Author: Spencer Bogart, General Partner at Blockchain Capital
Compiled by: Hu Tao, ChainCatcher
The on-chain economy possesses a series of truly unique characteristics, including programmability, composability, and global distribution. This means anyone can build, anyone can publish, and anything can freely connect to everything built by others. Protocols are tested in a production environment using real capital in a globally scaled adversarial setting. Ultimately, this fosters an ecosystem of innovation that is faster and more open than anything the financial world has ever seen before.
However, when it comes to truly large pools of capital, these same characteristics present a problem. Institutional investors with fiduciary duties and investment committees need to be able to assess the risks of their investment environment. The permissionless nature of on-chain infrastructure, coupled with the potential for newer, less-tested protocols to yield unexpected outcomes, makes this risk assessment more difficult than in more controlled environments.
For the on-chain economy to reach its full potential, it requires both open innovation and deep capital. I believe we are beginning to see a pathway that achieves both.
What is emerging is a two-tier architecture.
The first tier is our existing permissionless environment, where composability and open innovation drive the ecosystem. This tier is not going away, nor should it.
The second tier consists of a collection of chains—be they L2s, L1s, or otherwise—often built on the same codebase and security infrastructure, but with a different approach to handling the tails of the risk distribution. These chains have security models that include the ability to pause or freeze transactions in the event of extreme incidents. For institutional capital, this capability is a risk management feature that makes the entire exposure controllable.
We are seeing this today in secondary organizations: some L2s have already established security councils with some form of freeze authority. We recently witnessed this mechanism in practice when the Arbitrum security council intervened and recovered funds in the Kelp DAO incident.
These two tiers serve different purposes, and that is the key. The permissionless tier is the crucible where protocols are forged under real pressure, with real capital, in an adversarial environment. The protocols that emerge are stronger for it. The institutional tier allows for the large-scale deployment of capital with formal mandates and compliance requirements.
The cross-pollination between them is particularly important.
A protocol that has been battle-tested over years in a specific environment, likely having survived real security events, demonstrated reliable operation across various market conditions, and established mature governance, now has a credible path to expand its reach into the institutional tier. It can deploy onto the institutional tier and access a deeper pool of capital than what might be available in a purely crypto-native environment.
The lifecycle becomes: build and launch permissionlessly. Get tested in the open. Prove your mettle. Then expand to the institutional tier and access capital at a completely different scale.
This is indeed a great architecture. The open, experimental side of the ecosystem continues its work, launching new protocols and using crypto-native capital to take initial risks and push boundaries. The institutional tier provides the ample liquidity and stability that raise the ceiling for successful protocols. In this world, the reward for earning institutional trust is significantly higher. The incentive to innovate increases accordingly, as the payoff for success is greater than ever before.
However, the real challenge lies in overcoming the cold start: the blockchains most favored by institutional capital may not be the ones where the best applications currently reside. The protocols with the highest transaction volumes and battle-tested histories create deep network effects on the blockchains that do not offer these safety guarantees. How this resolves—whether the best protocols choose to deploy instances on institution-facing blockchains, whether new protocols are built from the ground up for the institutional architecture, or whether institutional capital eventually embraces existing blockchains—will be one of the dynamics worth watching.
But the overall architecture feels right. The on-chain economy is building a true capital structure, with different pools of capital flowing into a shared ecosystem. The permissionless base layer constantly creates new things. The institutional layer provides depth. And the connections between them make the whole system work.
