Crypto can help make the world more productive. 

One of the areas where crypto can catalyze productivity gains is within the realm of physical infrastructure. Projects in this category are often referred to as DePINs (decentralized physical infrastructure networks).  

This piece is part one of our thesis on DePINs. It’ll focus on supply-side challenges and, in particular, network characteristics that we believe crypto is uniquely well-poised to help tackle and scale. 

Coordination Challenges

Building new physical infrastructure networks often involves overcoming a series of coordination challenges. Coordination challenges, in turn, tend to arise when there is a scarce resource and some degree of competition for that resource. 

Crypto thrives in these types of situations: granting ownership in a network can both help incentivize individuals to cooperate and attract resources that may otherwise be unavailable. 

Along these lines, we’ve identified three big coordination challenges that crypto-enabled physical infrastructure networks can help tackle:

1. Solving verification 

2. Overcoming barriers to centralized supply formation 

3. Accessing broad financial services 

To date, these are the only three meaningful coordination challenges we’ve seen where crypto protocols are applicable. They’re also stack-ranked in order of where we regard crypto as most valuable on the supply side of DePINs. The more of these vectors a project utilizes, the stronger the case for why crypto is especially helpful.

#1: Verification

In a centralized network, the scarce resource is trust – in particular, trust that the services provided by the network haven’t been manipulated. 

Decentralized networks outcompete by offering stronger verification guarantees (thereby providing confidence that the network is correctly producing the intended outputs). Crypto-economic incentives help to attract an independent and uncorrelated set of supply-side contributors to the network. That many DePIN projects are open for anyone, anywhere in the world to contribute means the number of distinct participants supporting the network is almost always greater than in a centralized offering. The sheer number of independent participants, coupled with thoughtful economics around incentivizing network productivity / penalizing dishonest behavior, make it much harder for parties to collude or manipulate the network outputs.

Strong verification matters in verticals for which the products of the infrastructure materially impact how customers spend time and money. AI is a prime example. The infrastructure networks that power the AI – compute for training, compute for inference, data / file storage, and more – are likely to power trillions worth of value. For instance, distributed inference platform Hyperbolic has gained traction by offering verifiable compute for many foundation models. And as a bonus, because it coordinates a decentralized network of suppliers, it’s also been able to scale compute faster and cheaper than centralized alternatives.

#2: Barriers to Centralized Supply Formation

The second major coordination challenge we’ve identified is the ability to overcome barriers to centralized supply formation. Two of the more common resource constraints that can pose challenges to central supply formation are (lack of) hardware and (access to) land.

On hardware: supply chain constraints, manufacturing delays, and high purchase costs are all examples of why a centralized company may not be able to aggregate a physical resource. DePIN can help overcome such obstacles by activating latent but underutilized resources. In many cases, these may be resources that consumers purchased for entirely different reasons – e.g. gamers who bought GPUs to enhance their playing experience could contribute any extra compute to a distributed network, or Tesla owners who bought the vehicles simply for the best driving experience could collaborate with other Tesla owners to provide battery hotspots. 

On land: construction permits, access to the physical land itself (especially if in a densely built-out region), and getting labor to the relevant regions are all reasons that it could be slow, expensive, and potentially even impossible for a singular entity to construct a new physical infrastructure network. Engaging local residents can help bypass many of these constraints. A good example is the wireless network Helium. Building a new telecom network is a mammoth task: a centralized operator may need to install new cell towers, lay cable, get local licenses, and more. Helium instead took a decentralized approach. Any individual can purchase and install a Helium device to start contributing bandwidth and earning a share of network rewards. Just a few years in, the result of this coordination is hundreds of thousands of hotspots providing global coverage. 

A core part of how crypto overcomes the above barriers is via the appeal of network ownership. Ownership not only attracts participants to the network, but also can turn these contributors into evangelists for enlisting others to participate. DePINs often become more useful as they grow bigger – and ownership gives early contributors a clear economic incentive to help strengthen the network.

#3: Access to Broader Financial Services

A third benefit of leveraging crypto is access to onchain capital markets. 

