Web3 or the decentralized web refers to decentralized applications that run on the blockchain. The blockchain is the underlying technology for crypto organizations. According to the Ethereum organization, a blockchain is a public database that is updated and shared across many nodes in a network. An individual computer can serve as a node. There are two parts: the block and the chain. A “block" is the data and state, and when stored in consecutive groups, it is known as "blocks". If you use bitcoin to make a purchase, the transaction needs to be added to a block to be successful. The "chain" refers to the way blocks get chained together so that each block cryptographically references its parent. In other words, the data in a block cannot change without changing all subsequent blocks. Any such change would require the entire network to provide a consensus.
Crypto tokens operate on top of a blockchain. A crypto token is a type of virtual currency that represents a tradable asset or utility that allows the holder to use it for either investment or economic purposes. There is a distinction between crypto tokens and cryptocurrencies. Cryptocurrencies are virtual currencies that have their own dedicated blockchains and are primarily used for digital payments. Bitcoin is the most popular cryptocurrency, but there are growing number of altcoins (e.g., Ethereum, Solana, Cardano) that act more as tokens than currencies and are attempting to overcome some of Bitcoin’s drawbacks.
The blockchain is the medium for the creation and execution of decentralized applications or dApps and smart contracts. Crypto tokens are used to facilitate transactions within dApps and smart contracts. These dApps are effectively synonymous with Web3 – which is being touted as the latest iteration of the internet. This marks an evolution from read-only (Web1 applications like AOL online) to read/write (Web2 applications like Facebook or Twitter) to ownership in the Web3 era. For example, in the Web3 world instead of giving up your data to Facebook or Google, you could actually own your data, transport it between services, and be compensated for sharing it. Other Web3 use cases include payments, governance, decentralized finance or DeFi for short (which includes lending and borrowing services, platforms for earning interest, and smart contract facilitation), digital storage, marketplaces, games, and more.
Frostbyte clients should take note of this emerging technology. Web3 will enable new business models and has the ability to transform existing industries around the world, including those in the energy, mining, chemical, and construction sectors. Our goal is to help our clients prepare for this potentially game-changing technological evolution and explore how decentralization and tokenization can be integrated into your business.
Web3 economics is having transformative effects in enabling new business and financing models. The flywheel economics of Web2, and abundant venture capital funding, allowed start-ups to subsidize early users with the goal of building scale and network effects. Users want to use a subsidized service since they are getting something below cost. As more users come to the platform, it becomes more valuable to people using the platform. Eventually the platform provides such great value to users, the company can stop subsidizing their use. If the platform cannot transition from subsidizing users to getting them to pay full freight (plus a profit margin), the venture will become a perpetual negative cash-flow machine and die.
The Web3 version of flywheel economics depends not on abundant venture capital, but on project tokens. If you have a business or project idea, you issue a crypto token. People who use the project’s services (e.g., an exchange to trade digital goods) pay a fee and earn tokens. Early users earn a lot and the number of tokens issued to later-adopters declines over time. The tokens typically allow for holders to have some control over how the project is operated (commonly referred to as governance tokens). If more people want to participate in the financial upside of the project, they need to buy the tokens. This increases demand, and the price of the token increases. In other words, every product is also an investment opportunity. Imagine if being an early user of Google’s search engine automatically made you a shareholder. As the service grows, you get rich. This is the basic premise of Web3 economics. It combines the user incentives from the Web2 version, but instead of taking money directly from venture capitalists, it takes money from users.
The more the service is used, the more fees you collect. As the service grows it gets more attention and the token becomes more valuable because the expected cash flows are higher. The service could be anything from renting out property to facilitating ridesharing. Eventually tokens issuance declines, but by that point, the hope is that the service has attracted enough users that it we be valuable to people, and they will continue to use it even without being given free tokens. If people are only using the service because they want the tokens (not the service), then eventually the whole thing collapses, and the value of the tokens goes to zero.
Like all network platforms, getting the flywheel started is a problem. This is often described as the chicken and the egg conundrum or the cold-start problem. The platform doesn’t provide users much value unless there are already a bunch of people using it, but a bunch of people are not going to start using it unless it provides value. How do you acquire customers and create network effects?
