Recognizing Web3 Potential For Disruption Beyond The Hype
Many Web3 enthusiasts have had a rough few months as a result of the market prices of major cryptocurrencies falling sharply, a slowdown in the trading volume of non-fungible tokens (NFTs), and, most importantly, the bankruptcy of some industry pioneers due to poor risk management and misappropriation of investor funds. Business executives should not confuse market volatility or dishonest individuals with the Web3 potential applications of digital assets and the technologies that support them, even as the debris keeps flying. Applications for the coming generation of the internet continue to emerge in an increasing variety of industries, with the Web3 potential to have transformative effects, despite the very real hazards associated with this developing technology and its uses.
The financial services sector has substantially driven the adoption of several emerging digital technologies and assets; at its height, the daily amount of transactions completed on so-called decentralized finance exchanges approached $10 billion. Since then, the volume has mostly decreased in pace with asset prices, falling to around $2 billion. Among other industries, real estate, gaming, carbon markets, and the arts are using the lessons learned from the financial services experience—both the highs and lows.
We don’t yet know how quickly or how widely these technologies and their applications will increase; the road ahead is proving difficult due to persistent problems like fraud and bad user experiences. It’s critical to note that the regulatory landscape for Web3 is still uncertain, with demands for more clarity on specific assets and increased consumer protection for cash kept in custody. For business leaders across various industries, it is still crucial to comprehend the fundamental aspects of this new digital wave and also the potential disruption it may bring. To that aim, this essay serves as a primer on the fundamentals of Web3: what it is, the pillars on which it is based, what it can currently accomplish and what it can’t, the considerable risks and problems it must overcome, and the ramifications for stakeholders as it develops. Future articles will delve deeper into more particular facets and application cases.
Recognizing Web3 potential for disruption
The decentralization of business models is the primary characteristic of Web3. In that sense, it ushers in a third stage of the internet (thus the name “Web3”) and a change in users’ perceptions of the status quo. A more centralized approach in which user data, including identity, transaction history, and credit ratings, are gathered, pooled and frequently resold quickly replaced the open protocols that made up the initial iteration of the web in the 1980s, on which anybody could build. Applications are created, supplied, and monetized in a proprietary manner; a small group makes all operational and governing decisions of people, and profits are split between management and shareholders.
With a shift back to users in Web3, that power structure might be upended in the following iteration. Open protocols and standards might reappear. The idea is that power will be widely distributed through “permissionless” decentralized blockchains and smart contracts, as we explain later in this article, rather than remaining centralized in big platforms and aggregators. One of the most challenging components of Web3 is governance, which is expected to occur in public rather than behind closed doors. With appropriate incentives, revenue can be returned to authors and users to help with user growth and acquisition.
What does this mean? Essentially, by making disintermediation a key component, it could signal a paradigm shift in the business model for digital applications. Intermediaries may no longer be necessary for data, functionality, and value. Through open-source rather than commercial software, users and producers might have the upper hand and be encouraged to create, test, build, and scale.
The foundational elements of Web3
Three fundamental components make up Web3’s ground-breaking theory: the blockchain, which stores all data on asset ownership and the history of completed transactions; “smart” contracts, which stand in for application logic and have the capacity to execute particular tasks on their own; and digital assets, which can stand in for anything of value and work with smart contracts to become “programmable.”These three principles have varying degrees of intricacy and complexity, and each is changing to address starting issues and structural flaws. The high-level elements of these fundamentals are mostly covered in this primer.
The open-data structures of blockchains. In Web3, application data is saved on an open data structure that anybody may write to and read from rather than being kept in personal databases. The blockchain is a system for open data. Blockchains are open databases that securely and comprehensively store all pertinent and transactional data. The fundamental databases are duplicated and distributed among numerous participants in a network of computer servers known as “nodes,” which is why they are frequently referred to as “distributed digital ledgers.” Blockchain refers to discrete data chunks linked or chained together as “blocks.” A new block is made and permanently linked to the chain as fresh data are uploaded to the network. Then, all nodes are updated to reflect the modification. A key distinction from conventional databases is the absence of a central repository for data. This has several benefits, one is that there is no one point of control, censorship, or failure in the system. No longer are user data scattered across many platforms, nor are they private or for sale.
Smart contracts are a feature that removes intermediaries. On the blockchain, smart contracts are computer programs that automatically carry out a verified transaction based on previously established and mutually agreed upon criteria. Because they are frequently implemented as immutable programs, they require careful planning and setup. Still, once in place, they may be quickly and effectively operated without intermediaries and their extractive fees. Once an application is deployed, it can be challenging to update the logic because it is predetermined in the contract. A decentralized autonomous organization (DAO), a type of collective governance by users of the program who own governance tokens of the smart contract, frequently controls these applications. If the DAO is configured properly, no business can decide to change the application’s specifications. Web2 apps, in contrast, provide businesses with complete control over particular factors like pricing.
