Crypto Watch column | 'I have seen the future, and it works.' But is it Web3?

Second Column (10 Jan 2022)

This is first published in the Business Times.

HAVE you seen Web3? Web3 is undoubtedly one of the biggest buzzwords in 2021. It typically refers to the dream of building a decentralised Internet that will disrupt Big Tech corporations. Hence, both Web3 and decentralisation concepts are often mentioned together.

But buzzwords often lead investors to jump onto the bandwagon, and sometimes with both eyes closed. In this column, I would like to help demystify the Web3 concept and highlight the key concepts for investors.

To me, Web3 is an exciting thesis but really still a work-in-progress - mainly an experiment for now. Web3 ventures fall into the riskiest of profiles.

No one knows exactly what Web3 looks like, but it certainly generates a lot of excitement.

And in late December 2021, Web3 drew a new round of rapid fire, beginning with the Bitcoin-loving ex-CEO of Twitter, Jack Dorsey, unloading on Twitter:

"You don't own web3.

The VCs and their LPs do. It will never escape their incentives. It's ultimately a centralized entity with a different label.

Know what you're getting into…"

Serious discussions between his followers and many Web3 proponents ensued. Predictably, Elon Musk also crashed the party: "Has anyone seen web3? I can't find it."

To which Jack replied: "It's somewhere between a and z", clearly a jab at A16Z, venture capital firm Andreessen Horowitz which has pumped over US$3 billion into Web3 investments.

Those who have been following Jack know that he is a strong supporter of Bitcoin, having recently put wheels in motion for a decentralised Bitcoin exchange tbDEX. He also initiated the BlueSky project at Twitter to "free" Twitter from inside. He's a believer. So why would he launch an attack on Web3?

What exactly is Web3?

Web3 (technically Web 3.0) is a term coined by Ethereum co-founder Gavin Wood back in 2014. It is generally used to describe the next generation of the Internet where users, instead of Big Tech or governments, own and control their own data.

The Web3 world resists censorship, and is imbued with a solid open and collaborative culture. It is governed by the community through specific consensus mechanisms called governance tokens (more on this later), which are already in existence in today's crypto communities.

Web3 is already here, though facets of it are not as decentralised as its true believers would want. It is where digital assets like NFTs live, where virtual real estate can be bought and sold, where (in theory) finance is decentralised, where no one authority or institution makes the rules or dominates the ecosystem.

Such a vision certainly sounds very alluring as it indeed addresses many of the pain points of the current Internet. I'm excited by the possibilities that the vision presents - birthing new innovations and encouraging rapid iteration on top of a new infrastructure, which is open in terms of both technology and community culture!

The challenge with Web3 is that it can't be clearly defined, yet. And with interest exploding, people are jumping on the bandwagon and associating any remotely related stories (Metaverse play, anyone?) to cash in on the viral movement. A discerning investor would learn to see through the smokescreen and not jump on any old Web3 investments.

Circling back to Jack, who clearly embraces a decentralised Internet, but stands against those whose efforts hinder the formation of the new free world.

Jack's stance is that Bitcoin is the most - and perhaps the only truly - decentralised system. Bitcoin holders do not have any claim to voting rights in the Bitcoin community; there is no governance token with Bitcoin.

What's that about governance and power again? And what does decentralisation mean for investors?

Yet even Bitcoin went through a few alarming episodes of over-concentration in power over its lifetime.

In December, it emerged that the top 1 per cent of Bitcoin holders (the biggest 10,000 Bitcoin accounts) hold 5 million Bitcoins, which at today's rate tally up to over US$200 billion.

As The Wall Street Journal reported: "The top Bitcoin holders control a greater share of the cryptocurrency than the most affluent American households control in dollars, according to a study by the National Bureau of Economic Research… With an estimated 114 million people globally holding the cryptocurrency, according to crypto.com, that means that approximately 0.01 per cent of Bitcoin holders control 27 per cent of the 19 million Bitcoin in circulation."

It is also important to realise that there is a trade-off between decentralisation and the ability to quickly build and iterate the functional features of the Web3 project at the initial stage. (Sort of like the trade-off between democracy and state control when it comes to "getting things done".)

Many believe that this is all fine and trust that decentralisation may be achieved in the future.

