Web3: It's all still happening!
Reflections from investing in 50+ web3 projects
The Genesis: excited by a shared ethos
We met IRL a year ago. Like many people, we had taken the plunge into the world of web3 during COVID-19 and were now coming up for air. We had engaged in early projects inspired by visions of a different way of interaction. We networked with innovators and entrepreneurs, reimagining ownership and building online communities. We imagined and experimented with ways to issue micro-financial rewards for project contributions.
We came to web3 after years of working in education and as founders with an eye toward the public good. Eric had been a classroom teacher and later an entrepreneur who built and sold Whetstone. Katelyn had been an investor at Pearson, a global education company. She also co-founded a public sector advisory firm that enabled governments to actualize their ambitious goals.
Both of us had started to invest our time and capital in teams and ideas we wanted to see succeed. While we enjoyed geeking out about the technological and speculative aspects of web3, our primary motivations lay elsewhere. As Packy McCormick described it, a Scenius was forming. For us, crypto represents a new frontier of technology, entrepreneurship and culture. We know firsthand that the people involved in web3 are passionate, and we believe that passionate people create impact.
Is now the turning point for web3 and crypto?
Carlota Perez's theory of Technological Surge Cycles serves as a useful frame for understanding the recent history, present, and potential future of web3 technology.
Perez’s theory can be visualized as follows:
We are somewhere between the financial bubble expanding and persisting for a while but eventually pops; a “bear market” ensues, and certain successes from this innovation cycle get incorporated by entrepreneurs as a new layer of infrastructure. The token price bubble has burst. The ensuing price drop revealed the relative strengths and weaknesses of projects in the ecosystem. Unbridled euphoria has sobered, and the ecosystem has become more resilient as a result.
Now, we are beginning to see the next wave of technologists and entrepreneurs who will incorporate the learnings of this cycle as the infrastructure for future innovation.
As we turn a corner, what have we learned? Real products win, and leadership matters.
Ten lessons from the past year.
There has to be value. The fundamentals of entrepreneurship do not change in web3. While the first rule of startups continues to be the need to achieve product-market fit, in web3 we’ve seen this rule skirted thanks to perverse incentives and opaque market movements. Web2 leaders and web3 skeptics have called this phenomenon out. Rightly so. Entrepreneurs building in web3 are no exception to the rule of needing to create fundamental value for users. People want their problems addressed, and their desires met.
Web3 and crypto are not consumer-friendly brands. Existing nomenclature has been more confusing than helpful. Crypto. Blockchain. DAO. Coin. Token. Utility. Is it a DAO? Is it not a DAO? Is it a company? Is it a DINO - DAO In Name Only? The labels don’t matter. People want their problems addressed, and their desires met. Crypto will scale when the technology becomes the invisible enabler of what consumers actually care about. Consumers don’t think about internet protocols when using their iPhones. For those curious about the labels, here are some resources.
Incentive design matters. “Show me the incentive, and I will show you the outcome” as Charlie Munger famously quipped. This is no less true in the world of web3, where incentive design takes the form of so-called “tokenomics.” Memberships, points, and tickets are powerful incentives, particularly when gamified. Well-designed incentive systems look to be effective marketing mechanisms in the coming years. Passage Protocol has built a solution for NFT-based memberships. Chainstarters has a no-code NFT builder that brands can use to better engage their stakeholders (side note: they have a great blog) Yet, we’ve seen the collapse of incentive schemes predicated on access to a limitless supply of capital. Axie Infinity’s boom and ensuing bust may be the most visible example of this (See below from Bloomberg). Play to earn still may have potential, but incentive schemes need to be thoughtfully constructed to maintain long-term community.
Leadership is critical. Leaderless organizations don’t function. Not all web3 organizations are Decentralized autonomous organizations (DAOs). Many models work. They all need a leadership team able to execute on the vision. DAOs conjure a vision of a flat organizational structure. In reality, while these organizations are fluid and flexible, they nevertheless run on leadership. For example, CabinDAO, a network built by creators, cites their culture of ‘do-ocracy’ and, ‘manifesting your role’ as core to their operations. Cabin has laid out an ambitious vision and invites interested individuals to join the movement. Joiners declare themselves the leader of their own project within the broader DAO. This requires a new type of leadership, which Cabin’s founders (Jon and Zakk) are defining by the day.
The barriers to entry for starting a web3 community are low but significant work is still required to instill strong governance. The paucity of barriers to entry is good for lowering the costs of entrepreneurship and fueling experimentation. However, this has a downside in the form of profiteers and copycats who enter the ecosystem looking to make a quick buck. This demoralizes new entrants to the ecosystem. Communities that wish to endure will need to invest in the hard work of governance. Reading, remembering, and executing the agreed-upon governance documentation is time-consuming work. But the rules and nuances matter, and it’s all too easy in an environment where people want to move fast and make things happen to gloss over the details. This is a mistake, and the DAOs that stand the test of time will be the ones who invest in working through the finer points of governance.
The balancing act with investors is being worked out. A major promise of the web3 movement was to democratize ownership and wealth. There are a few mega investors in the space who have taken significant ownership of key projects. Participants have questioned whether this runs counter to web3’s ethos of democratized ownership. The role of capital in a decentralized movement remains unclear. Ambitious visions need capital to kick-start and grow. Web3 organizations should carefully examine deal terms and diligence the values espoused by those offering them capital. Lack of transparency in both respects runs counter to the ethos. The ecosystem has learned that being the liquidity provider to a venture capitalist looking for a quick flip isn’t a winning proposition.
Better tools are coming. DAOs are succeeding despite having no tools purpose-built for their use case. Purpose-built tools for decentralized organizations are critical for success. Many DAO organizations are pieced together through various web3 native software platforms like Discord, where it’s difficult to separate signal from noise. We’ve seen some of the leaders, like Clarity, improve over time in response to user feedback. Wonderverse is also making strong progress. They are building tools for contributors. This velocity of product and user design improvement separates the winners from the rest.
The future belongs to digital natives. Young people all over the world readily participate in global online communities across games, social media, and the classroom. They don't give a second thought to using digital coins, tokens, and goods. A recent survey showed that 53% of children aged 6 to 8, and 68% of children aged 9 to 12, are playing Minecraft. More than half of those play more than once per week. This group is used to collecting coins, paying in native digital currency, buying, selling, and trading digital goods. They don’t need to be convinced. Parents are being actively educated on the various in-game coins so they can buy them. The future, their future, will be built on lessons they learned in the gaming environments that are native to web3.
Digital money is here to stay. Although Bitcoin and Ethereum are down from their all-time highs, they have not plummeted to zero value. The total market capitalization for each is still massive, at $460B and $235B as of today. Major institutions are still behind the adoption of these digital currencies. The gimmicks have gone away, but the infrastructure is already built.
Regulation is coming. The SEC has now moved against many of the ecosystem players who played fast and loose with their customers and capital providers. There may be more blow-ups like Luna and Celcius. The SEC has an investigation open against many other players. Forthcoming regulation and case law clarity will play a greater role in both legitimizing and scaling the sector, even if it causes pain in the interim.
We're still bullish.
Web 3 is a genuine philosophical and technological movement. While we’re still in the early days, the application layers on top of the technology are being built. And not all projects and experiments will survive. But those that do have the potential to define the next generation of the internet, commerce, community, and education.
Disclosure: Avalanche VC is an investor in Passage Protocol and Chainstarters. Eric is an investor in Clarity and Wonderverse. Katelyn and Eric hold ₡ABIN.