Tokens and digital assets as decentralized ownership. Digital assets are ownership-rights-encumbered intangible goods. These assets can interact with smart contracts and are on the blockchain across several applications. The legal context surrounding these digital assets and their own rights is still not adequately defined in many locations, even though they are expected to represent verifiable and ownable digital values. Currently, there are primarily five categories of digital assets:
- Stablecoins, which are meant Regarding fiat currencies like the US dollar or central bank digital currencies (CBDCs), which are used to represent money on the blockchain a central bank controls, are alternatives to native tokens.
- Native tokens are the financial incentives used to reward nodes for maintaining and updating the respective blockchain.
- Non-fungible tokens (NFTs), a single, indivisible digital asset with provable ownership and governance tokens, are tokens that reflect voting rights on the functional parameters of smart contracts.
- Claims on physical assets, like commodities, real land, or intellectual property, are represented by digital assets that are “tokenized” into tradable digital assets on the blockchain.
Although each digital asset has a distinct role, asset ownership data is now kept on the blockchain rather than on regulated, private ledgers (like a bank), allowing for the storage, verification, and exchange of user-owned value without the involvement of third parties. These assets can also interact with smart contracts and be put to “productive” use by generating yield for their owners while being deployed autonomously by these contracts.
Automated lending as an illustration of what might change in Web3
It is good to start with the use case where Web3 achieved its initial product-market fit: financial services, to demonstrate the disruptive potential of Web3. Smart contracts are used in remittances, asset swaps, trade finance, and insurance to increase automation efficiency. One of the most convincing Web3 implementations to date may be seen in lending.
In today’s traditional financial services, loan origination relies on the bank as the dependable third party to protect funds. Depositors contribute money in exchange for a tiny bit of interest. The bank then maintains records on a separate ledger and compiles data on prospective borrowers to assess their creditworthiness and calculate the cost of their loan. Borrowers are charged additional fees to support these operations and give the bank’s management income. Although rates were historically low in recent years, relatively little interest was paid to depositors.
With Web3, depositors still hope to get interested in their money, but rather than giving it to a bank or unregulated platform, they store it themselves in a non-custodial wallet that acts as a blockchain account. Instead of being stored by the bank or any unregulated organization, all ownership and transaction data are stored on the blockchain. Customers can now put their cash as liquidity into a smart contract rather than entrusting a corporation with the responsibility of lending them out. The smart contract effectively keeps these monies in escrow, which only releases them when certain requirements are satisfied. Borrowers can still apply for loans but can only withdraw money from the smart contract (initially funded by the depositors) after posting enough collateral. Borrowers can still benefit from possible collateral price growth and generate liquidity by taking out a loan secured by collateral without triggering a taxable event (which would occur when selling).
The logic in the smart contract predetermines all loan terms and makes them available to all participants, including the loan-to-value (LTV) ratio, interest paid, and liquidation thresholds. Although borrowers continue to pay interest on their loans, management and shareholders are no longer benefiting from these interest payments. The contract in question is managed by a DAO that frequently has no claim to any of the revenues and neither management nor shareholders. The loan interest is deposited into the smart contract and distributed to the liquidity’s original depositors. Due to over-collateralization requirements and automatic liquidations, credit risk is reduced. The top Web3 lending platforms disbursed more than $200 billion in loans last year, and despite significant volatility, the total amount of bad debt is currently close to $1 million. Even despite the market turbulence, 3 Web3 lending platforms kept running. Withdrawals went on as usual, and no deposits were lost or blocked. After declaring bankruptcy, one well-known failed cryptocurrency lender kept repaying its debts via Web3 platforms to recover its collateral.
This illustration highlights the potential for disintermediation in the bank’s traditional roles as custodian, central ledger, and credit decisioning engine. Instead of going to the bank’s management and shareholders, the depositors receive the customary interest payments connected with this service. The smart contract itself frequently generates little revenue, but occasionally it will provide a modest spread that is utilized to ensure assets. Additionally, as the value of the underlying loan collateral has decreased recently, each smart contract has autonomously liquidated loans without causing any associated delinquencies.
Compared to Web2 analogs, Web3 effectively enables users of a platform to get traditional revenue streams, improving the user value proposition. The loan example also demonstrates how Web3’s common infrastructure, compliance, and automation may make it possible for services to be offered more affordably and around-the-clock. 4
Compared to Web2 analogs, Web3 effectively enables users of a platform to get traditional revenue streams, improving the user value proposition.