This comes down to the governance token, which is a bit of blockchain tied to a specific cryptocurrency or decentralised finance (DeFi) project, which gives the holder "membership" in that community. Think of it in terms of a shareholder's right to vote in matters related to the management of the company - in this case, the crypto or DeFi project.

On the positive side, the governance token acts to incentivise active community participation. But on the flip side, the existence of the token is not by itself a guarantee of legitimacy, and could well turn out to be an exit path for fake Web3 projects, or Ponzi schemes.

Nor is it a guarantee that the system will get to its Holy Grail of true decentralisation.

In general, Web3 projects that issue governance tokens are seen as legitimate because there is a consensus mechanism to vote on developments.

What investors need to pay attention to is that Web3 governance tokens generally come with a specific income incentive (e.g. a fee that is collected from users, and can be distributed to token holders, or incentive distributed through other mechanisms), and an element of control in the voting rights.

However due to institutions, large investors (such as venture capitalists) and very wealthy individuals accumulating investments in DeFi ventures, capitalists have also accumulated rights, ownership, and by extension, power. This is at the heart of Jack's Twitter tantrum.

I agree with Jack that institutions might always find ways to gain control or exert a stronger influence.

Jack himself has experienced that firsthand in Twitter despite it being a US$40 billion company, when activist investor Elliot Management accumulated a significant stake to exert pressure on the company's direction.

A similar game has played out in the crypto world when in late 2019, Justin Sun, founder of crypto platform Tron, mounted what was effectively a hostile takeover of the Steemit blockchain project.

More recently, in December 2021, the EOS community voted to "fire" Block.one, the company that originally designed the EOS network, over claims that it is no longer acting in the network's best interests. The community also pushed to halt the issuance of EOS tokens over the next 6-7 years, which would also halt the vesting of tokens to Block.one founder Brock Pierce.

Clearly, decentralisation won't be an easy thing to achieve.

It's all about the power of community

Instead of evaluating whether a Web3 project is truly decentralised when investing, examine whether the community is deeply engaged and shares the decentralisation vision.

The silver lining behind these 2 negative examples at Steemit and EOS is the "power" of community, which does not usually exist in the Web2 world. Decentralisation, while a challenging goal, is the mission statement that unites the community of any Web3 project and is an integral part of the culture's DNA. Hence, it is ultimately the community that will determine the potential and sustainability of the project in the long run.

Blockchain by design keeps the database permissionless and infrastructure open. What empowers the community is the governance token. But note that it is nothing but a technological mechanism to facilitate the Web3 community's operations. It is the community which ultimately decides on the project's direction.

Whenever the power becomes centralised in the hands of a few and starts to shift the project away from its original mission, with the token, the community is empowered to fight back or "fork" away and build a spinoff. The community keeps the power in check.

It is worth noting that at the beginning, the community may agree to prioritise functionality over decentralisation.

Hence, many current Web3 projects are still experimental and indeed not very decentralised. Personally, as a tech investor, I find it somewhat acceptable despite the higher risk.

Know what you're getting into

Still, Jack is not totally against VCs. He did Tweet before, somewhat incoherently: "I'm anti-centralized, VC-owned, single point of failure, and corporate-controlled lies". And: "I'm telling you I've learned from the issues taking on VCs creates. Block *had* help from VCs yes. But ones that know their place."

Not all money is the same. Each VC has its investment strategy and reputation, e.g. some choose to "spread and pray", some are "vulture capitalists", some "know their place" in providing valuable support to help founders to achieve the great vision.

While traditionally a VC's job is to identify and support promising founders, in the Web3 thesis, VCs will need to take the culture and strength of the community as one of the most critical investment rationale, if not the most critical one. For founders, community, and investors, it will be important to choose to follow VCs that are really in sync with your mission statement.

Jack is right. "Know what you're getting into…"

Web3 is an exciting thesis but can be controversial. The only thing we know for sure is, the internet we know will be very different in the coming years.

Like the article? Read the rest of the Crypto Watch Column here.

Edited by: Elise Tan

For the latest news on Vertex Ventures SE Asia and India and our portfolio companies, follow us on Linkedin or subscribe to our monthly newsletter.