New physical infrastructure can be expensive to build. One option is to motivate individuals to purchase and install the physical hardware themselves. But some infrastructure networks require hardware that scales beyond what any singular individual may be willing to afford (or can reasonably set up within their home). 

In these scenarios, the coordination challenge is in matching dedicated physical infrastructure builders with broader sources of risk capital. Well technically, there are two coordination challenges: aggregating a sufficiently large amount of capital, and then matching that financing with infrastructure builders. Crypto can help with both.

The most direct approach we’ve seen is via project-specific lending markets. Here’s loosely how it works: 

• A DePIN protocol is created to help match capable infrastructure deployers with entities that are willing to supply risk capital. The protocol likely has a token that subsidizes early yield in the network, distributes ownership, and can eventually evolve into sharing network revenue. The protocol also manages the token emissions rate, with the ultimate goal of building a distributed network of performant infrastructure nodes.

• On the supply side, entities (retail consumers, investment firms, etc) provide capital to lending pools. They could earn tokens directly from the protocol for their work, receive a share of the token emissions slated for infrastructure providers that they helped capitalize, and/or collect interest in stablecoins (or other assets) derived from revenue the infrastructure may generate. The protocol tokens are especially important in attracting the initial capital. 

• The demand side is comprised of prospective physical infrastructure installers. They come to a pool seeking capital that they can borrow for the buildout and, in return, share a portion of their earned protocol tokens, revenue generated, or both.

Relative to traditional paths for raising private capital, utilizing onchain markets can dramatically expand access and improve efficiency: more people can participate, it’s easier to find & obtain sources of funding, and the aggregate value of capital supplied may be even greater than what’s available in private markets given the sheer volume of entities that can partake. In recent months, we’ve seen this model start to find traction within energy markets. We’re actively looking for others.

Concluding Thoughts

One of the challenges with building a comprehensive framework for thinking about DePIN projects is simply the scope of industries included in “physical infrastructure networks.” Some networks produce commodity-like resources (e.g. compute), while others have extremely granular outputs (e.g. mapping, weather). Geographic density may matter for some networks (e.g. telecom), while widespread distribution may be critical for others (e.g. proxy networks). There’s no cut-and-dry way of thinking about DePIN.

It’d also be intellectually dishonest to claim that protocolizing a physical infrastructure network can always supercharge the end product. There are some scenarios where a decentralized supply side creates real performance or quality trade-offs for the customer. And there are certainly scenarios where crypto can improve an infrastructure network – e.g. by leveraging blockchain rails for cross-border payments – but are innovations that can be adopted and incorporated by incumbents.  

Where DePIN shines is when there is a true coordination challenge to be solved. We’ve identified what we see as the core three: verification, barriers to centralized supply formation, and access to financial services. For each, a crypto protocol can offer novel and efficient solutions. Most importantly, decentralization is not just about cost; it’s about creating a better product, an entirely new product, or both.

This piece focused on how we’re thinking about the supply side of DePIN projects. The next piece will dive into the other side of the market: the characteristics of DePIN customers that we believe could lead to sustainable sources of demand.

Thanks to Jesse Walden, Nikhil Raman, Hootie Rashifard, and Mason Nystrom for comments and feedback on this piece. 

Disclaimer: All information contained herein is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice or investment recommendations. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment. None of the opinions or positions provided herein are intended to be treated as legal advice or to create an attorney-client relationship. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by Variant. While taken from sources believed to be reliable, Variant has not independently verified such information. Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by Variant, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Variant (excluding investments for which the issuer has not provided permission for Variant to disclose publicly as well as unannounced investments in publicly traded digital assets) is available at https://variant.fund/portfolio. Variant makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This post reflects the current opinions of the authors and is not made on behalf of Variant or its Clients and does not necessarily reflect the opinions of Variant, its General Partners, its affiliates, advisors or individuals associated with Variant. The opinions reflected herein are subject to change without being updated. All liability with respect to actions taken or not taken based on the contents of the information contained herein are hereby expressly disclaimed. The content of this post is provided "as is;" no representations are made that the content is error-free.

Variant is an investor in Hyperbolic.