As a supporter of web3, my goal is to help individuals and businesses transition to this new generation of the internet. Don’t miss out on the potential benefits and competitive edge that web3 offers. Join me in embracing the web3 revolution. #ethdomains #Web3 pic.twitter.com/HPj7F2foUu
— Web3Domains (@Webb3Domains) December 27, 2022
While loans and deposits were among the earliest demonstrations of product-market fit, new decentralized finance (DeFi) applications, most notably swaps, have come to light. Due to the open-source nature of the protocols and automation, Web3 may result in pricing-power compression (in other words, lower prices). Similar reasoning holds here: the Web3 implementation makes it possible for traditional income in the form of trading fees to flow to smart contract depositors (or liquidity providers) rather than the conventional central-exchange operator. The average trading-fee revenue for liquidity providers for some of the most well-liked swap pairs last year ranged from 30 to 70 per cent of the capital supplied (for example, Ethereum and USD Coin). 5 Once more, no income is generated by the DAO that controls the smart contract; all profits go to the people who make deposits rather than the administration of a central exchange. Even though past returns were generally high, think about the return on equity that organizations could achieve if they could significantly lower trading administration costs with the help of a smart contract and outsource their infrastructure costs via blockchain, excluding the cost of crucial risk-management and compliance professionals.
Some product market applications have been largely theoretical. However, the expanding breadth of financial services applications indicates the significant innovation that Web3 may produce. More than $250 billion was actively used in smart contracts before the recent market slump, producing autonomous returns for its depositors.
As a result, in DeFi, automated and programmable smart contracts have started competing with traditional intermediaries like banks, brokers, and insurance agents in lending, trading, derivatives, and insurance, among others. In some circumstances, they answer traditional finance’s problematic issues, including counterparty risk, high transaction costs, protracted settlement delays, the significant value intermediaries extract, system opacity, and a lack of interoperability. Businesses would be wise to pay attention if they now offer services that can be programmed into an automated smart contract.
Finally, innovation is not expected to slow despite the recent market downturn. Every month, thousands of fresh developers join the Web3 movement. 7 Because the technology is open-source, programmers can quickly create new applications by building on tried-and-true solutions that have withstood harsh market circumstances. Even the greatest companies may find competing with this global creativity and development level challenging, and the pace may quicken as more users and developers sign up.
Web3’s risks and difficulties that still need to be resolved
Web3 is currently gaining traction in various industries, such as the social sector, carbon markets, art, real estate, gaming, and more. It is also a component of the interoperable metaverse, a parallel reality that is fully virtual and is currently being built. Venture capitalists and consumer product businesses are investing heavily in this metaverse. 8 It remains to be seen how revolutionary blockchain, smart contracts, and digital assets will prove to be, as with other new technology hailed as disruptive. Although there is considerable cynicism in public, particularly in light of the sharp drops in the value of digital assets and the recent failures of various funds and consumer deposit firms, user interest is still high, and involvement is rising, especially among younger generations. Twenty percent of respondents aged 25 to 44 reported owning digital assets in a McKinsey poll of 35,000 active online users in some of the biggest markets for digital assets, including India, Singapore, the United Kingdom, and the United States. Over half had used NFTs as a form of digital identification or engaged in play-to-earn activities using digital assets, and two-thirds had already made payments using them (likely for peer-to-peer payments or Web3 commerce).
Web3 must overcome ongoing difficulties, hazards, and barriers for consumers and institutional actors before it can fully establish itself. Before Web3 fully establishes itself, it will still need to overcome ongoing difficulties, dangers, and risks for both consumers and institutional participants.
The main difficulty is regulatory oversight and outlooks. Regulators are working to balance the risks and the opportunities for innovation in Web3 in many different nations, but the situation is still unclear. As of right now, there is no consensus on how to categorize these assets, services, and governance models across jurisdictions. For instance, smart contracts are not yet enforceable in court. Consequently, this reduces the likelihood of institutional adoption, particularly by highly regulated companies. The integrity of decentralized autonomous organizations, the collective community mechanisms meant to oversee this new decentralized world, varies widely and is frequently not yet rock-solid (as some recent examples in DeFi have shown), but it is evolving. Governance is still very much a work in progress.
Additionally, this new ecosystem’s user experience is not yet prepared for widespread adoption. The underlying technology is still too complex for people to have a smooth experience, and interfaces are frequently badly designed. Security is another issue; people won’t likely use this technology widely unless they feel secure using it. Various “rug pulls,” Ponzi schemes and social engineering scams plague the developing industry, and know-your-customer and anti-money laundering processes are frequently weak. Fraud is still a problem. Although the user value proposition will eventually take center stage in Web3, the level of consumer protection is insufficient.
