Web3- sector primer

Sector primer: Web3

This article is part of our sector indices primers. Find out more about this series here and get the full report here.

Definition

Web3 projects are building the infrastructure of the new, decentralised and user-controlled version of the internet. Web3 is designed to improve on previous iterations of the internet by being censorship-resistant, being more reliable with almost no downtime or a “kill switch” and offering interoperability across platforms.

The blockchain revolution is taking the evolution of the internet in a different direction from what had been anticipated previously. The internet initially evolved from a purely one-way information system and a tool (“Web 1.0”) that users could interact with in only predefined ways (such as watching videos and shopping) to Web 2.0, where users became content creators. The inventor of the internet, Tim Berners-Lee, had a vision of Web 3.0 in which the internet would become increasingly AI-driven. The expected evolution has been described as progressing to Web 4.0, with smart personal assistants and wearable technology, and Web 5.0, with “direct brain link” and human–technology convergence. While this path would take the internet increasingly towards the elimination of privacy and anonymity and allow potentially extraordinary levels of censorship, the crypto version of “Web3” aims to achieve the opposite.

Even within the crypto market, there is confusion around using the term “Web3” as some refer to all decentralised applications as “Web3” (including gaming and the metaverse) while others use the term “Web3” to describe the entire blockchain space, including the protocol layer (Bitcoin, Ethereum, etc.). We use the term Web3 purely to refer to projects that are building the next iteration of the internet, where users control their data and their user experience instead of centralised entities.

Even in this narrower sense, Web3 is a broad sector as it involves creating both the foundations and the infrastructure that allows the decentralised internet to operate and the user-facing applications of it.

History

The concept of decentralised file sharing – a cornerstone of enabling the decentralised internet – was conceived before Bitcoin was created. The BitTorrent protocol was designed and released in 2001. BitTorrent later joined up with the crypto ecosystem and issued a token in 2019 on the TRON blockchain.

Another important concept for the decentralised internet, the idea of developing a tokenized domain name system, was first introduced in 2010 in the internet chatroom #bitcoin-dev, where users discussed the merits of bitdns, a Bitcoin-like domain name system. The first peer-to-peer naming system, Namecoin, was introduced in April 2011 on the same forum that was used to announce Bitcoin.

Ethereum and Polkadot founder Gavin Wood first introduced the term Web3 in 2014, laying out his vision for the future of the internet. A number of prominent Web3 projects were conceived around this time, including the peer-to-peer file transfer system IPFS (InterPlanetary File System) protocol on which the leading decentralised data storage project, Filecoin, is based, and the decentralised cloud storage provider Sia. The original idea of Chainlink, a data verification and data provision system, was also conceived in 2014, and a few years later launched as a crypto project – a decentralised mechanism to interact with real-world data. The Internet Computer project, a decentralised internet independent of centralised web hosting, also started in 2015.

The first decentralised social media platform, Steemit, launched during the ICO boom. Many more Web3 projects were conceived at this time, including the Polkadot interoperability protocol, weaving previously incompatible blockchains into a single web, and an alternative idea for the internet of blockchains, Cosmos.

But it wasn’t until the 2018–2019 bear market that a large number of Web3 projects launched, with the sector being the most active area of innovation in the decentralised applications space at the time. Projects launched in this period include decentralised streaming platform Theta, innovative decentralised data storage network Arweave and decentralised wireless network Helium.

As the opportunity of the technology megatrend represented by crypto was increasingly embraced by the mainstream, the concept of the decentralised internet and projects such as Internet Computer and interoperability protocols such as Polkadot and Cosmos gathered a lot of interest. Meanwhile, platforms delivering various components of Web3 such as decentralised file sharing, decentralised web hosting, decentralised data services and decentralised domain name services were steadily growing their user bases, and interest spiked in the consumer-facing aspects of Web3 on the back of centralised social media’s escalating censorship and business practices that were hostile to creators.

Subsectors

The decentralised internet requires a foundational layer that weaves blockchain protocols into a single net and provides a decentralised execution layer. We refer to this subsector as layer 0.

To ensure that the decentralised internet is independent of centralised providers that can act as single points of failure, bottleneck or control, the related infrastructure of data provision, storage, file sharing, web hosting and computational resources also needs to be executed by decentralised projects that rely on a large network of providers. Such decentralised networks operate with a much more reliable uptime, avoid a “kill switch” and optimise for quality and reliability without central control. Web3 projects providing data security and privacy such as decentralised access management are another important component of the decentralised internet.

