web3 snapshot

This is a note to future Ernest about the state of crypto/web3 and my understanding at the end of 2021.

First things first. Term web3 is replacing crypto/blockchain as the term to describe this field. At least that is done.

I have been following the crypto environment since Bitcoin was born and more actively since 2016 when Ethereum introduced smart contracts and the ICO bubble exploded. Now 5 years later there are no ICO's. But there is another bubble - NFT's.

In this post, I'm not going to dive into technology, how it works or terminology. Here is a good source if you are interested to go down that rabbit hole.

This post is more of a snapshot and discussion with myself about the topic. Similarly to one Johnny Harris has had with himself

The good bits

Blockchain is the missing piece of the internet. A distributed system that enables the exchange of value. Not owned by anyone but accessible by everyone. Like the internet itself. It is a value exchange infrastructure for the internet. What does it mean? A simple example is giving one bitcoin to someone else. This transaction is saved on blockchain and now everyone can see that I don't own this bitcoin. It might sound trivial but beauty is in its simplicity - there is no single institution that can temper with that record, hold these funds or do anything. It is out there and everyone can check who owns what. Ethereum has gone a step further. A transaction essentially is a very simple agreement - what was mine, is yours now. Ethereum has expanded on this idea. On the ethereum network, it is possible to have "smart contracts" - small programs which define how you exchange value. Instead of saving a simple transaction record to the blockchain, now there is a piece of code describing the logic of value exchange. "Value" can be a lot of different things:

• Transaction - I pay bitcoin/ethereum to you. This is a simple record keeping use case;
• Attention - You pay me by reading this article. Or I pay you because there is advertising in this article. Basic attention token works in this direction;
• Computer resources - You can sell your computer idle time and earn money. Golem token works to build such a network;
• Network bandwith - Trade your network as part of distributed VPN. Orchid.com is one of the players in this market;
• Hard drive - You earn money by storing other people data. Filecoin;
• Your gaming time - You earn while playing or developing in-game goods/character. One of the pioneering games is Axie Infinity. Broader discussion about the whole Play-to-earn concept can be found here;
• Piece of art/content/music - Your unique piece of content is encapsulated into a token that is stored on the blockchain and can be traded. This is the NFT bubble happening now.

And there are more. You can visit any crypto exchange and dive into assets. They all claim to solve some problem.

The challenge

Cool story bro but why this bright future is not here?

First, let's address the elephant in the room - there isn't a single project we could name as a web3 killer app and used by mere mortals.

When you ask about challenges in web3, a lot of times people will say that user experience is to blame. True, the whole onboarding and usage of web3 solutions are clunky. But I would argue that it is not the main problem. In past, there have been products and services with bad UI/UX but that hasn't been a deal-breaker because they solved a problem for someone.

Utility vs. speculation

The beauty of blockchain is that assets can be traded. To become part of a certain network, you have to acquire assets that work in a particular network. For example, if you want to pay for my attention, you have to get BAT tokens. Now you have BAT tokens and you can start to pay for the time I spend watching your advertising videos.

Essentially tokens are the currency for a specific market/economy. Demand and supply determine the value of a currency. As with any currency, there are two markets - utility and speculative. We usually don't talk about e.g. euro utility. We simply use it to buy and sell stuff. Utility value comes into play when there is hyperinflation and realisation that yesterdays money can't buy much today.

The stronger economy, the stronger its currency. Euro is strong because it is the currency of Europe (eurozone, to be exact). In Europe, you trade in euros. Some people purchase currencies just to hold them. That is a speculative market. Both - utility and speculation - have an impact on the price of a currency. Most of the time utility determines price of a currency. But there are exceptions. For example, that one time when George Soros bet against the British pound.

Back to the blockchain world. We have assets to take part in certain markets (e.g. attention market with BAT token). Here is the problem. The actual usage (utility) is small and trade activity is heavily shifted towards speculation. In the case of the crypto world - a future promise that this thing will go to the moon. Value of assets goes up and down significantly. On July 21st BAT token price was 0,4 euros. On November 27th it was 1,71 euro. Those are extremes but still demonstrate the volatility of cryptocurrencies. As price is unpredictable, ROI is unpredictable and thus it is not used for actual business - as a utility.

Asset can become store of value. Gold is classic store of value. Now there is discussion that Bitcoin is replacing gold as a store of value. Microstrategy has been investing in Bitcoin for couple years now.

Sometimes assets just have perceived, emotional value. For example, dirty canvas in a wooden frame can cost quite a lot. This is the NFT's bubble we are experiencing now. Those .jpgs are going for big quite a buck.

If currency is not used as a utility and is not established itself as store of value, it becomes fake currency or funny money. At some point people figure this out and bubble burst.

Web3 products have cold start or chicken egg problem similar to marketplace startups. Marketplace challenge is how to get the first 100 from supplier and demand sides.

In web3 cold start is a bit different. How to get people to use tokens/currency before speculation has kicked in? I don't see a lot of discussion around this and I'm very curious to see how this gets solved. Whoever cracks this, have the potential to become The web3 app.

Gas prices

Ok, wtf are gas prices? When you do something on blockchain - transaction, changing ownership, updating some records - the state has to be saved on the blockchain. This has to be approved by miners. The process now involves solving cryptographic riddle which is done by pure computational power - by the proof of work. The more powerful miners computer, the faster it can be done. Now when you are doing anything on Ethereum, you have to pay 10+ dollars in gas fee. And it doesn't matter if it is simple transactions of funds or updating some records for your ENS domain name. Any action has quite a big price tag. It doesn't help for user adoption. Moving some NFT which costs 1000+ dollars and paying 20 dollars for this action, is not the end of the world. But when you want to update a single text record for your ENS domain and you have to pay 10 dollar fee, that is just ridiculous. Made a mistake? Yep, 10 dollars and you can fix it.

Proof of work is also not the most environmentally friendly approach and there has been work done to move towards proof of stake or other methods to validated transactions. Looking forward to see how this work will change fees.

Yes, there are networks with lower gas prices like Solana.

Speed

Not much to say about this. Blockchain is not the fastest environment. Using Bitcoin or Ethereum to buy a beer is quite slow and comes with a surprise because of the reasons mentioned above - currencies are volatile and there is a price for the transaction which most likely exceed the price of a beer.

Said that, there are projects aiming specifically towards payments and money transfer - Stellar and Ripple.

Future

Will there be killer app used by "normal" people in 2022? I'm skeptical. Gaming seems to have huge potential as that is industry where in-game currencies have been used for decades and they understand how "economy" works. Will see.

As these are micro-economies, I would predict that there will emerge crypto economists. The job of these people would be to figure out how to kick off the network and monitor the dynamics of the economy.

With network growth, the need for governance grow. Networks are decentralised but there is still a need to agree on future development. Some of these cases are popping up (ENS governance). I think there will be "a great split of networks" at some point. Some will leave bigger networks to start their own ones. But as the power of the network comes from the size, winners will be those who figure out how to govern the community. Good discussion about this over here.

Moving from proof-of-work to proof-of-stake might improve the adoption of web3. Simply put, it will be cheaper to do something in web3. 

Bubbles. There will be more bubbles. Anything with a price tag has the potential for a bubble. It is just human nature to find easy schemes to earn money.

As I mentioned at the beginning, these are notes for future me and around my current understanding. Web3 is not only about technology. It is also about the economy, microeconomics and how decentralised societies organise themselves.

What are your thoughts?