental Value
While 2017 combined interesting ideas with the blockchain, the downfall was the lack of fundamental value. But now, cryptocurrencies, especially DeFi ecosystems are creating complex economies with built-in revenue models around borrowing, lending, exchanging assets, and more.
While crypto economies in the past were based on ideas, crypto economies of today are based on flow of capital and creation of value. The graphic below shows how meaningful those revenues can be. These businesses are not just significant in crypto, but they rival similar startups in conventional industries.
And it’s important to note that we’re still early within all of this: less than 1,000 full-time developers are responsible for over $100 billion in total value locked in smart contracts, and crypto devs represent under 0.1% of the 26.8 million software developers worldwide. Crypto enables brainpower and capital to be leveraged in ways that we’ve never seen before, and that’s exciting to see (even in bearish conditions).
During bull markets, price dominates the crypto discussion. No one cares about the innovations occurring, all that matters is if price is going up.
However, during bear markets, there is time to hunker down and learn as much as possible about the underlying applications, their importance, and the products their founders create. Conviction is created when you understand the fundamental value of a product despite adverse market conditions.
As markets calm down, keep your finger on the pulse of development. Understanding where fundamental value comes from will serve you well as a crypto investor.