This article was adapted from a Twitter thread published by The DeFiEdge.
Warren Buffett will not invest in companies without a moat —competitive advantages that are very difficult for rivals to copy.
This is because a moat gives the business long-term competitive advantage(s) for sustainable growth, which is what you’re looking for in any crypto projects you want to invest in.
Therefore, understanding the moat concept can help you identify better crypto investments and become a more successful investor.
Moats in crypto
It’s difficult to build moats in crypto because of how easy it is for anyone to fork any project.
However, some of the more established (OG) DeFi protocols are still dominating years later despite all the copycats or forks.
Let’s see why…
The 7 moats that you should look for
Moat 1: Scale Economies
A business where the per-unit costs decline as volume increases have economies of scale.
For example, a small burger restaurant can’t negotiate much on its food costs but Mcdonald’s has the Scale Economies to negotiate for rock bottom prices.
Therefore, their ability to negotiate a lower cost for raw materials is a moat as smaller rival restaurants do not have such negotiation powers.
In Crypto: Bitcoin Miners
This continues to happen with Bitcoin miners.
The electricity costs of mining Bitcoin have increased so much that only the larger mining firms with Scale Economies could remain profitable.
As a result, smaller miners are going bankrupt and closing shop while the big miners consolidate.
For example, how can the little guys compete with this mining setup from Russia?
Moat 2: Network Economies
With the network economies, the business becomes more valuable as the number of users increases.
For example, it costs around $50k to create an app like Tinder but Tinder sold for $3 billion because of the number of users it had acquired.
Furthermore, Uber, Airbnb, & Facebook are dominant in their markets because of network effects.
In Crypto: Ethereum
We can see a clear example of this in crypto with Ethereum.
Some alternative Layer One (L1) chains like BSC, Solana, Cosmos, Avalanche, etc, are faster and cheaper than Ethereum.
However, Ethereum remains the smart contract platform of choice for developers and users because of its network effects.
For example, a Large amount of users attracts more developers, which leads to the development of more awesome dApps, which further attracts more users.
This is called the flywheel effect…
Moat 3: Counter Positioning
This is where a business creates a new and superior business model that the incumbents can’t adopt because it’ll cannibalize parts of their existing business.
For example, Kodak invented digital cameras in the 1970s, but they didn’t Pivot. They were hesitant to cannibalize its cash-cow businesses in film photography
Furthermore, stock photo companies know that A.I. photos are the future, but adopting AI would kill their existing business model.
In Crypto: Music NFTs
Imagine owning unique music NFTs from your favourite artist, and they get to keep all the royalties.
Record labels could capitalize on Music NFTs if they wanted to, but to do so would put them out of business.
Moat 4: Switching Costs
This is when a customer loses value by switching over to a competitor.
For example, I use only Apple products and a good number of my favourite apps are OSX only.
This makes it hard for me to switch off Apple products because I’d lose a lot of apps that I’m already used to.
In crypto, there are plenty of Web 3 wallets now, yet MetaMask remains the dominant one because people are so used to it.
it’s a pain for most people to switch over and set everything up again with another wallet. Plus every dApp on all EVM chains is configured for MetaMask first.
Moat 5: Branding
Does a Rolex tell the time better than a cheap Seiko? No.
Does a Chanel bag hold items better than a Michael Kors? No.
Branding power allows a company to charge a premium on its products. And this is why luxury companies pay so much for celebrity endorsements.
In Crypto: Polygon and Bored Ape Yacht Club
Polygon has been onboarding brands such as Nike, Starbucks, Reddit, and Facebook onto Web 3 and now has a branding moat now.
If you’re a Web 2 giant, working with Polygon is “safe” compared to other blockchains.
After all, “No one ever got fired for buying IBM”
Furthermore, anyone can create a 10,000 NFT collection, but one brand is in a league of its own —Bored Ape Yacht Club (BAYC).
Fueled by celebrity endorsements and pop culture, BAYC is now a mainstream NFT brand.
Their brand successful brand has helped the company sell over $300 million of virtual land in the Otherside metaverse.
Moat 6: Cornered Resource
A company has a cornered resource when it has preferential access to limited and desired resources.
Previously, empires fought over spices, salt, silk, and gold. Today, the modern world is fighting over oil and semiconductors.
And DeFi Protocols fight for liquidity.
For example, Curve controls so much liquidity in DeFi and acquiring their veCRV tokens (and Convex) allows you to vote on which Curve pools get more rewards.
So, protocols fight for veCRV tokens because they can use it to vote for an increase in their tokens reward allocation, which ultimately helps attract more users and liquidity to it.
If you want to keep up with the DeFi wars narrative, check out DeFi Wars for the list of tokens and projects actively hunting for liquidity on Ethereum.
Power 7: Process Power
This refers to when a project has improved products and lower costs due to its superior and cost-efficient processes.
For example, Toyota created the Toyota Production System to eliminate waste and improve consistency in its cars.
Furthermore, TikTok has an algorithm for showing people exactly what they would be interested in.
In crypto, a good example is the capital efficiency formulas which the major DEXs use to create processes for lower fees and greater efficiency.
For example, the Uniswap V3 and its concentrated liquidity model is a process for improving capital efficiency.
Advantages vs Moats
You might be wondering about other aspects of Crypto such as Total Value Locked (TVL) or the Community and how would they fit in under this moat framework.
They’re competitive advantages, not moats, as they can be easily gamed or duplicated by rivals.
For example, you can watch the charts and see how non-sticky TVL can be, especially if some of it was fueled by incentives.
Furthermore, I’ve seen how fast communities abandon protocols when the prices go down or rewards are reduced.
But moats are a core aspect of the projects themselves and are not easily imitated by competitors.
A few more examples of Crypto Moats:
- BNB —by being associated with the biggest centralised exchange (CEX) in the world.
- Chainlink —they virtually have a monopoly in the Oracle space.
- Chiliz —Exclusive partnerships with large football teams.
Building moats
Moats take time to build or develop, and keep in mind that DeFi is only a few years old.
Some of these moats such as branding and switching costs can take years to build.
So, look at which moats a protocol has now, and what they’re working towards establishing.
Applying this concept
This moat concept is useful for evaluating potential long-term holds.
You have to think about how the projects you invest in will be able to remain competitive and remain competitive in their respective markets in the long run.
I wouldn’t use it for short-term shitcoin trades that are mostly driven by hype and marketing.
Conclusion
The 7 moats concept discussed above comes from the book “7 Powers: The Foundations of Business Strategy” by Hamilton Helmer.
I use business frameworks to help me analyse protocols, and this is one of the best books I’ve read on business strategy. I recommend you pick it up!
If you find this article helpful or interesting, please help me share it so others can benefit from it.
