Understanding DeFi: Web3 explained
Crypto has produced many buzzwords over the years. One of the latest ones to catch on is “Web3” — a term used to describe a decentralised version of the Internet that will run entirely on blockchains and cryptocurrency technology. While blockchains like Bitcoin and Ethereum were most frequently used for exchanging value over the Internet in their early years, in more recent times the vision crypto believers have of Web3 has started to come to fruition. In this guide, we’ll explain the concept of Web3 and the emerging token economy it is powering.
What is Web3?
To understand the premise of Web3, it’s worth revisiting the history of the Internet, and the epochs known as Web1 and Web2.
The birth date of the Internet is considered to be 1st January 1983, when Transfer Control Protocol/Internetwork Protocol (TCP/IP) was first established as a way for computers to communicate with each other. A few years later, in 1989, Sir Tim Berners-Lee invented the World Wide Web, which created a way for people to publish information online and create their own websites. In its early years, the World Wide Web was popularly used to browse websites containing hypertext menus, JPEGs, and MP3 files, search engines such as Yahoo, and e-commerce websites such as Amazon and eBay. This era has become known as Web1.
After forums and message boards gained popularity, the Internet also became a hub for applications that let users communicate with one another and share their own content. Known as “social media networks,” early examples of user-based platforms that gained traction included MSN and MySpace. The arrival of Broadband then allowed for video-based content to thrive on YouTube. Facebook also emerged, eventually attracting 3 billion users by the 2020s. The arrival of social media networking had ushered in the Web2 era.
In 2009, Satoshi Nakamoto launched the Bitcoin protocol to enable a decentralised “peer-to-peer electronic cash system” that would run over the Internet. Since its early beginnings within the Cypherpunk community and as a medium of exchange on the Silk Road marketplace, Bitcoin has been an overwhelming success. Today there are roughly 150 million users on the Bitcoin network, and its value proposition has more recently shifted to that of a “digital gold” store of value. While Bitcoin’s store of value narrative has been its core strength, it’s also highlighted its limited utility. Since Bitcoin gained traction, the arrival of smart contract blockchains like Ethereum has created new possibilities for how blockchains can be used. Ethereum’s ecosystem already includes an array of decentralised finance applications, games and a burgeoning digital art movement. This ecosystem forms the hub of what’s become known as Web3.
The advent of Big Tech
During the Web2 era, a small number of companies came to dominate significant portions of the Internet. The rise of social media and the Internet paved the way for the so-called “Big Tech” giants to thrive. Companies such as FAANG, otherwise known as Facebook, Amazon, Apple, Netflix and Google, became increasingly powerful as they attracted more users, but this brought many problems.
Users flocked to social media networks to communicate with others, but they inadvertently became the product as apps like Facebook monetised their services through advertising. Due to the number of Facebook users worldwide, the company’s data is very valuable to other companies. In cases such as the 2018 Cambridge-Analytica scandal, Facebook users have been the subject of data harvesting. The company is even thought to have influenced the 2016 US presidential election.
While social media platforms have proven very popular over the last decade, many people have become increasingly aware of the power they hold. In more recent years, apps like Facebook and Twitter have taken to censoring some users.
Another limitation of Web2 is that a small number of companies hold a monopoly over the space, reaping in huge profits. While users create content help build platforms like Facebook, they rarely see any return from it as there’s no open platform for them to share their work. Companies pay Facebook to run adverts, but Facebook doesn’t pay users who are served those adverts. YouTube, which is owned by Google, takes advertising revenue, but it only pays a small amount to those who upload content that amasses large views (viewers don’t take any cut). The growth of Web2 has made content increasingly abundant and disposable, meaning only a small number of creators can earn from their work.
How could crypto help?
Web3 is aiming to fix the problems that Web2 is fraught with by leveraging the power of blockchain technology. Web3 is imagined as a decentralised version of the Internet, where entities like Facebook and Google will no longer hold all of the power. The Ethereum blockchain is permissionless, trustless, and has what’s known as “credible neutrality”. In other words, you don’t need to ask or trust anyone to use it, and no one party has control of the network.
While crypto started out as a way to exchange decentralised currencies over the Internet, Ethereum has become the nerve center to a new ecosystem of activities. So far, crypto has created decentralised finance, which replicates some traditional finance activities such as lending and borrowing on the blockchain. Decentralised finance, or DeFi, is already changing finance and creating a more open, inclusive system free of the gatekeepers of the traditional world.
