Imagine an internet that is built, run, and controlled by users rather than a few big tech companies. Social media users can monetize their data, content creators can receive direct cryptocurrency payments every time someone views their latest post; ride-sharing platforms can be owned by drivers.
That's the promise of Web3 - a decentralized internet based on an open, permissionless blockchain network.
The internet as we know it now is centralized — data is stored in data centers owned by a handful of tech companies. But in Web3, data are stored and flowed on the blockchain network, and no single entity can control them. From e-commerce to social media to gaming, it is maintained and controlled by democratic groups of developers, creators and users.
Three use cases for Web3 have gained traction today:
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Decentralized Finance (DeFi): A financial ecosystem powered by smart contracts that allows participants to access financial services on a peer-to-peer basis without relying on traditional intermediaries such as banks, credit unions or brokerages
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Non-Fungible Tokens (NFTs): Representing digital assets - ranging from images to songs to videos - verified by blockchain technology
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Decentralized Gaming: Based on a token economy and a virtual world powered by blockchain technology. Most decentralized games integrate NFTs in some way.
While a fully decentralized internet may still be a distant vision — critics say the idea is little more than hype — its ramifications could be far-reaching.
In this report, we break down the elements of Web3, its use cases, and what it means for the future of the Internet.
How does Web3 work?
- dApps aim to remove the middleman
- DAO to manage Web3 applications and communities
- Decentralized network owns and controls data on Web3
- Decentralized identity (DID) authentication for Web3 users
What impact will Web3 have in the future?
- Metaverse
- digital content
- Dispute Resolution
- social media
How does Web3 work?
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Decentralized applications (dApps) aim to remove the middleman
The main goal of Web3 is to "remove the middleman", which is a significant goal.
For example, an idealized Web3 ride-sharing application would connect passengers directly with drivers. Payments will be sent directly to the driver and the app will not take a cut.
The middlemen will be replaced by decentralized applications (dApps). These applications run on the blockchain and use code-based smart contracts to facilitate agreements between parties without pre-establishing trust. In theory, these apps do not belong to any individual or company.
To be considered decentralized, an application must meet the following criteria:
- It is completely open source, data is stored on an open blockchain, and no entity will own most of the application's tokens.
- Ability to generate tokens that are necessary to use the app and reward users in exchange for their contributions.
- It can only change/upgrade the agreement with the majority consent of the users.
Over 11,000 dApps are listed on the dApp store DappRadar. However, most dApps today are not technically decentralized - the entities that created them often still run or own them (a far cry from the Web3 vision).
Image credit: DappRadar
Likewise, dApps cannot all run on the Ethereum blockchain, as this can be complex, time-consuming, and expensive. This was illustrated by the "Internet Congestion Crisis" triggered by CryptoKitties in December 2017.
Today, many dApp developers either keep the main user interface on a traditional website and just send transaction requests to the blockchain through an API; or build on “sidechains” — independent platforms that can interact with the larger blockchain small blockchain.
Nonetheless, dApps offer some benefits that traditional apps cannot. For example, they may be more resistant to control or censorship by governments or other organizations. They are also open source, which removes barriers for developers to build a dApp ecosystem. Since dApps use blockchain technology, cryptocurrencies can be easily integrated.
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DAO manages Web3 applications and communities
But how will dApps (and other Web3 activity) be managed if no one is in control?
Answer: Decentralized Autonomous Organization (DAO).
A DAO is a blockchain-based organization. The rules of the organization are written into smart contracts - which can include automatically executing code related to certain events or conditions.
The DAO embodies the collective ownership and decentralization aspects of Web3. In the full Web3 vision, DAOs will replace companies as the main body running on the blockchain. Many Web3 startups have a roadmap for transitioning to a DAO structure.
An example of a DAO is Opolis, which was created for independent workers and evolved from a digital employment cooperative.
Opolis provides its members with automatic payroll, health insurance, retirement plans and other benefits. Its members voted to create a DAO in 2021 and fund a liquidity pool for its token $Work on exchanges. Although Opolis received $5 million in seed funding, only co-op members have the right to vote.
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Decentralized web changes the way data is processed
The Web3 platform hosts data on a distributed network rather than on centralized servers. The idea is to decentralize data and prevent a handful of companies from taking control of the internet.
One of the most popular peer-to-peer storage networks is the Interplanetary File System (IPFS). Computers all over the world can connect to the system and act as nodes that store data and make it available to users. IPFS is not blockchain based and its records are neither immutable nor permanent.
Filecoin is similar to IPFS, but it is built on a blockchain-based protocol. Anyone can join the network, contribute their open hard drive space for storage, and earn Filecoin tokens for doing so.
However, a disadvantage of data decentralization is that it can lead to bottlenecks in application usage. Retrieving data from a large network or blockchain like IPFS takes time, which limits the usability of Web3 applications. So developers are looking for workarounds.
An example is The Graph, a protocol for indexing and querying blockchains and distributed file storage networks such as IPFS. The Graph is designed to make Web3 applications run smoothly even when querying distributed data.
