How to Keep Web3 from Repeating Web2’s Mistakes

READ MORE: WEB3: 2Be Or Not 2Be (Forbes)

“The future is already here — it’s just not very evenly distributed,” wrote sci-fi sage and cyberpunk godfather William Gibson in 1993, a quote that neatly sums up the current status of Web3.

The consensus is that what we are witnessing is an industry still trying to figure how the next-generation internet, and specifically a new economic model, might pan out.

All while Web3 ventures attracted $30 billion of investment last year, according to Forbes, with a total market cap exceeding $3 trillion.

READ MORE: An Overview Of Web3 Venture Capital Activity In 2021 (Forbes)

For a deeper dive into the current state of web economics, including cryptocurrencies, decentralized finance, tokens, blockchain, and more, Hessie Jones, a partner at MATR Venture, has assembled the opinions of a number of experts, Web3 advocates and critics alike.

She starts with some definitions of Web3, which are worth restating:

Web3 (as opposed to Web1 and Web2) is succinctly defined as: Read + Write + Owned, with the “owned” part being the newest bit.

According to Chris Dixon, co-founder of venture capital firm a16z, “Web3 is the internet owned by the builders and users, orchestrated with tokens.”

READ MORE: Why Web3 Matters (a16z)

Web 3 is also a response to Web2, which is considered by some to have failed. In particular in Web2 (i.e., today’s paradigm), advertising and platforms profit from personal information, whereas in Web3, equity, access and accountability will occur within a shared governance and a self-organizing ecosystem.

“[Web3 is] where creators can truly own what they produce and enable and control new value creation,” says Jones. “And where a currency for the Web truly revolutionizes access for everyone.”

That’s the utopia. So how is that shaping up?

1. Web3’s Centralization of Wealth

However alluring the promise of democratized participation is, what we’re really witnessing is a concentration of wealth once again among the hands of a very few.

Jones lists Peter Thiel, Chris Dixon, Andreeson Horowitz as the “whales” within the system.

Whales are indeed profiting. Since the start of 2022, the global market capitalization of cryptocurrency has fallen (per AOL), but that volatility has yet to affect the fortunes of crypto companies seeking venture capital.

READ MORE: Crypto exchange FTX raises $400M in new venture capital, now valued at $32 billion (AOL)

In a recent article, a JP Morgan strategist attributed this market volatility as a byproduct of the “Bitcoin concentration where 2% of bitcoin holders own 72% of its value.” Others have noted that the top 9% of accounts hold 80% of the $40 billion market value of NFTs on the Ethereum blockchain.

READ MORE: JPMorgan Strategist: Crypto Is Like Hydrogen (Bitcoinist)

READ MORE: How NFTs became a $40bn market in 2021 (Financial Times)

“The biggest issue with the system is it’s like capitalism with all the breaks and all of the controls basically just removed in this kind of complete anarchic system in which everybody has to be their own bank,” says software engineer and crypto skeptic Stephen Diehl on the Tech Won’t Save Us podcast. “By today’s standards, it’s not only difficult, it’s unrealistic.”

If Web3 is not yet democratizing participation, there still hope that improvements can be made.

Val Bercovici, CEO of click2nft.com, does not dispute the early concentration of wealth, but tells Jones, “Wealth (measured by price) is independent of ownership ratios, and Crypto indeed suffers from a concentration of ownership in this early phase. However, the pace of new protocols, DeFi protocols, GameFi (Play to Earn) and NFT projects is accelerating the breadth of both ownership and new wealth creation to a more diverse population on a daily basis.”

2. Bringing Accountability to Decentralized Structures

The promise of decentralization is really about disrupting existing centralized financial and trade structures.

Jones writes, “It’s known that every single transaction will consume vast amounts of computational power to confirm its validity because that’s part of the consensus algorithm — in essence, math puzzles compete for tokens. To what extent can DAOs (decentralized autonomous organization) scale given the cost of power required to maintain the infrastructure?”

In other words, the sheer cost in financial terms of mining new coin to get onto the crypto ladder is already too high for most people. Those wealthy individuals in at the beginning and able to speculate are the ones who will reap rewards and end up centralizing Web3 economy just like in Web2.

Roxana Nasoi, MD of Launchpool Labs, tells Jones the volatility in the variable cost of transaction fees is “proof that the technology behind Ethereum is yet to mature, and that the consensus is broken.

“The high transaction fees turn Ethereum into a gated product, affordable only to a select few.”

Accountability also means responsibility to the planet as much as democratization. Early days mining of Bitcoin using so called Proof of Work methods are deemed highly inefficient in terms of energy consumption and continues to make the industry look bad, according to Mete Gultekin, analyst at Analyst Bayshore Capital Advisors.