The projects that ultimately deliver the tangible reality of the decentralised internet are consumer-facing Web3 projects such as decentralised social media, music streaming, video streaming, decentralised encyclopaedias, peer-to-peer travel bookings, ride-sharing and peer-to-peer talent networks. These function exactly like their centralised counterparts but with a censorship-proof, user-owned, privacy-preserving backend.

Users

The foundational layer of Web3 services other crypto projects and blockchain developers.

Web3 infrastructure projects have two sets of users. They provide a service to other projects that require data, web hosting, file storage and so on. At the same time, they offer the opportunity to users to become providers of these services and be compensated for offering data feeds or their unused storage space, excess bandwidth or computational power.

Consumer-facing Web3 applications such as social media platforms, music streaming and video streaming interact with both content creators and consumers of the content. Digital identity management is another service the Web3 sector offers to users.

Opportunities & Challenges

Many believe that Web3 will be the next frontier of the online world. This entails tremendous opportunity for Web3 counterparts of current Web2 applications as well as for the supporting infrastructure and enabling technologies.

Some of the opportunity lies in winning the battle for the path the internet will follow: more control, more centralisation, less privacy, more censorship – or the opposite, which is offered by the decentralised internet.

The other, more pragmatic, contribution of Web3 is the opportunity to offer a better service cheaper. Filecoin storage, for example, is 0.001 percent of the cost of Amazon S3 Infrequent Access storage. In addition, Web3 is optimised for less downtime and lower operational risk due to the lack of a single point of failure, based on the large decentralised pool of resources it draws on.

The value proposition of Web3 is a further advantage, as it enables traditional revenue streams to accrue to the users of a platform.

Despite these advantages for users, taking market share from incumbents is rarely easy, as people need a significant motivator to change their habits. Additionally, in the case of consumer-facing platforms, the size of the potential audience is an important factor for creators. And, while the practices of Big Tech are currently driving away a lot of their audience, Web3 projects are still in the early stages with teething problems that slow adoption.

The user experience and the user interfaces are still quite poor in most cases, and certain issues have not been satisfactorily resolved yet, such as curating the content on platforms. While Web2 censorship of opinions and ideas is a strong motivator for users to look to Web3, a total lack of control over content leads to the “welcome to hell” problem, where the user experience is extremely negative for another reason.

Another challenge in the way of adoption is that many Web3 projects focus on the technological advantages in their communications and use unrelatable “tech speak” to describe their platforms to potential users.

The disadvantages that arise from the early-stage nature of Web3 create a “Web2.5” opportunity, where established businesses onboard with Web3 projects, creating a blended offering for consumers. We have seen a number of examples of this, including Helium’s collaborations with T-Mobile and Arweave’s collaboration with Instagram.

The Web3 sector is still searching for the ideal model for building user bases fast, possibly with the help of token incentives, but the economic models are still experimental.

Additionally, as there is a lot of newly developed technology in the Web3 sector, such as interoperability protocols, it experiences a disproportionate share of hacks and scams.

The beginnings of the sector’s success meant that scalability also became a challenge for some projects. Some responded by launching their own purpose-built chains. Others (for example, Helium) have abandoned their own chain in favour of more efficient layer 1 protocols.

Although there has not been a lot of regulatory focus on the Web3 sector, it is expected that issues such as data privacy and access, creators’ rights and criminal online content will receive regulatory attention.

Value drivers

The evolving narrative about the advantages of the decentralised internet vs Web2 is an important driver of the sector. The current attempt to reposition Twitter as a free speech platform is a sign that Web2 is fighting back to retain its user base.

Customer adoption is the key metric to watch for Web3 projects. User growth and collaborations with established traditional players are important milestones.

The incidence of hacks and advancements in the security of the platforms to protect against attacks are also critical factors.

The limited regulatory attention to date creates a risk, and it is important to monitor the regulators’ communications and actions.

Disclaimer

This document is purely for educational purposes and has been issued by Sygnum Group. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication. It does not constitute an offer or a recommendation to subscribe, purchase, sell or hold any security or financial instrument. It contains the opinions of Sygnum Group, as at the date of issue. These opinions and the information contained herein do not take into account an individual‘s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes personalized investment advice to any investor. Therefore, you must verify the above and all other information provided in the document or otherwise review it with your external advisors. Some investment products and services, including custody, may be subject to legal restrictions or may not be available worldwide on an unrestricted basis. The information and analysis contained herein are based on sources considered as reliable. Sygnum Group uses its best efforts to ensure the timeliness, accuracy, and comprehensiveness of the information contained in this document. Nevertheless, all information indicated herein may change without notice.

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