Web3 — The new Internet: Democratizing ownership models
Disclaimer: this blog post was put together for informational purposes only based on our review and analysis. This should not be construed as a solicitation, offer, or recommendation to acquire or dispose of any investment, engage in any transaction.
By Nassim Olive, CFA — Partner at Eterna Capital and Jack Traube — Investment Analyst at Eterna Capital
While the idea of Web3 (or Web 3.0) has been around for some years now, it has recently started to gain serious traction. This can be attributed to a tremendous 2021 for the crypto industry, where we saw the proliferation of NFTs (non-fungible tokens), the market capitalization of cryptocurrencies surpassed $3 trillion at one point, and large corporations entered the market with the intention to accelerate their long-term involvement in the near future. We are making a bold statement, Web3 is no more an illusion — it has all the ingredients to become the next generation of the Internet, an Internet that shifts power from Big Tech to individual users.
We believe that existing business models focus heavily on shareholders’ value accruing rather than customers loyalty. Let’s consider a practical example, why should a shareholder who rarely goes to Starbucks and contribute very little revenue to the company be economically benefiting the most, when loyal customers are the reason for the success of Starbucks (i.e. without them, it would probably be worthless)? Shouldn’t it be the customers who benefit the most from Starbucks’ success? This raises an interesting situation; one that we call a ‘systematic misalignment’. Web3 reshuffles this equation and has the potential to realign incentives by placing individuals at the core of the business model.
What is Web3?
Have you previously been asked to use your Google, Twitter, or Facebook login details to sign-up to a new platform, order food, or book a plane ticket? The primary goal of Web3 is to promote decentralization and to remove dependency and reliance on these Big Tech companies who currently have full control over our data and our access to the Internet. In this blog, we will cover the evolution of the Web, the role blockchain technology plays, and talk about some of the main use cases that Web3 offers.
The first iteration of the Internet — known as Web 1.0 — was launched back in the early 1990s and can be categorized as what people consider a “read only” version of the Internet — content published as links and homepages which weren’t interactive.
In the mid 2000s, it was upgraded to Web 2.0 — a “read-write” version of the Internet allowing users to not only read but also interact with online content and experiences. The likes of Facebook, YouTube, and Twitter created ‘free to use’ platforms that allowed users to create their own content, publish it and share it with others. This caused the level of data being created to start growing exponentially. While considered as a clear revolution of social interaction and data consumption, the incredible capabilities provided by Big Tech companies came with consequences — almost all the value and data created started accruing to a handful of large centralized platforms and their shareholders. Users, creators, and consumers that brought all of the content to these platforms received very little rewards, if any. This is where Web3 and decentralized platforms come in to reshuffle the model.
Web3 is the transition to a “read-write-own” decentralized version of the Internet that allows users to keep ownership of their data and participate in the governance of these protocols. This would mean that you ultimately could own a piece of the network and benefit from its growth — think about it like being the participant/shareholder rather than the customer/product itself. Blockchain technology allows for such decentralized networks to prosper through the creation of tokens and smart-contract driven governance models. By holding tokens of the network, you would own a piece of it and have a say over it.
How is blockchain technology enabling Web3?
So how are we now able to ‘own’ parts of the Internet? Rather than dive into the technical aspects of what blockchain is, we want to highlight the key characteristics of public blockchains  that allow for Web3 to be possible.
Blockchain allows for Peer-to-Peer economies without the need for a middleman by reinventing how data is stored and managed. Rather than storing data on a centralized server controlled by a ‘trusted’ intermediary, data is stored as multiple copies among a distributed network of computers called nodes, that ensure correctness and reliability of the entered data on the blockchain. This in turn gives the ownership of data and control back to the user, rather than the centralized platform, and is the backbone for why Web3 is now possible. There are two other key characteristics that we wish to touch on.
The so called “permissionless” blockchains make sure that anyone can interact with the blockchain and access the data. Smart contracts do not need permission to interact with one another and anyone can submit a transaction to the blockchain. This combined with all data being publicly stored on the blockchain, allows for complete transparency. This is a big shift away from Web 2.0. In Web 2.0, interactions with other platforms are typically done through APIs which can be gated or have high access costs. Data is also not publicly stored and thus there is no transparency.
