Over the past couple of years, the term “Web3” (aka Web 3.0) has generated significant buzz. Venture capital firms, such as a16z and Lightspeed Ventures, have poured billions of dollars into Web3 startups such as Coinbase, OpenSea, Alchemy, Dapper Labs, and other unicorns. Among its supporters, Web3 has been touted as the decentralized future of the Internet. Let’s dive in and learn how to invest in Web3!
Key Takeaways
- Web3, or Web 3.0, is a new way to interact with the Internet using blockchain technology.
- Blockchain technology is an innovative way of storing and managing data. It is a distributed database that allows for more secure and transparent transactions.
- Four popular investment opportunities available in the Web3 space include decentralized finance (DeFi), non-fungible tokens (NFTs), the metaverse, and decentralized autonomous organizations (DAOs).
A Primer on the Internet
The World Wide Web has gone through several transformational phases since its inception. In the early days of the Internet (aka Web 1.0), the web consisted of static web pages, one-way data flow, open-source protocols (i.e. HTTP, SMTP, FTP), and a limited number of creators (think blogs, message boards, AOL, etc.). Back then, getting a site up and running required significant investments into bandwidth and servers.
In today’s Internet (aka Web 2.0), we have read and edit access, interactive applications, and private servers. Companies like Meta, Google, Twitter, and Netflix give us access to their services, but all the data servers are private, meaning these individual companies act as gatekeepers of their own content and all of our data. With this model, a small number of powerful companies control a significant chunk of all Internet traffic, including the ability to ban accounts, change the usage rules at a whim, and censor people. FAANG companies are worth so much because of this market power.
Introducing Web3
While Web3 is only in its early stages, it promises to change the way we interact with the Internet using blockchain technology. Proponents of Web3 envision a world with decentralized finance, “play-to-earn” video games, tokenized economies, NFT platforms, and more. Instead of the web being controlled and monopolized by centralized, corporate platforms, everyone would tap into the same database and have ownership over their digital identity. With a focus on open protocols and decentralized, community-oriented networks, the power would tilt back to creators and users like you and me. To learn how to invest in Web3, it helps to understand how its value and how the underlying blockchain technology works.
Blockchain Technology
Blockchains are run by a network of nodes, allowing for more secure, transparent, and private transactions (though they are not immune to hacks). Various industries, ranging from finance to healthcare to entertainment, have started using blockchains to track the movement of assets or data. You can build many things using the blockchain, such as cryptocurrencies like Bitcoin and Ethereum, authentication processes, video games, art, etc.
How Blockchain Technology Works
A decentralized public ledger, made up of distributed computers (aka miners and nodes), records transactions between two parties, and runs programs to take actions using that information, such as creating crypto or buying and selling NFTs. Because the ledger is public, anyone can look it up and read the data.
Today, companies like Facebook, Apple, and Snapchat host your data on private servers. With blockchains, everyone taps into the same database, and transactions get encrypted and made public. Copies of the data exist across thousands of computers globally, allowing anyone to access the ledger and their own data.
Blockchains are comprised of series of blocks and each block has a group of transactions. Imagine each block as a storage unit for your data from the moment it is created up to now. Blockchain uses existing cryptography schemes to add new blocks and is immutable, meaning you cannot overwrite or delete existing data. As new blocks get added, a chain of blocks gets formed, creating a history of blocks.
Using an analogy from William Mougayar, think of Microsoft Word vs. Google Docs. With Microsoft Word, one person would work on a word document while the other person waits to receive the file and make edits or add comments. Only the person working on the doc can see the changes in real-time. With Google Docs, anyone you share the doc with will have read and write access at the same time. The revision history is also visible. Likewise, blockchains are shared ledgers that anyone involved can access. Miners or nodes in the network verify changes and additions through a consensus mechanism.
What Type of Information Goes on Blockchains?
Bitcoin records transactional information, such as fees, the hash of the block, timestamps of transactions, and where the money is going. On the other hand, Ethereum is a network that allows developers to run “smart contracts.” Think of these as regular contracts but governed and executed by code.