“The shift to Proof of Stake (PoS) models should help eliminate the energy discussions… alternative smart contract platforms [to Ethereum] like Avalanche, Solana, Polygon, Fantom, Immutable, Terra — all using PoS.”

Val Bercovici, CEO at Chainkit concurs that PoW will be replaced by PoS. He says more than two-thirds of all crypto transactions no longer use energy-intensive Proof of Work.

“That will further improve as Ethereum itself moves to Proof of Stake later this year…Bitcoin is very sustainable, proving to be a net positive for energy grid stability and investment in renewables.”

3. Crypto: The Market of Artificial Scarcity

This is the crux of current Crypto activity. Artificial scarcity is the “purposeful imitation of an item’s supply” in order to promote demand for a product.

Increased demand = higher value on things that are deemed limited or exclusive.

Jones says, “This pervasive FOMO is what has driven massive activity in the NFT market. Bitcoin, for example, will only ever have 21 million coins mined, which means that as long as demand increases, the price will rise because supply is fixed.”

Web3 can be read as a marketing scheme (or con) to create this illusion of demand masked through pre-ICO private sales, token burning, airdrops, and wash-trading.

These tactics in more detail:

Pre-ICO Private Sales: investors and VCs with early access will pay a premium with the belief that later investors will come in at higher investments, more often than not mean that early investors can capitalize much sooner than traditional VC.

Token Burning: the destroying of remaining tokens not sold to raise the price by reducing the supply.

Airdrops: campaigns that give away tokens for free for the purpose of awareness building. Holders can receive bonus coins in proportion to the amount they hold, further incentivizing people to purchase more coins to get the larger portion of free coins.

Washtrading: investors can buy and sell the coins simultaneously to artificially inflate the value of the coins

Mark Xue of Kaiju Capital Management tells Jones he agrees that these are massive problems plaguing the industry, and are the reason why fraud is prevalent:

“Most people do not have a deep technical understanding of how these distribution and incentive schedules work (Tokenomics). They are trying to either hit the lottery, or are investing with minimal research, relying on influencers or social media for suggestions, chasing the next pump and hoping they don’t get dumped on.”

Xue also adds: “Most mainstream media also barely spend any time learning or objectively representing the crypto space. Lack of education and the newness of crypto really poses issues in understanding and perception. What will be reported and read will be the most salacious, eye-catching, and easy to understand news about crypto like hacks and NFTs.”

Vitalik Buterin, the Canadian programmer who is one of the founders of Ethereum, has also voiced concern that Eth’s potential transformative power is at risk of being overtaken by greed.

“If we don’t exercise our voice, the only things that get built are the things that are immediately profitable… And those are often far from what’s actually the best for the world.”

5. So, is Web3 the Promised Land?

In short, the jury is out. Or rather, it is just too soon to tell. Jones thinks that if decentralization is the goal it won’t be achieved without proper oversight.

However, she points out, no one entity governs TCP/IP protocols, the communication standard that governs the internet.

“Some form of central authority is required to legitimize the industry while scrutinizing its methods for fair access,” Jones says. “This needs to happen while creating guardrails to protect the creators, end consumers and investors in the process.”

Current governance structures, protocol bias and more pervasive user education need addressing to scale adoption. However, the benefits of this evolving space cannot be realized without education and resources to bring more familiarity to DeFi, which is severely lacking.

“Those who’ve jumped in with both feet have experienced polarized wins/losses. It’s less likely that more often, than not, those driven by FOMO would have been more vulnerable to artificial scarcity schemes, or NFT counterfeiting.”

Ryan Pannell, founder and chief investment officer of Kaiju Capital Management, thinks the time to consider this entire asset class as a “phase” or “fad” has long passed.

“You’re seeing the most conservative, risk-averse Sell Side institutions now taking their first meaningful positions in tokenized assets,” he says, “with capital and resource commitments commensurate with what you’d expect to see in a class they intend to take seriously.”

He adds, “Resistance can no longer be marketed as ‘caution’; investors are increasingly seeing it instead as ‘ignorance.’”

Nasoi of Launchpool Labs is clear-eyed about the pitfalls and the potential of decentralized finance.

“We expect to solve all the problems of the world with what is essentially an experiment, in which a small group of people take a risk, while the world watches on the sidelines,” she says. “We have one foot in the Pioneers’ club, and one in the Early Adopters’ club. It could go down to zero. Or it could fly.

“It’s possible that some geographies that aren’t embedded in the traditional financial system could benefit more from it, the moment the whole decentralized web goes mobile. Who will be first? When, if ever? I don’t know, but I have the patience to wait and see.

“What I do know is that a younger generation is more minimalist, consumes digital goods, digital entertainment, likes social tokens wants to be part of the cool tribe. That’s what Web3 is offering them, in a very modest setup (for now).”

Are you interested in contributing ideas, suggestions or opinions? We’d love to hear from you. Email us here.