A Web3 Primer: 7 Concepts You Need to Know
Like earlier iterations of the internet, the arrival of Web3 has the potential to change business and society in any number of ways, from the rise of cryptocurrency to the proliferation of truly user-owned content
First, though, it is important to understand what exactly Web3 is.
Here are seven concepts that you need to know, as described by University of Virginia Darden School of Business Professor Dennie Kim, who co-authored the paper “The Promise of a Decentralized Internet: What Is Web 3.0 and How Can Firms Prepare?”
Web3 is essentially the next iteration of the internet, made up of internet applications built on blockchain technology (more on that in a minute), which can securely store data. The distinguishing characteristics of Web3 are decentralization and user ownership — an important shift from decades of digital power being concentrated in the hands of a few companies.
Web3 is also called Web 3.0. It’s preceded by Web 1.0 of the 1980s and early 1990s, which was relatively decentralized but did not meaningfully capture data or easily allow users to create content, and our present-day Web 2.0, with which companies have learned to store and use vast quantities of data — and therefore tend to hold more power than individual users.
“The definition of Web 3.0 is still evolving as it is being created,” Kim notes. “For our purposes, it is important to note right now that it is focused on empowering users and businesses to co-create things and mutually benefit.”
Blockchain technology, also known as distributed ledger technology, is the backbone of Web3. Kim and his colleagues define it as a “decentralized, public database that allows information to be securely recorded on a network of computers rather than verified and controlled by centralized entities.”
“Essentially, blockchain is a digital accounting system that records ‘who owns what’ and maintains all state changes over time,” they write. It does this by storing “blocks” of data, which are “chained” to the previous blocks, digitally building on each other each time they transfer between users.
Because these digital ledgers are maintained on a decentralized network of computers rather than a single server, they tend to be secure — and are not owned by any one company or individual but instead collectively managed. Many blockchains are also open and transparent, allowing anyone to access records, unlike, say, Meta, the Facebook parent company, which is notoriously opaque and rarely shares data.
A blockchain can support things like smart contracts — software code that can run automatically once predetermined conditions are met. Kim offers the example of Modum, a startup company that integrates blockchain technology into pharmaceutical supply chains, using smart contracts to maintain important conditions like temperature during the transit of perishable medication. Without human involvement, it can analyze and approve shipping conditions and send synchronous updates. Because these scripts are executed “on chain” (i.e., on the blockchain), they are much more difficult to manipulate or alter, and interactions can be made more transparent than code executed on enterprise software or centralized servers.
Of all of the terms on this list, perhaps the most loaded is cryptocurrency — a digital asset exchanged somewhat like traditional currency but without physical form. Instead, its individual units — or tokens — exist as blocks of data in the chain. One of the most famous cryptocurrency protocols is bitcoin, which uses bitcoins as its native tokens. Native tokens serve a very important purpose as they are used to pay for the transaction fees on their respective blockchain protocol.
Tokens can be sent from one user to another, traded for other tokens (including fungible cryptocurrencies and non-fungible tokens, or NFTs), and can even be used to pay for goods and services, either directly or through payment processors that will convert tokens into fiat currency. The hallmark of Web3 websites is the digital wallet function in its upper right corner, which allows users to connect their blockchain wallet to various blockchain-based applications and pay with cryptocurrency or other tokens.
Since cryptocurrencies and other tokens are features of blockchain protocols, they are not tied to a central authority such as a government or bank in traditional ways. For the most part, there are no restrictions on how users send cryptocurrencies to other users. This is great for innovation but also creates opportunity for malfeasance. Additionally, since markets for cryptocurrencies remain relatively unregulated, prices of many tokens (relative to fiat currency such as the U.S. dollar) can be highly volatile.
“Cryptocurrency investing is still so new,” Kim says. “There are a lot of investors coming into the market, ranging from experienced, savvy investors using bots and mathematical models to inexperienced individuals investing in decentralized assets using centralized platforms, and there are few regulations.”
Decentralized Finance (DeFi)
While native tokens have served as the groundwork, it’s decentralized finance, or DeFi, that’s growing financial systems on blockchain based on the fact that any user has the ability to create a fungible or non-fungible token on a blockchain protocol. Once created, these tokens can be easily transacted with others built on the same blockchain. Further facilitating this are the existence of decentralized exchanges where users can create their own liquidity pools to enable swapping between any two tokens.
For example, in March 2022, a company called Yuga Labs created its own cryptocurrency, Ape Coin, on the Ethereum blockchain. Users could immediately convert other types of cryptocurrency into Ape Coin, or swap Ape Coin for ether (the native token of Ethereum), because Yuga partnered with many decentralized exchanges to have deep liquidity pools ready at launch. Since its launch, users have been able to use Ape Coin to purchase other digital assets and physical merchandise.