Indeed, a significant fear is that Web3 users may not fully comprehend the dangers of decentralized technology and expect the same kind of protection from centralized (and frequently regulated) businesses. For instance, because blockchain transactions are irreversible, there is currently no such thing as clawbacks or user fund retrieval (although it is technically possible).
The technology itself might not be prepared for widespread use. There is questionable data privacy in the current setup. While wallets are originally anonymous, for instance, current tools are getting better at identifying wallet identity based on transaction history. All transactions could be seen anywhere around the globe if anonymity is removed. Although this openness can be advantageous, consumers will probably need access to on-demand privacy for the technology to be widely accepted.
Last but not least, transaction costs play a role and make some technology protocols unaffordable at the moment. For instance, the costs associated with completing and recording a transaction on the Ethereum blockchain (referred to as “gas fees”) may be prohibitive for users in many parts of the world. At the same time, less expensive and quicker alternatives frequently lack the stability or operational uptime required for widespread adoption. With new “logic hacks” or exploits of flaws in new code occurring weekly, the robustness of smart contracts is yet unknown, and the reliability of “oracles,” or the information feeds that smart contracts use to make decisions, is still a work in progress. Many vital services are frequently too centralized or too vulnerable to failure. Therefore Web3 infrastructure needs to keep developing to become more resilient. In addition, despite ongoing efforts to lessen it, the environmental footprint of proof-of-work blockchains is always changing, which might make it difficult for consumers, businesses, and regulators to accept them when concerned about environmental, social, and governance issues growing.
Thinking about the Web3 endgame
The instances above demonstrate Web3’s potential for disruption as well as its current state of implementation. For adoption to become widespread, regulatory oversight, user experience, and the underlying technology will all need to advance. Leading Web3 players and others implementing the technology are aware of these difficulties and are working diligently to address them, frequently with substantial venture capital (VC) support. VC investments in Web3 reached $18 billion in the first half of 2022, surpassing the $32.4 billion total for the entire year of 2021. Despite these early difficulties, the increased user value proposition and disintermediated business models have accelerated the adoption of Web3 applications.
Web3 is still a significant internet trend despite its technological complexity and open questions. C-suite executives from various industries may want to keep it on their radar, if only because of its potential for quick disruption. Asking how Web3 native startups might disrupt their market and what obstacles and possibilities this would help executives design a determined strategy.
If the disruption does occur, it is likely to affect assets, infrastructure, and services on three different levels and present other chances for incumbents (depending on their risk tolerance).
Assets. Stablecoins, CBDCs, governance tokens, NFTs, and tokenized real estate, among other novel and undiscovered assets, could continue to develop due to new use cases and growing latent consumer and business demand. Indicating that for many assets, including bonds and commodities, both their traditional and tokenized versions may coexist, and some assets may also continue to tokenize. As a result, organizations have the chance to make new Web3 assets like NFTs accessible or to try and integrate current assets into a Web3 ecosystem. Tokenization services could be used to introduce real-world commodities like bonds, music, or artwork into Web3 contexts.
Infrastructure. Core infrastructure will probably keep developing and maturing to support new assets as they appear. More infrastructure is required in areas like custody and asset servicing, clearing and settlement, tokenization and issuance, risk and compliance, and wallets and identification, to name just a few. These are issues that legacy companies are currently under-reacting to. Existing banks and other organizations have the chance to collaborate with Web3 native businesses to innovate their offers and promote the development of the Web3 infrastructure necessary for widespread adoption.
Services. New Web3 native counterparts that mimic some of the functionality of existing services may appear as the infrastructure to support Web3 native assets develops and the technology advances. Web3 native marketplaces, payment networks, and deposit and loan platforms are already emerging. Many anticipate the next step to be the introduction of Web3 gaming, social and media platforms, or the Web3 metaverse. Conventional and Web3 platforms may coexist to provide comparable functionality, but it may be difficult to forecast which use cases would expand the fastest. Each can offer a different value proposition: the traditional service might offer a better user experience and greater consumer protection.
In contrast, the native Web3 version might offer better user economics or be available 24/7. To supply or access new services, incumbents may increasingly collaborate with Web3 disruptors that act as a bridge. The trend’s victors may discover ways to provide their current user base with new and improved value propositions while keeping some of the economics, robust compliance, and consumer safeguards of traditional services.
Web3 is still a world that is being built. Before it successfully scales up to achieve mass adoption, several challenges, including concerns about regulation, will need to be handled. However, it has a strong value proposition for customers that combines data, functionality, and value and opens up possibilities for new and more effective application types and asset ownership. If history is any indication, big and small businesses and the public and social sectors may wish to pay attention to the progress Web3 has already made and begin formulating ethical strategies for interacting with it. Failure to do so could result in incumbents swiftly surpassing various new technologies, resources, and business models.