The success of every company – from tech giants to century-old conglomerates – can be reduced to its moat. Whether in the form of network effects, switching costs, or economies of scale, moats are what ultimately enable companies to evade the natural laws of competition and sustainably capture value.

While defensibility is often an afterthought for crypto investors, I would argue the concept of a moat is even more important in the context of crypto markets. This is due to three structural differences uniquely underpinning crypto apps:

1. Forkability: The ability to fork apps implies that barriers to entry are implicitly lower in crypto markets
2. Composability: Users have inherently lower switching costs given the interoperable nature of apps and protocols
3. Token-Based Acquisition: The ability to use token incentives as an effective user acquisition tool means that cost of acquisition (CAC) is also structurally lower for crypto projects

These unique properties have the net effect of collectively accelerating the laws of competition for crypto apps. As soon as an app turns on a “fee switch”, not only are there countless other indistinguishable apps offering a similar yet cheaper user experience, but moreover, there may even be a handful of apps that will actually pay users with token subsidies and points.

Taken to its logical conclusion, in the absence of a moat, 99% of apps will experience an inevitable race to the bottom and thus fail to evade commoditization.

While we have numerous precedents and heuristics for understanding moats in traditional markets, we lack equivalent frameworks that account for these structural differences. This piece aims to bridge this gap by getting to the root of what constitutes a sustainable moat, and downstream of this, identify the handful of applications positioned to sustainably capture value.

A Novel Framework For Assessing Application Defensibility

Warren Buffet, the king of defensibility, has one of the most simple, yet effective, heuristics for identifying defensible companies. He asks himself, If I had a billion dollars, and I built a competitor to this company, could I steal significant market share?

By tweaking this framework slightly, we can apply this same logic to crypto markets while taking into account the aforementioned structural differences:

If I fork this app, with $50M in token subsidies, can I steal and maintain market share?

By answering this question, you naturally simulate the laws of competition. If the answer is yes, it is likely a matter of time before an emerging fork or undifferentiated competitor erodes that applications market share. Conversely, if the answer is no, the app by default possesses what I believe is downstream of every defensible crypto app:

“Un-Forkable” and “Un-Subsidizable” Properties

To better understand what I mean, take Aave for example. If I forked Aave today, no one would use my fork given it wouldn’t have the liquidity for users to borrow nor the users to borrow said liquidity. TVL and the two-sided network effects underpinning money markets such as Aave is therefore an “un-forkable” property.

However, while TVL certainly provides money markets with some degree of defensibility, the nuance lies in asking if these properties are also immune to subsidization. Imagine a well capitalized team came along and not only forked Aave, but additionally engineered a well-designed $50M incentives campaign to acquire Aave’s users. Assuming the competitor is able to reach a competitive liquidity threshold scale, there may not be much of an incentive to switch back to Aave given money markets are inherently undifferentiated.

To be clear, I don’t see anyone successfully vampiring Aave anytime soon. Subsidizing $12B in TVL is a non-trivial task. However, I would argue that for the rest of money markets that have yet to reach this scale, they are at risk of losing meaningful market share. Kamino provides us with a recent precedent in the Solana ecosystem.

Moreover, it is also worth noting that while larger money markets such as Aave may be insulated from emerging competitors, they may not be entirely defensible from adjacent apps looking to horizontally integrate. Spark, the lending arm of MakerDAO, has now stolen over 18% market share from Aave after spinning up their own Aave fork back in August of 2023. Given Maker’s market positioning, they were able to both siphon and retain users as a logical extension to the Maker protocol.

Consequently, in the absence of some other properties that cannot be easily subsidized (e.g. a CDP embedded in the fabric of DeFi markets), lend/borrow protocols may not be as structurally defensible as one may think. By once again asking ourselves — If I fork this app, with $50M in token subsidies, can I steal and maintain market share? – I would argue that for the majority of money markets, the answer is in fact, yes.

DEXs

The popularity of aggregators and alternative front-ends makes the question of defensibility slightly more nuanced in the DEX market. Historically, if you asked me which model is more defensible — DEXs or aggregators — my answer would be evidently DEXs. At the end of the day, given front-ends are simply different lenses through which a back-end is viewed, switching costs are inherently lower across aggregators.