Despite these increasingly robust decentralized alternatives to the traditional financial system, some important barriers remain. First, most cryptocurrency users purchase cryptocurrencies on centralized exchanges in exchange for fiat currency.
“Therefore, the primary ‘on-ramp’ to Web 3.0 and a decentralized internet is controlled by a small number of centralized (public and private) firms,” Kim and his co-authors write. “Businesses will need to innovate methods to make it easier for new users to seamlessly integrate into Web 3.0.”
The researchers also note that, despite the potential and benefits of DeFi, it comes with risks, as it is absent the protections of existing financial institutions.
Nonfungible Tokens (NFTs)
Whereas the tokens that are commonly referred to as “cryptocurrency” are fungible, interchangeable and divisible, nonfungible tokens (NFTs) are discrete and indivisible digital entities. An important implication of nonfungibility is that only one user can possess a given NFT at any time. Just like cryptocurrency, no third party is required to arbitrate the transaction, making NFTs “a critical next step in the evolution of digital ownership,” according to Kim.
Right now, he said, NFTs are most commonly associated with art, advertising and community building. For example, ownership of a Banksy painting is being divided into 10,000 NFTs, each one sold as a unique digital token. McDonalds, to promote its McRib sandwich and encourage social media activity, released a limited number of NFTs billed as “limited-edition digital collectibles” that were quickly snapped up by consumers.
However, Kim sees potential for more on the horizon.
“There are so many things on the internet that we should own but that we do not because the infrastructure is not there or because many business models do not consider users to be the owners of their own data,” he says. “Our medical records are a perfect example and are the primary reason I became interested in blockchain after working and researching in the health care system for nearly two decades. Despite that unique information being ours — some of the most personal information we can give — we cannot easily access or share it. What if we could?”
Decentralized Autonomous Organizations (DAOs)
Decentralized autonomous organizations, or DAOs, are new types of virtual organizations with structure, governance and/or activities managed by “on-chain” (i.e., on a blockchain) smart contracts. The decentralized aspects of DAOs often refer to decentralized decision-making and governance, such as allowing all members to vote on proposals or requiring approval for managerial decisions. “Decentralized” may also refer to the manner in which the organization’s activities are coordinated and executed, or the ease with which members can join and leave the DAO. “Autonomous” refers specifically to the integral role of smart contracts in the organization — the “machine layer.” While DAOs vary greatly in the extent of smart contract utilization and integration, the autonomy derives from the fact that smart contracts can be programmed to execute without human intervention and, because of the blockchain, cannot be easily manipulated or exploited.
“Much like enterprise software in more traditional organizations, blockchain-based smart contracts enhance security, increase transparency, and reduce the ability for individuals or small groups to break policies or rules due to automation,” Kim and his colleagues write. “Yet, unlike traditional organizations where humans must often interact with digital systems to approve and verify certain actions, smart contracts allow DAOs to automate a host of actions when certain conditions are satisfied.”
As an example, a DAO might be formed to advance a collaborative project. Each member’s work can be assigned a unique NFT, and compensation can be automatically determined based on their unique contributions indicated by the NFTs. All of this can be done securely and potentially anonymously.
“I am particularly curious about how organizations will experiment with DAOs and how they might evolve,” Kim said. “What are the most likely organizational problems that could be solved with some degree of secure automation? What will some of the archetypical DAOs look like in a few years?
While some may have previously heard of the term metaverse in science fiction, it caught the attention of many when Facebook’s parent company renamed itself Meta in 2021. Today, most metaverses are online, virtual worlds similar to video games, with participants controlling 3D avatars and interacting with others and their digital environments.
Unlike video games of the past, however, many envision metaverses to provide more than just entertainment in the future. Kim and his co-authors point out that future metaverses will include user-generated worlds or games, as well as virtual stores selling digital goods and experiences. In fact, many companies have already ventured into the metaverse. In one example they cite, Decentraland hosted a “Luxury Fashion District” in March 2022 for more than 108,000 attendees, with Dolce & Gabbana showcasing virtual pieces and Estee Lauder giving out wearable NFTs for avatars.
The virtual reality of a metaverse, Kim said, is an extension of the online worlds we already create for ourselves on social media, online forums, video games and more.
“Arguably, we already move between many different realities,” Kim said. “The internet has integrated deeply into our lives and the adoption of remote work as allowed us to take on even more. The metaverse is about continuing to blur that line between digital and analog.”
In the world of Web3, metaverses and the other terms on this list are the architecture, the stage for what users and businesses can do. In our next post, Kim will discuss how businesses can adapt to and thrive in this new digital world.
Dennie Kim co-authored “The Promise of a Better Internet: What Is Web 3.0 and What Are We Building?” which is forthcoming in Business Horizons, with Alex Murray and Jordan Combs, both of the University of Oregon.