Why you need to understand Layer 1 protocols

As we discussed last week, the first quarter was a great time for cryptocurrency prices, but a terrible time for industry sentiment. I’d like to elaborate on that last point, given that crypto is clearly in the crosshairs of regulators and politicians – including some who seem to not want this sector to exist at all.

But instead of criticizing the critics, I’d rather talk about what drew me into crypto, which is illustrative. My first interest in 2018 was based on speculative interest, which can be dirty words to many. Why is speculation used in the pejorative? I don’t know anyone who invests capital with the expectation that it will decrease in value. If you are that person, feel free to forward your asset to me and I can hold it for you.

Here are the questions I asked myself when crypto came on my radar:

Intellectual curiosity, the desire to generate wealth and a goal to increase my knowledge of a new technology led me to bitcoin (BTC). In hindsight, however, it wasn’t just bitcoin. That was the concept of layer 1 blockchains, because ultimately that’s what we get access to: space on a blockchain.

The value of a Layer 1, or L1, network comes from people conducting peer-to-peer transactions with that blockchain. The original token of a given blockchain – BTC in the case of Bitcoin – acts as an incentive mechanism to get people to ensure that the data stored on the blockchain is secure and accurate.

The value is particularly relevant in areas of the world where central bankers have caused local currencies to hyperinflate. One of the mistakes made by US lawmakers and regulators is to look at cryptocurrencies only from a US-centric perspective.

Regulators don’t seem to care about the functionality or reliability of blockchains, especially as some of the most vocal opponents of crypto are for central bank digital currencies – a type of digital currency issued by a central bank. The animosity feels more related to the decentralized nature of crypto – the ability to take fiat currency and exchange it for another value, without the need for a central body (central banks, regulators, politicians, conventional banks, etc.).

Here are some of the larger Layer 1 protocols and their recent performance:

(Note: data for ALGO and SOL are from April 2020. Data for AVAX is from 2021)

The performance goes from impressive to anything but, as it probably should be. On a technical level, BTC is most correlated to ether (ETH), the second largest cryptocurrency after bitcoin, with the lowest correlation to crypto exchange Binance’s BNB token.

What I find exciting about layer 1 is the nuance that exists between them. As one L1 comes about, another tries to improve it on the basis of speed, scalability, etc. For example, I am admittedly rooted to Bitcoin. Its foundation as a peer-to-peer network gives it a first-mover advantage and the largest market share.

The ability to develop smart contracts on top of the Ethereum blockchain, where predetermined conditions are met and executed via code, is another facet that I find value in.

In many ways, crypto forces someone focused on assets and prices to increase the level of technology, while the technology-focused person is incentivized to speed up market dynamics. The discipline of technology and the discipline of assets are drawn together, much in the way that code connects tasks within a smart contract.

My own experience led me to discover differences between blockchains. For example, Avalanche uses a “heterogeneous network of blockchains.” Instead of all applications occurring on one blockchain, Avalanche uses an Exchange (“X”) chain, Platform (“P”) chain, and Contract (“C”) chain. By doing so, the goal is to increase scalability and reduce fees, things the Ethereum blockchain has struggled with.

Asset ownership is important. It makes little or no sense to ignore an emerging technology, unless you want to be completely left behind. If people can engage in peer-to-peer transactions while having full confidence in its accuracy, and not having to compensate a third party, they will.

L1s are at the bottom of the crypto economy and should be understood and used as a base network for applications. And, yes, sometimes also used to generate profits.

From CoinDesk’s Nick Baker, here’s some recent news worth reading:

To hear more analysis, click here for CoinDesk’s “Markets Daily Crypto Roundup” podcast.