Conversely, given DEXs own the liquidity layer, there are much higher switching costs associated with using an alternative DEX with less liquidity. Doing so would assume more slippage and worse net execution. Consequently, given liquidity is un-forkable and much more difficult to subsidize at scale, I would have argued that DEXs are meaningfully more defensible.

While I expect this to remain true over the long-run, I believe the pendulum may be swinging in favor of front-ends increasingly capturing value. My thinking can be reduced to four reasons:

1) - Liquidity is more of a commodity than you think
Similar to TVL, while liquidity is “unforkable” by nature, it is not immune to subsidization. There are numerous precedents throughout DeFi’s history that seem to underscore this logic (e.g. SushiSwap vampire attack). The structural instability in the perps market also reflects the inability for liquidity alone to serve as a sustainable moat. Countless emerging perps DEXs have been able to quickly gain market share given the inherently low barriers to bootstrapping liquidity.

In less than just 10 months, Hyperliquid is now the most popular perps DEX by volume, eclipsing both dYdX and GMX who respectively owned over 50% of the entire perps market at one point.

2) - Front-ends are evolving
Today, the most popular “aggregators” are now intent-based front-ends. These front-ends outsource execution to a network of “solvers” who compete on giving the user best execution. Importantly, some intent-based DEXs also tap into off-chain sources of liquidity (i.e., CEXs, market makers). This allows these front-ends to circumvent the liquidity bootstrapping phase and immediately offer competitive and oftentimes better execution. Intuitively, this undermines on-chain liquidity as a defensible moat for existing DEXs.

3) - Font-ends own the end-user relationship
Downstream of owning the user’s attention, front-ends have disproportionate bargaining power. This can enable front-ends to either reach exclusive deals or subsequently vertically integrate themselves.

By using their intuitive front-end and ownership over the end-user as a wedge, Jupiter is now the four largest perps DEX across all chains. Additionally, Jupiter has also successfully integrated their own launch pad and SOL LST with plans to build out their own RFQ/solver model as well. Given Jupiter’s proximity to the end-user, JUP’s premium feels at least somewhat justified, albeit I expect this delta to close.

Moreover, as the ultimate front-end, no one is closer in proximity to the end user than wallets. By specifically owning the retail user in the mobile context, wallets have access to the most valuable order flow – “fee insensitive flow”. Given wallets are subject to inherently high switching costs, this has enabled wallet providers such as MetaMask to print over $290M in cumulative fees by strategically selling retail users convenience over execution.

Additionally, while the MEV supply-chain will continue to evolve, one thing will prove increasingly true — value disproportionately accrues to whoever has the most exclusive access to order-flow.

In other words, all the ongoing initiatives to redistribute MEV — both at the application layer (e.g. LVR-aware DEXs etc) as well as closer to the metal (e.g. encrypted mempools, TEEs, etc) — will disproportionately benefit whoever is closest to the origination of that orderflow. This would imply that protocols and apps will get increasingly “thinner” while wallets and other front-ends get “fatter” given their proximity to the end user.

I will be expanding on this idea more in a future report titled, “The Fat Wallet Thesis”.

Conceptualizing Application Moats

To be clear, I expect liquidity network effects will nonetheless result in an inherently winner-take-all market at scale. That said, I concurrently believe we are far from this future. Accordingly, liquidity in isolation may continue to prove to be an ineffective moat in the near-term to medium-term.

Conversely, I would argue that liquidity and TVL are more prerequisites and true defensibility may instead come from intangibles such as brand, differentiating on the basis of a better UX, and most importantly — constantly shipping new features and products.

This would imply that Uniswap’s ability to overcome the Sushi vampire attack was a function of their ability to “out-innovate” Sushi. Similarly, Hyperliquid’s meteoric rise is explained by the team’s ability to build out arguably the most intuitive perps DEX of all time while constantly shipping new features.

Put simply, while thing like liquidity and TVL can certainly be subsidized by emerging competitors, a team that never stops shipping cannot. Accordingly, I expect there will be a high correlation between apps that sustainably capture value and apps backed by relentless teams that never stop innovating. In an industry where moats are nearly impossible to come by, this is arguably the strongest source of defensibility.

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