The product-market fit nuances in Web3

Web3 represents the next phase of the internet, characterized by decentralization, user ownership and equitable value distribution. Like all new technologies, its success depends on addressing market needs and understanding user challenges. However, many Web3 initiatives have missed achieving a product-market fit, often adopting a “build it and they will come” approach. This mindset has been harmful, especially during market downturns. While the core principles of product-market fit (PMF) remain consistent, their application in the Web3 context has evolved.

Product-market fit levers

The PMF equation is one of the hardest problems to crack in Web2 as well with most startups not making it to this stage. Most Web3 protocols have alo not shown their ability to cross the chasm of a product-market fit. This is largely due to attraction speculators rather than real users — many may not survive this brutal crypto winter. My thoughts around PMF have been formulated by applying Web2 principles learned over several years of operating SaaS companies for years with some notable successes and some failures.

Pragmatically speaking, PMF is only about two levers — customers or developers using the product at a high frequency (usage) and over a prolonged time (retention). If one can crack the code on both of these, you are on a path to achieving PMF.

Web3 challenges, risks and opportunities

While principles of PMF remain constant for any product, in any era, there are nuances to Web3 due to its decentralized nature and community ownership. While most people accept groundbreaking technology with blockchain, very few Web3 projects/platforms have reached scale through PMF.

Nuanced network effects

Network effects drove Web2 platforms’ success, wooing builders and investors for years. While some predict stronger network effects in Web3, others argue that Web3 might diminish them due to a lack of defensibility.

Web2 platforms, like eBay, are primarily driven by market participants and manage their own infrastructure, funding and governance internally. A Web3 variant must operate on a wider scale, involving not just the market but also infrastructure, financing and governance layers. Web3 platforms coordinate infrastructure, manage token liquidity for funding and value appreciation and adopt a more inclusive governance approach. Crucially, Web3’s value is deeply rooted in its community, with users playing a central role in its value creation, unlike the user-centric community of Web2.

Web2 platforms gained defensibility through four primary forms of accumulated value: data, content, reputation and influence. These stored values, coupled with high switching costs, let Web2 platforms benefit from extensive extraction practices, whether through high take rates or data collection. However, with diminishing switching costs and all attributes being portable in Web3, network effects are less defensible.

Token mechanics

Tokens play a crucial role in Web3’s market strategy, aiding in achieving network momentum. However, an overemphasis on tokens can mislead one into believing they’ve achieved a product-market fit (PMF). True PMF is based on the product’s inherent value and utility. Merely using tokens to boost usage without a solid product can be costly and risks devaluing treasury assets.

Users attracted only by monetary gains aren’t loyal; they often leave when token values drop. Successful Web3 products like dydx, Uniswap and Arbitrum achieved PMF before introducing tokens. While tokens can incentivize the acquisition of developers and users, relying on them prematurely has led many projects astray — especially when market dynamics shift. Tokens might boost engagement in bullish times, but in bearish phases, they can lead to increased attrition, especially if the underlying platform lacks substance.

PMF metrics

The PMF journey does not unfold overnight and entails several iterations, trial and error scenarios and some planned testing with demand and usage. This is a 12- to 18-month journey. The key levers of a PMF are important to understand. In Web3, while tokens can help catalyze and bootstrap the go-to-market motion or scale the PMF once established, it is not a substitute for PMF and may also create a false sense of achievement.

The general theory around PMF points to NPS(Net Promoter Score) surveys, etc. Conventionally, Web3 folks have chased vanity metrics (e.g., community size on specific channels like Telegram or X, the number of dapp downloads, influencer endorsements, etc.). These vanity metrics do not drive towards PMF. A PMF hinges on two fundamental levers: frequency of product usage and retention of users creating Customer Lifetime Value (CLTV).

Frequency of usage

If the product is not used frequently, it is not in demand and users will eventually not see value in price satisfaction and churn. In Web3, the frequency of usage is correlated to token movements, transaction volume and utility…