Blockchains that are permissionless and open source enable one of the most powerful characteristics: blockchain’s composability. Anyone can freely access the code as it is open-source. Instead of reinventing the wheel, an engineer can utilize code out there as the building blocks for their new projects. It becomes an iterative process rather than a process that starts from scratch every time. This allows for an incredible pace of innovation in this space.
What use cases can be built on Web3?
Web3 can be the infrastructure on which you can build pretty much everything happening in the real world. We will cover a few key themes here and aim to dive deeper into some of the most exciting areas of Web3 in subsequent publications.
Decentralized Finance (DeFi)
DeFi has been described as the “money legos” that make up the financial railways of our world. This new concept aims for the gradual disappearance of financial intermediaries by slowly introducing the transition into “Uberized” financial markets. Traditional finance is highly dependent on intermediation — bankers, brokers, clearinghouses and the likes.
DeFi users are able to complete similar financial transactions offered by the traditional finance (TradFi) system without any middleman — lending, borrowing, leveraging, trading spot and derivatives, and insuring against risk. Not only is DeFi decentralized by nature, but it is also permissionless and transparent. In other words, anyone can use it and see what is happening regardless of where they live.
In many respects, DeFi has all the ingredients to be more efficient than TradFi. From trade execution, to margin calls, and money transfers, blockchain technology permits many functionalities to be automated which would ultimately result in significant cost savings to the end-user.
Even with the volatility in crypto markets, DeFi has continued to experience rapid growth. Over the last year, the Total Value Locked (TVL) within DeFi protocols has risen from $55 billion to $218 billion (as of 25th March 2022).
According to data from Dune Analytics, the total number of unique users in DeFi has grown from 145,000 in 2020 to 4.55 million in 2022 . While there has been significant growth, DeFi is only scratching the surface when compared to TradFi services. However, with the number of developers entering the space, and the incredible amount of innovation, we believe that DeFi is poised to disrupt TradFi markets. DeFi is only 3 years old and is therefore still in its infancy, but, as can be seen below, it is evident that it has substantial room to grow .
Decentralized Autonomous Organizations (DAOs)
We like to describe DAOs as a community that is collectively governed by its members in a decentralized way via a self-enforcing open-source protocol.
Members own a piece of the DAO in the form of a token that gives each participant some decision-making power on governance matters related to the DAO. The use of blockchain technology enables members to seamlessly interact with and participate in the DAO without the need to know or trust each-other (‘code is law’). Any governance related rules can subsequently be adjusted throughout the life of the DAO if the majority of network participants decides to (or according to whatever pre-agreed rules and criteria).
DAOs are usually established by a community with the idea to collaborate towards a common goal that can revolve around pretty much anything — a political, economic or social purpose. We have seen DAOs aiming to solve climate change, to buy the US Constitution or a professional sports team, to invest in specific areas, to lobby for a specific political cause, etc.
The landscape is constantly evolving and new use cases for DAOs are frequently coming out.
Non-Fungible Tokens (NFTs)
While many people have heard of what an NFT is, few actually know what it really is. An NFT, or Non-Fungible Token is a unique token that can act as a digital representation of a physical item or items, or digitally native items whose proof of ownership can be verified on a public blockchain. Unlike fungible tokens, such as Ethereum or Bitcoin, NFTs tend to be unique assets. They confirm the ownership of an asset, but they do not restrict sharing or copying the asset itself. This form of digital ownership is a whole paradigm shift from what we typically conceive as ownership.
NFTs are becoming mainstream. Total sales volume surpassed $22 billion in 2021 alone. The leading forms of NFTs at the moment are collectibles and digital art. Top collectible projects, such as Cryptopunks and the Bored Ape Yacht Club (BAYC) have recently had individual pieces sold for hundreds of thousands of dollars and millions of dollars for rare pieces. In addition, we have seen Big Tech starting to enter the space. Meta (a.k.a. Facebook) confirmed that NFTs will be coming to Instagram and reports have suggested Meta is planning on launching an NFT marketplace to rival the likes of the current biggest NFT marketplace, OpenSea. Twitter has recently launched NFT capabilities for profile pictures. We have also seen major sports brands such as NASCAR, UFC, NFL, Adidas, and Nike enter the NFT space. The total number of transactions has gone from around 30,000 at the beginning of March 2021 to a peak of 1.1 million at the end of January 2022 . OpenSea remains the largest NFT marketplace by far.
