You can tell when the hype cycle is in full swing when the consultants and vendors join in.
Executives from the likes of Accenture and IBM have been on the recent conference circuit extolling the unfolding future of “Web3”. Financial institutions have to get on this! What is it? Why, it’s a combination of all kinds of stuff: artificial intelligence, IoT, 5G, big data, you name it, hell, why not cloud too, all on blockchain-based businesses.
The more technologies they throw in, the bigger the dollar signs you can see in their eyes.
It is true that banks and other big financial institutions need to be on top of Web3, which is still more buzzword than reality. Web3 could represent the ultimate disruption of finance by information technology, finally consigning banks to the lost worlds of Kodak, Blockbuster, and other failed businesses.
Web3 isn’t about AI or IoT, though. It’s a service in which the user owns or has control over their own data, and the services are provided by multiple entities, none of which is fully in control, so that they can’t suborn the platform to their own ends.
Back to the future
Another way to think of Web3 is as the decentralization of the internet. This isn’t new. The internet began as walled gardens among government, research, and corporate websites. It was highly decentralized. The invention of the World Wide Web and browsers made it possible to create a commons: the consumer internet. This was Web 1.0.
Its next iteration, Web 2.0, was the maturation of Big Tech platforms that sucked up and monetized data. Its leaders, such as Amazon, Google, Facebook, and Alibaba, emerged intact from the dotcom bust. They delivered world-changing services but they concentrated data, and power, and the bargain for users is no longer so attractive.
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These platforms grew so powerful that last year China cracked down hard on its technology sector, ensuring its biggest companies would not threaten the government.
For the rest of the world, DeFi and other aspects of Web3 may be the best way to break these monopolies, by creating apps in which users can own a piece of the action (via a token) and in which decentralization among service providers means no one entity can amass the kind of power that a Big Tech giant enjoys. Whether such decentralization merely leads to the fragmentation of the early days of the internet remains to be seen.
How banks respond
In this context, large money-center banks are part of the centralized Web2 status quo (never mind that banks aren’t even capable of Web2 organization).
Banks have been grappling with the assault by fintech since 2008 (the introduction of the smartphone plus the American crisis in subprime mortgages). The consumer-oriented, mobile-first business models of Silicon Valley have pushed banks to fight for the digital front office.
Blockchain is an infrastructure technology and it represents a new way of organizing the back office.
Banks have been dabbling with blockchain but as a way to make their existing businesses and processes more efficient. This is what efforts in trade finance, supply chains, and cross-border payments are about: market-wide digitization to create better ways to clear and settle transactions.
These projects borrow a lot from the permissionless, decentralized blockchains of Bitcoin and Ethereum, but they are in fact centralized or oligopolistic. They are closed clubs. This makes them controllable, but it also makes them more efficient, because those big public blockchains are too slow when it comes to processing.
Banks are also curious to see securities tokens emerge as viable markets. This is a world in which they could compete. Unfortunately, securities tokens have been a bust; asset owners haven’t been convinced they should tokenize their real estate or other illiquid properties. This may yet change.
Follow the money
Neither banker’s clubs in blockchain nor securitization tokenization is Web3. These are blockchain for Web1.5 financial services. Nothing wrong with it, but it’s improving existing systems, not creating new ones. That means these models are vulnerable to disruption should Web3 gains traction.
We aren’t going to find out this year if such disruption is possible, but 2022 is the year when Web3 businesses need to build the kind of infrastructure that can go the distance. That means surviving a collapse in crypto markets, the way Apple and Amazon triumphed amid the wreckage of the dotcom bust.
Every phase of technological innovation comes with its own speculative bubble: the dotcom stocks for the early internet, radio stocks in the 1920s, railroads in the nineteenth century. The frenzy of greed enables a massive investment in infrastructure and value-adding businesses, a handful of which survive the financial meltdown.
Crypto is probably closer to its bust than takeoff. As global interest rates slowly reverse the ever-declining trend of the past four decades, the most speculative assets are at risk, including US tech stocks and crypto.
Maybe the bust will come in 2022. Who knows? But while there is feverish investment into the space, what survives any eventual wipeout will probably be projects that add value. In crypto, this means infrastructure tied to real-world outcomes, not self-referential models of purely tokenized trading.
Design to be resilient
More specifically this means building models of identity, trust, and payments in DeFi that deliver value in the internet economy, not just within cryptoland. This is the kind of infrastructure required to power the Internet of Value and the digital economy.
It’s not clear that we’ve seen this yet. Things like NFTs got all the attention last year, but this feels more like tulip mania than laying the foundation for the Internet of Value. Just a guess, but the Bored Ape Yacht Club doesn’t look like the next Amazon.
There are exciting ideas bubbling up, however: DeFi apps, flash loans, automated market makers. Projects providing users with governance tokens so they own a piece of the businesses they use. Even NFTs could have their day in the form of creating tradeable digital assets in gaming and other digital environments.
The problem with these projects is they are based on attracting new users rather than creating sustainable revenues. Democratizing user access and attracting huge VC rounds is not a mark of sustainability, nor of creating trust. Nor does crypto automatically mean decentralized, given the high concentration of Bitcoin holdings among a small group of “whales”.
This leads to self-referential business models; crypto remains a circular industry, unrelated to the fast-growing internet economy that is propelling real growth and wealth throughout Asia and the world.
Most of these projects will get wiped out when there’s a sustained collapse in crypto markets.
Those that survive have a good chance of becoming the infrastructure of 21st century finance, and the incumbent banks will have to adapt to their reality.
Such resiliency requires three things.
- First, projects have to fit into traditional regulation, even if such regulation is backwards or opaque. The Travel Rule, mandating crypto exchanges identify the provenance and beneficiary of transactions, is not fading away. Decentralized autonomous organizations (DAOs) need to prove their value-add over legal contracts.
- Second, infrastructure must lead to mass adoption. Banks have their faults but they are also very good at trust, and at complying with privacy laws. What Web3 projects are going to find meaningful ways to compete with banks in these fields? Can DeFi service a mass market as centralized exchanges do now?
- Third, projects should be able to generate revenues even if user numbers slow, halt, or reverse.
As for banks, it is probably not necessary to shell out megabucks for convoluted advice about Web3. Instead they should look to participate in projects via their venture arms or labs, and then guide useful projects towards safer shores. Banks can be vital conduits between crypto and regulators. We can already expect a lot more involvement and progress in stablecoins in 2022. This should set the stage for a productive year in building Web3 businesses.
The coming year holds a lot of promise for Web3-related projects, ones that can stand the test of time. If you are building or investing in such projects, please let DigFin know.