Over the last year in crypto, one major development has been the explosion of NFTs. By allowing creators to tokenize assets such as digital art, music, or video on the blockchain, NFTs have created a way for creators to monetise their work and connect with their fans over the blockchain. NFTs soared in popularity and attracted the attention of many musicians and artists in 2021, kickstarting the next phase of the “creator economy.”
Crypto enthusiasts widely believe that decentralised autonomous organisations, otherwise known as DAOs, will fundamentally change how humans coordinate and interact on the Internet. DAOs are communities that govern themselves by rules embedded in smart contracts. So far, DAOs have been established to acquire crypto art, a copy of the US Constitution and even the Blockbuster franchise, but crypto believers think that they could one day disrupt traditional working models around the world.
While decentralised social media is yet to truly take off, networks like Ethereum could help community-based DAOs and new social platforms thrive. Ethereum co-founder Vitalik Buterin has previously discussed how the network should expand beyond DeFi for such use cases.
The token economy
While the full vision for Web3 is yet to be realised, the emergence of DeFi, NFTs, and DAOs has shown the early promise of a decentralised version of the Internet. Some even liken the Web3 space of today to the early stages of the Internet, before the arrival of Big Tech giants. While each of these niches occupy different subsects of crypto, they often collide and share similarities.
DeFi, NFTs and DAOs have begun to form the base for a new token-based economy, where users earn rewards for their participation. DeFi users can earn tokens for activities like providing liquidity and yield farming. NFT creators can mint their own tokens and sell them for other tokens; the smart contracts for NFTs can also be programmed so that they earn from secondary sales. DAOs, meanwhile, have governance tokens that give users voting power in key decisions members decide on.
While the token economy is still in its nascent stages, it could prove to be as transformative as the Internet itself. This is because it will replace the centralised powers of Web2 and create new ways for users to earn for themselves.
Web3 and The Metaverse
Web3 is often referred to interchangeably with “the Metaverse,” an abstract term referring to a network of virtual worlds that will allow users to build their own identities, connect, and play with others over the Internet.
Many believe that the Metaverse could eventually replace social networks of today and become increasingly tied to our lives alongside the physical world. Crypto is a fundamental part of the Metaverse as it’s what enables users to earn value through activities like play-to-earn gaming. NFTs are also crucial to the Metaverse as they give users a way to own digital items such as fashion accessories and in-game assets. Popular Metaverse-focused crypto projects like Decentraland and Axie Infinity have become increasingly popular over the last year.
NFTs have been the main gateway to mass crypto adoption over the last year. As they start to onboard more users and provide more utility, the Metaverse should also see rapid growth. While digital art has been the main use case for NFTs to date, soon millions of people will be using the technology to play, earn tokens, and more.
Criticisms of Web3
Web3 has faced occasional criticism from the likes of Jack Dorsey, the former Twitter CEO and known Bitcoin proponent. This is largely because of the involvement of venture capital firms such as Andreessen Horowitz. VCs accounted for $30 billion of investment in crypto and Web3 projects in 2021, while the amount of capital entering the space has hit record highs.
Critics like Dorsey argue that VCs “own” Web3 and that they hold power over the space. While many Web3 proponents have taken issue with his comments due to the opportunities the space provides for regular users, they aren’t entirely unjustified: Andreessen Horowitz, for example, has a big influence over Uniswap governance decision because it holds such a large portion of UNI tokens.
Moreover, in the DeFi space, the number of multi-million dollar hacks has highlighted the risks of using cryptocurrency technology. Blockchains also have a public ledger tracking every transaction, creating major privacy concerns for users. The issue is yet to be addressed, though solutions could emerge in the future.
Without a doubt, the Internet has been one of the most significant inventions the world has seen. By allowing for the global distribution of information and content, Web1 and Web2 created a way for humans to connect, communicate, and share ideas with each other in a way that was never possible before. But if Web3 fulfils its promises, it could cause as much of a transformative change as the Internet itself. Rather than exchanging information or content, users will earn from exchanging value through tokens. In the world that Web3 enthusiasts envision, the Internet won’t be controlled by a small number of companies who make money off their users. Instead, the users themselves will form communities and earn from their usage and the value they create. While Web3 is still in its infancy, the early developments in the DeFi, NFTs and DAO spaces prove that there is every reason to believe in decentralisation and the limitless possibilities it could enable.