Last month, venture capital firm Paradigm announced a $2.5bn crypto fund, the largest single fund made public by a VC firm for crypto and blockchain projects. The motivation: to help roll out Web3, which supporters herald as the future of the internet.

Unlike our current Web 2.0 world, which centralizes communication and commerce within proprietary platforms like Google and Amazon, Web3 (shorthand for Web 3.0) would be open and decentralized. Communities of Web3 users would maintain and operate applications and services in exchange for crypto tokens like Bitcoin or NFTs. Meanwhile, platform decisions would be executed through transparent smart contracts (autonomous software programs).

Web3 supporters believe it will transform everything from the creative economy to communication. Its architecture may help unlock new forms of value creation, especially for smaller players. NFTs for example are helping less endowed creators sell their work directly to fans and earn commissions on secondary sales while cutting out intermediaries that would normally eat into earnings. Critically, this new web would be designed with the concept of interoperability at its core - a concept that currently exists in open banking schemes, but that would be generalized to any kind of platform (e.g. social media) under Web3. Such interoperability, in turn, could help to reduce barriers to entry for small- and medium-sized digital companies.

As of now, Web3’s most prominent—and tangible—application is decentralized finance (DeFi). An $80bn industry in 2021, DeFi conducts financial services using blockchain, thus cutting out financial intermediaries such as credit card companies or banks. In theory, DeFi delivers lower cost and nearly instantaneous, borderless transfers of value. It may also help to enhance financial inclusion as there’s no need for consumers to have a bank account in the first place or hold hard currencies that can be exposed to inflation.

Whether DeFi successfully redefines the way financial systems operate remains to be seen. Regulators will determine how truly “decentralized” the industry can be, and signs suggest that they may opt for a heavy-handed approach. The U.S.’s Securities and Exchange Commission (S.E.C), for instance, may likely rule that crypto assets are securities, which will require them to be registered with the S.E.C. (and thus subject to a centralized actor’s scrutiny). Countries may also come with their own digital finance alternative. South Korea, the United Kingdom and Sweden, are all exploring developing their own central bank digital currencies (CBDCs), which would offer similar advantages to decentralized currencies (such as low cost, instantaneous value transfers) without the risks (e.g. volatility from speculation). This could lead CBDCs to displace cryptocurrencies in the long run.

In spite of this, venture capital firms are investing huge sums: more than $27bn this year alone, according to the New York Times. Alongside Paradigm is Andreessen Horowitz, one of the most bullish VCs in the space, with a $2.2bn fund created in 2021 to support crypto founders. Institutional investors are also entering the mix, and the preliminary results seem promising. A research paper for instance found that “a small but growing number of institutions” that put capital in crypto between 2018 and 2020 outperformed their peers by 2.8% on an annualized basis. But this may pick up over the near future. A survey of 100 wealth managers and institutional investors found that 62% expected to invest for the first time in the coming year due to perceptions of long-term capital growth and an improved regulatory environment.

Faced with the threat of disruption to their business models, incumbents are now starting to fold Web3 ideas into their services. Examples include Twitter, which announced last month the launch of a crypto team to explore decentralized technologies, Reddit, which is devising a way to utilize cryptocurrency tokens to enable users to own portions of the communities they partake in, and Meta, which has promised an interoperable metaverse.

As exciting as the prospect of a new internet may be, its feasibility continues to be rooted in the material. Blockchain faces a scalability problem which limits its ability to process large volumes of transactions simultaneously. It also has a huge energy consumption. Bitcoin mining alone requires approximately 91 Terawatt-hours of electricity annually, more than the total energy use of Finland. In the short term, transitioning fully to Web3 might thus mean settling for a slower, more energy-intensive web. Whether users are willing to make the trade-off remains to be seen.

A Brave New Web