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Decentralized Identity (DID) Authenticates Web3 Users
Another challenge with Web3 is how to authenticate users. This is where Decentralized Identity (DID) comes into play.
A DID is a string of numbers and letters that form the basis of an application called an "identity wallet." These wallets contain verified credentials and other data generated by users on the blockchain. Identity wallets grant their owners access to applications and can also be used to prove ownership of NFTs, social media accounts, and other assets on the blockchain.
Spruce allows users to create DIDs on blockchains including Ethereum, Polygon, and Solana. Synaps allows users to create and manage identity documents, such as ID cards and passports, and store them on the blockchain, which is especially useful for applications with KYC requirements.
Identity wallets are also useful in professional settings. For example, developers can share verified academic qualifications, as well as their contributions to certain open source projects, or proof of creating digital assets.
DEX) - users can trade cryptocurrencies
- Lending platform - users deposit assets that can be loaned and receive rewards/interest from fees paid by borrowers
- Asset management and yield - depositors are rewarded for holding tokens and contributing to liquidity pools
- Derivatives - smart contracts derive their value from the underlying asset for hedging or speculation
- Payments - users pay each other with cryptocurrencies
- Insurance - Users can get protection for the crypto wallets, DeFi and other smart contracts they use
- NFT lending - users use NFT as loan collateral
Trading is one of the most popular use cases for DeFi. PancakeSwap, a decentralized exchange (DEX) on Binance Smart Chain, is one of the most popular DeFi applications with 2.4 million active users in June 2022 alone.
Another popular DEX is Uniswap, which surpassed $1T in all-time total trading volume in May 2022 – less than 4 years after launch.
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NFTs may have use cases beyond art and gaming
Non-Fungible Tokens (NFTs) are another well-known Web3 use case.
NFTs provide blockchain-based proof of ownership of digital assets - ranging from images to songs to videos. Each NFT represents a unique and immutable proof in the blockchain, kind of like a title deed.
Creators can sell NFTs directly to their fans to help monetize their creations, or on NFT marketplaces like Opensea or Rarible.
With NFTs embedded in smart contracts, the creator can add some additional conditions, such as the NFT automatically earning royalties when it is traded - no matter how many times it is bought and resold.
While early use cases focused on art and gaming, NFTs can be used in a number of different ways.
Web3 gaming models typically involve NFTs and Earn-As-Play (P2E). Users can purchase game assets in the form of NFTs, such as skins, weapons, characters, and avatars. Unlike traditional games, players can sell or trade NFTs on the marketplace, or exchange them for cryptocurrencies in DEXs.
One of the most popular NFT games is Axie Infinity created by Vietnamese studio Sky Mavis. The game reportedly generated $1.3 billion in revenue in 2021. Users buy NFTs of in-game creatures called Axies, which are then used in battle, and can also be freely traded. The most expensive Axie sold for a whopping $820,000 in July 2021.
But the current envisaged use cases for NFTs extend beyond art and gaming, with some developers arguing that NFTs could facilitate professional certification or DAO membership.
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metaverse
Another technical concept that is often discussed with Web3 is the Metaverse.
The Metaverse is a shared virtual world driven by highly immersive, interactive virtual products and digital experiences.
The Web3 Metaverse, on the other hand, is blockchain-based and built on open standards, sometimes referred to as the "Open Metaverse" - no single entity can control it.
An example of an open metaverse is Decentraland, a virtual world managed by its users through a DAO. Using Decentraland's software development kit, users can build their own spaces, experiences, content, and collectibles on virtual land. Ownership of these assets is represented by NFTs, and transactions are made using Decentraland’s MANA tokens.
Facebook's parent company, Meta, is investing heavily in developing immersive 3D virtual worlds as well as virtual reality (VR) and augmented reality (AR) glasses. Apple also seems ready to join the race, with the company reportedly building a headset that will provide users with AR and VR experiences.
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digital content
One of the main promises of Web3 is to enable content creators to control, distribute and monetize their content.
LBRY is a protocol that allows users to post content, set prices, and receive payments directly without going through social media sites. Users also have the option to share their content for free. Likewise, Dtube is a blockchain-based social media platform focused on letting creators post and share content.
Other content-driven Web3 use cases focus on preserving history. For example, The Starling Lab uses cryptography and blockchain to hold verified photos, articles and datasets documenting war crimes, human rights violations and genocide. One of its original projects was to replicate the USC Holocaust Foundation's Holocaust archive and upload it to Filecoin.
The company is also working with a human rights group to encrypt and verify social media content documenting the Russian-Ukrainian conflict and keep its records on the blockchain.
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Dispute Resolution
Some proponents argue that Web3 could even have an impact in resolving disputes, such as contract breaches between freelancers and companies or conflicts of interest within a DAO.
The best known in the field is Kleros, a decentralized dispute resolution protocol based on the Ethereum blockchain. Kleros selects a group of "jurors" to decide disputes, the entire process - including the final decision - is recorded on the blockchain, and jurors receive PNK tokens as a reward for their services.
In addition to online disputes, Kleros has also been used in real-world tenant-landlord disputes where courts in Mexico, where the dispute occurred, recognized and enforced the verdicts of Kleros jurors' decisions.