VC and institutional investments into this space have been considerable. OpenSea recently raised a $300 million Series C at a $13.3 billion valuation. The round was led by Paradigm (founded by Fred Ehrsam, Co-Founder of Coinbase) and Coatue . Dapper Labs, the company behind NBA Topshot, Cryptokitties, and the Flow Blockchain raised $250 million at a $7.6 billion valuation late last year. The round was led by Coatue, with participation from a16z (Andreessen Horowitz), Google Ventures, and others . There have been many other significant raises in this space (e.g. Yuga Labs, Animoca Brands, etc.), which highlights the incredible growth this sector is experiencing.
NFTs can have unique features associated with it. We are witnessing a growing interest for projects that offer community access. Community access is an interesting evolution of exclusive clubs with many potential iterations. A great example of this is Bored Ape Yacht Club (BAYC). Owners of a Bored Ape have access to an exclusive community section of the official BAYC website as well as exclusive real-life events. Another form of community access is Proof of Fandom which is gaining traction in the music industry as it provides a way for artists to directly engage with their top fans. Owners of the artist’s NFTs may be given exclusive access to special events held by the artists. Through the use of NFTs as tickets, artists could actually track which fans have gone to most of their concerts and decide to reward them, engage on a more exclusive basis, etc.
It has always been possible to collect gaming related digital assets such as weapons, objects, or wearables. Some of these could be collected through completion of in-game objectives and some could be collected through paying real money for the assets. The issue with this model is that these digital assets are held on walled off data networks owned by the companies that created the game, and thus these centralized companies have complete ownership of the in-game economy. As a result, it is typically impossible to transfer the digital asset out of the game or sell it for real world value.
With the introduction of blockchain technology, a new paradigm of gaming has emerged, Play-to-Earn (P2E). From a foundational level, P2E is a new business model where you can earn cryptocurrencies that can either be exchanged for in-game assets (weapons, objects, wearables) or for real money. Through the use of NFTs, you can also now truly own these in-game assets and can freely sell them outside of the platform where they were created for fiat currency or use them in another P2E game. Different games have different in-game economic models and thus different ways to earn. What P2E allows for is real world value for the time you invest into the game, which is a shift from traditional gaming models, where all assets and thus value are held within the game.
Two of the largest P2E games include Axie Infinity and Defi Kingdoms who boast millions of daily users. The number of new P2E games has climbed by 71% over the last year to around 1,200. The number of daily unique wallets interacting with game-related smart contracts increased to 1.3 million last year, a 46x increase from the end of 2020 .
The Metaverse has been the centre of much hype as of recent, which has been fuelled by announcements from companies such as Meta, JP Morgan, HSBC and Twitter. So what is the Metaverse? The Metaverse is a broad definition for a conglomerate of sectors, but can be defined as follows:
“The Metaverse is a seamless convergence of our physical and digital lives, creating a unified, virtual community where we can work, play, relax, transact, and socialize… There is no one virtual world, but many worlds, which are taking shape to enable people to deepen and extend social interactions digitally .”
The two largest Web3 metaverses are Decentraland and The Sandbox. Large institutions have started entering these virtual worlds. For example, Sotheby’s own a piece of land in Decentraland, where they showcase NFTs that are on auction. Users can enter their virtual shop to view NFTs and even buy them directly through the virtual store. Adidas, Nike, Balenciaga, Pandora, Gucci, Ralph Lauren, and many other brands have also entered these platforms, where they are either selling NFTs of their products or presenting their clothing collections virtually. At the end of March 2022, Decentraland hosted the first ever Metaverse Fashion Week, with a lineup of brands including Dolce & Gabbana, Etro, Tommy Hilfiger, Selfridges, among others. The event included virtual runways with digital wearables, organized discussion panels, and housed shopping experiences.
JP Morgan recently became the first bank to enter the Metaverse after they opened a virtual lounge in Decentraland. At the time of the announcement, the bank also issued a report stating that the “The Metaverse will likely infiltrate every sector in some way in the coming years, with the market opportunity estimated at over $1 trillion in yearly revenues.”  HSBC also recently entered the Metaverse through a partnership with The Sandbox. The British bank is planning on buying a plot of land in The Sandbox, which it will develop to engage with sports, e-sports, and gaming fans. According to a statement by Suresh Balaji (HSBC Asia-Pacific CMO), the partnership will enable the bank to “create innovative brand experiences for new and existing customers.” 