To solve this challenge, start-ups need to develop a go to market strategy. The Web2 version of this is to invest in sales and marketing teams (which typically subsidizes users to use the platform until it is profitable). The Web3 version uses tokens to catalyze customer acquisition. Early users now have a stake in the success of the start-up since more user growth will result in the tokens appreciating in value. Companies often reward early employees by giving them an ownership stake, but financially incentivizing customers is a new solution to the cold-start problem.
Web3 companies can take one of 4 forms:
Here, we focus on companies that are decentralized with tokens. This category of Web3 company has no formal corporate structure and uses token economics to attract new users and participants. These companies often approach their go to market strategy with purpose (to drive meaningful engagement) and community (the community are owners).
Decentralized companies with tokens are often organized as decentralized autonomous organizations or DAOs. DAOs are member-owned communities that do not have a central form of leadership. They facilitate collaboration with like-minded people all over the world. They also serve as a way to commit funds to a specific cause. Decentralized finance or DeFi is a common focus for DAOs. DeFi is an alternative to the current financial system that allows users to borrow, save, invest, and trade through an open-source applications. Many DeFi projects first develop a protocol and then decentralize the protocol in order to increase security and distribute its operations to token holders via the issuance of a governance token. Uniswap and MakerDAO are to DeFi projects that have followed this model. The goal is then to generate more usage within the project. For MakerDAO which issued a stablecoin, called Dai, for use in transactions, the goal was to ensure that Dai could be accepted as payment for goods and services. This involved more traditional business development that sought out partnerships and integrations with payment platforms. Some metrics that are used to measure the success of go to market strategies in the DeFi space include: number of exchange listings, number of token holders, number of integrations, total value locked in for trading/lending/staking, and protocol revenue.
DAOs can also be focused on culture and the arts. One of the key measures of success in go to market metrics for culture and arts-focused DOAs is the engagement of the community. Game DOAs are another category of decentralized organizations. Game DOAs commonly use a play-to-earn model that allow users to open in-game assets that can be used across other platforms and become true stakeholders in the game by earning governance tokens. Game DOA success is often measured by active users, user retention, community engagement, and the size of the marketplace within the game ecosystem.
While Web2 companies have a traditional corporate governance structure, Web3 companies are often decentralized with no hierarchical power structure. Instead of optimization for revenue and profitability, Web3 founders might optimized for protocol adoption and community engagement. Community engagement is vital since it increases the number of people that are working for the success of the project.
The possibilities for Web3 companies are endless and we have just begun to see what is possible when people embrace crypto, decentralized technologies, and Web3 models. How is Web3 applicable to your company? To answer this question, consider the ways in which your company’s products or services act as a platform. Web3 business models are not strictly for technology companies. Every company has a network of suppliers and customers. As the network grows procurement can happen and sales can happen more efficiently. Now, consider your company as a platform that takes supplier goods and services, adds some sort of value (whether that is manufacturing, resource extraction, processing, etc.), and connects your business outputs to customers. Your company is a platform.
Now, consider how you can increase adoption of your platform. In other words, get more people to use your company to convert inputs to outputs. This is where the Web3 go to market flywheel comes in. If suppliers and customers benefited from the growth of your platform, they would sell inputs at a discount and purchase outputs at a premium. Under the Web3 model, this benefit typically comes in the form of some sort of token which reflects some future claim to the platform. This could be an equity share, special access, or governance rights. As suppliers and customers use the platform, they earn a token. As the number of platform suppliers and customers grow, the platform (and the token) becomes more valuable. The increasing value of the platform will draw in more users and create even more value.
We are advising clients on the adoption of Web3 business models and mapping pathways to platform acceleration. We have over 20 years of experience working with data systems in the information technology space, so we are well positioned to help you get started on your Web3 strategy. We’ve worked with countless businesses around the world, including those in the energy, mining, chemical, and construction sectors. Ultimately, our goal is to ensure that your organization meets its full potential while also balancing the needs of people, the planet and your profits.
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