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social media
Some of today's popular social networking platforms have begun to transition to Web3. For example, Reddit is testing the virtual currency Karma points, and users who earn them can govern the Reddit subcommunities they belong to. However, there is still centralization here because Reddit owns and controls the platform.
New decentralized social networks are also emerging. Known as the Web3 alternative to Reddit, Aether is open source, user-governed, and users have the right to vote and impeach moderators. Users can also review whether the content in the platform is compliant, and obtain tokens through this contribution.
Other Web3 platforms offer more functionality. For example, Only1 is a decentralized social platform that includes NFTs with a range of features, including superfan NFTs, messenger services, NFT marketplaces, and more. Creators can create NFTs to give their fans access to exclusive content, images and videos.
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Web3 is a digital "Wild West"
One of the main challenges of Web3 is the lack of regulation and increasing cybercriminal activity.
Because Web3 is blockchain-based, it's easier for transactions to remain anonymous. While this protects users' privacy, it also makes it harder to track cybercriminal groups -- while making it easier for them to sell "ill-gotten gains."
Billions of dollars in cryptocurrency have been stolen this year. According to Chainanalysis, from January to April alone, $1.7 billion worth of cryptocurrency was stolen — 97% of which occurred on DeFi protocols.
According to Cointelegraph, most of the hacks against DeFi protocols that occurred between June 2020 and June 2021 were made possible by vulnerabilities that were overlooked by developers. In projects where rapid deployment is a priority, smart contracts can carry critical vulnerabilities. These contracts are often open source and public, making it easy for hackers to scrutinize them for ways to manipulate the protocol. Profits are also easier, as hackers can directly attack the protocol and withdraw funds.
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DAOs are vulnerable to abuse and centralized control
Similar concerns surround the oversight and security of DAOs.
Proponents of DAOs say their structure promotes democracy and transparency in decision-making, while critics say it is more of a pyramid scheme (layered selling) that concentrates power on a small number of participants, while avoiding zero. Wealth from wary members.
In October 2021, just 20 hours after AnubisDAO launched, $60 million worth of ETH in its liquidity pool disappeared and reappeared in a crypto wallet. Some investors accused the project's creators of fraud, while others suspected a phishing scam.
Aside from malicious attacks, another problem with DAOs is that participants can buy more tokens to increase their influence over decision-making. This has resulted in a concentration of power in many DAOs.
According to Chainalysis, governance token allocations across 10 major DAOs show that 90% of voting power is owned by less than 1% of users.
At the same time, the threshold for creating proposals related to DAO governance is higher. The same study found that out of 10 DAOs, only 1 in 1,000 to 1 in 10,000 token holders have enough tokens to submit proposals.
Gitcoin, a crowdfunding platform managed by a DAO, aims to solve this problem with quadratic funding, where each additional token you cast for the same vote is worth less than the previous one. However, quadratic financing does not eliminate the possibility that decisions are controlled by a single actor or by a few coordinating actors.
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Full decentralization is hard to achieve — and could make Web3 wobbly
Even if it were possible to achieve complete decentralization of the Internet, it would pose significant problems.
For example, blockchains are very slow due to the consensus mechanism. Ethereum can currently only complete 30 transactions per second - although the upcoming "The Marge" upgrade aims to increase that.
Using blockchain can also be expensive. As of March 2022, the average cost of transacting on Ethereum (also known as "Gas fees") is $15. In 2021, the average gas fee tends to be as high as $50, while some complex transactions cost upwards of $200.
Also, it is cumbersome for crypto wallets, dApps to interact directly with the blockchain itself, so they usually do not. Instead, they rely on APIs built and controlled by a handful of companies. But this approach increases the potential for potential cyberattacks and involves handing over power to a third-party ruler—a direct violation of the lofty goal of a "trustless" Internet.
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Cryptocurrencies still face huge hurdles
Since cryptocurrencies are an integral part of dApps and DAOs, Web3 is vulnerable to the weaknesses of cryptocurrencies, as revealed by the May 2022 cryptocurrency market crash.
It started with the decoupling of Terra’s algorithmic stablecoin UST from the U.S. dollar, and the value of UST’s sister coin, Luna, plummeted to $0. Confidence in the cryptocurrency market has been shattered by factors including a slump in the stock market, rising inflation and heightened regulatory scrutiny — also undermining assertions that cryptocurrencies provide a natural hedge against broader market volatility. In one day, the entire cryptocurrency market lost over $200 billion. Bitcoin prices fell to a 16-month low.
The prices of cryptocurrencies related to utility tokens have also fallen sharply. Within a month of the market crash, the prices of Filecoin and Solana fell by nearly 50%, while ETH fell from over $2,700 to around $1,900 — and they are still falling. For dApp builders and users, this means less value for their contributions.
Major cryptocurrency platforms Coinbase, Gemini, BlockFi and Crypto.com are all laying off staff as the June cryptocurrency crash continues. The lending platform Celsius, which was affected by the Luna zeroing, even suspended all withdrawals and transfers.
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