The Metaverse is becoming a new frontier for digital advertising and marketing and as stated by JP Morgan, it is expected to see incredible growth. At the end of 2020, the Metaverse market size reached $107.1 billion and is expected to reach $758.6 billion by 2026 . A lot of this growth will be driven by the adoption of Augmented Reality (AR) and Virtual Reality (VR) technology alongside improved computer hardware capabilities. Many of these virtual worlds are integrating AR/VR capabilities, which will dramatically improve the user experience. There have been rumours going around for a while that Apple is planning on releasing a VR headset, which would be significant news for the industry and would rival Meta’s VR headset, Oculus. To add to this hype, Tim Cook was also reported saying that “we see a lot of potential in the space (Metaverse) and are investing accordingly.” We believe that integration of AR/VR and access to cheaper, more powerful computers is crucial for adoption and growth of the Metaverse over the long term.
The creator economy comprises content creators of all kinds: influencers, artists, journalists, gamers and anyone else making content and connecting with fans. At the end of 2021, it was estimated that there were 50 million  independent creators worldwide who represented a market estimated to be worth more than $20 billion . According to a report by the Influencer Marketing Hub, this market for creators is expected to grow to $104.2 billion in 2022 .
There are many Web 2.0 versions that are connecting creators directly with fans, such as Patreon, Substack, Twitch, and Spotify. However, we believe that the current Web 2.0 model is broken as these centralized platforms take an unfair percentage of ad revenues and fees. While the Web 2.0 model can be a great source of revenue for the top creators, they leave out the ‘lower-middle class’ creators. As a matter of fact, the top 1.4% artists on Spotify account for 90% of royalties, which equates to around $22,395 per artist per quarter . The remaining 98.6% of artists on Spotify make on average $36 per artist per quarter. This is primarily due to the business model of the social Web 2.0 platforms. They generate most of their revenue through ads via widely ranged tiered compensation models, and thus the larger the audience, the more ad revenue they receive, which is why the top creators are so successful.
Web3 gives creators other ways to own and monetize their content while involving their community and aligning incentives, without the need for a centralized platform. It allows creators to truly own their audiences, while enabling followers to invest in their success. This is primarily being done through NFTs, social tokens, and DAOs. Fans invest in creators to own a piece of their content, to access exclusive material, or even join the creator’s community. Creators have been turning to DAOs to really create and foster a loyal community, and are in some cases giving their community voting rights to determine what the creator does next. The Web3 creator economy brings us back to the Starbucks analogy. The incentives are aligned as the fan actually owns and is invested in the creator’s success. It is a whole paradigm shift which has the opportunity to inspire a new generation of creativity and success for the creator community.
State of Web3
While the idea of Web3 has been around for a while in the crypto community, it has just recently started to gain significant traction. We have started to see a large migration of developers moving from Web 2.0 to Web3. A report from Electric Capital , a VC firm investing in Web3, analyzed data from nearly 500,000 code repositories and 160 million code commits across Web3 and found that over 34,000 new developers committed code to Web3 projects in 2021 — which represents a significant increase over the last few years .
The report also highlighted that 65% of active developers and 45% full time developers started working on Web3 last year. In addition, according to LinkedIn, crypto-related jobs skyrocketed from 2020 to 2021. Job postings containing terms such as ‘bitcoin’, ‘ethereum’, ‘blockchain’ and ‘cryptocurrency’ grew 395%, which considerably outpaced the wider tech industry who saw a 98% increase in listings .
There has also been a significant amount of capital invested into the space. Venture Capital funding for blockchain startups reached more than $25 billion last year, up 713% from c.$3 billion in 2020 according to CB insight ‘2021 State of Blockchain Report’ . Within the last couple of months alone, we have seen several billion dollars being raised by new funds with a mandate to invest in blockchain startups.
The potential of Web3 is limitless. With the advent of blockchain a new era has emerged in the Internet. As such, with all of the human and financial capital inflows into the space, incredible use cases have started to gain mainstream adoption. NFTs have seen incredible growth with total sales passing $22 billion in 2021. With the introduction of DAOs, we have witnessed the creation of a new way to organize and work together. Web3 has the potential to put the power back in the hands of creators and the Metaverse has turned from just a Ready Player One fantasy into something that could become a reality.
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