"Fat Protocol" Thesis: Is "Thin" Better Than "Fat"? It Depends.

The 'Fat Protocol' thesis originated in 2016, referring to the idea that crypto protocols and base layer networks such as Ethereum and Solana would be valued higher than the application layer built on top of them — i.e., the decentralized applications built on those networks. 

The thesis brought forward the notion that the crypto sector consisted of “fat” protocols and “thin” applications. That compared to the internet stack which was composed of “thin” protocols and “fat” applications, with value concentrated in the latter (leading to high valuations of large US tech companies such as the Magnificent-7).

Decomposing the crypto market structure today, we see that the ‘Fat Protocol’ thesis still holds.

Among the top 20 crypto assets by market capitalization, nine are layer-1 blockchains (excluding BTC). Those nine L1 networks have consistently accounted for 50-60% of the total crypto market-cap when removing BTC.

However, when it comes to revenue generation (defined as the portion of fees that accrue to the tokenholder, including the portion of network transaction fees that are passed to holders via token burns - supply reduction which benefits holders passively - and fees paid to validators and stakers), those same base layer protocols have underperformed relative to the applications built on top of them.

Major decentralized applications on the Solana network (such as Pump.fun, Meteora and Jupiter) now collectively generate more revenue than the Solana network as a whole.

We see a similar trend between the Ethereum network and some of its major applications.

The Ethereum network still generates more revenues than lending protocol Aave, but since Aave’s launch, revenues have grown from $12K to over $250K, while revenues on Ethereum have drifted lower from a peak of $46M down to $400K.

Therefore, despite the application layer making up a fraction of total crypto market capitalization, it is trending towards matching (and potentially exceeding) base layer protocols in terms of revenue generation.

Despite this trend towards revenue outperformance, crypto traders have historically been far better off holding the native token of the network, and not the native token of the application itself.

That is ...

App performance is yet to translate into token outperformance.

For example, when we compare the performance of ETH and the AAVE token since its launch in October 2020 we notice that a holder of AAVE since launch would have doubled their money, while that same holder would have seen a more than 400% gain holding ETH.

The same can be said when comparing the Solana network’s SOL token relative to the tokens of some of the largest applications built on Solana. Take the example of DEX aggregator Jupiter’s JUP token – after a brief period of outperformance during launch, it is down 77%, while holding SOL would have returned a smaller -10%.