Bitcoin operates on a consensus mechanism known as “proof of work,” while Ethereum transitioned from proof of work to “proof of stake” last year. Under proof of work, miners consisting of hundreds of computer servers solve complex math problems (Byzantine General’s Problem) to add a new block to the chain recording the most recent transactions. For their efforts, the miners receive a block reward, or the new currency created from the block. To compute a hash, or solve math problems, it takes ~10 minutes of intense computations. Mining is the economic incentive for decentralized decision making, maintaining the network, and receiving reward for the computation work.
4 Popular Investment Opportunities
While the Web3 space is still in its early stages, there are many ways you can get involved in Web 3.0, ranging from decentralized finance to the metaverse. This list is by no means exhaustive, but feel free to use it as a launchpad to dive into Web3.
1. Decentralized Finance (DeFi)
Today, we have a centralized financial system in which governments print fiat currencies, and financial institutions such as banks act as “record keepers” and “holders” of the money and its transactions. Banks issue debit and credit cards to consumers that act as “messengers” to deliver money and manipulate it through loans, cash advances, fractional reserve banking, etc.
The current financial system has several key issues. Because it is a centralized system, the government and banks decide all the rules and regulations. Financial institutions often take a small fee on transactions and generally only operate on weekdays from 9AM to 5PM. Additionally, ~2 billion people globally, or roughly 25%, remain unbanked, according to data from the World Bank’s Global Financial Inclusion Database.
Decentralized finance, or DeFi, attempts to give people more control over their finances by giving them access to financial services they didn’t have before. DeFi does this through an electronic payments system based on cryptographic proof instead of trust. By using blockchains, miners print money, and everything gets recorded on a public ledger rather than a financial institution.
People can use crypto wallets to hold money and send it over the blockchain by requesting a transaction through a wallet application like Coinbase or MetaMask. You do not need third-party intermediaries to approve your transactions or determine your creditworthiness with this peer-to-peer system. Think of DeFi as a digital alternative to Wall Street without any physical costs, such as buildings, trading floors, business hours, bureaucracy, etc.
Critical Infrastructure
DeFi is akin to building a Minecraft server or Lego model where each program acts like generic blocks that are used to build increasingly complex things. Key infrastructure includes:
- Exchanges and platforms: You can use crypto exchanges or lending platforms that function similarly to online brokerage platforms for stocks to purchase Ethereum, Bitcoin, and other cryptos. Currently, I have accounts with Gemini and Coinbase. Other popular ones include Kraken and Cash App. Alternatively, some brokerage platforms allow investors to purchase cryptos, such as Webull and Robinhood, and give you direct custody of the cryptos.
- Wallets: You can store your crypto in either hot or cold wallets. Hot wallets are online wallets, such as exchanges and platforms, that you can access on your laptop or phone. Cold wallets are not connected to the Internet and store your crypto offline. Ledger and Trezor are popular options among investors.
- Stablecoins: Stablecoins are pegged to a fiat currency, such as the U.S. dollar, and are used to make fiat currencies usable in the crypto space. Real-world use cases include getting a loan with limited paperwork, 24/7 wire transfers with no fees, high yield savings account equivalents through lending platforms, etc. Stablecoins command the highest yield on most DeFi or CeFi lending platforms.
- Bitcoin: Bitcoin was the first cryptocurrency to debut in 2009 under pseudonymous founder Satoshi Nakamoto. While there are thousands of other cryptocurrencies in circulation today, Bitcoin is among the most reputable and valuable coins available and is used to back other cryptos. Since its inception, the value of Bitcoin has grown more than 10M%! In comparison, Goldman Sachs data indicates the average annual return of the S&P 500 in the past 10 years is roughly 13.6%.
- Ethereum: Ethereum is an altcoin (any coin that is not Bitcoin) whose blockchain stores smart contracts, transactions that are more complex than a direct payment. Instead of renting space in a data center and hiring system administrators, everyone uses a shared global resource powered by computers worldwide. Ethereum is the base layer for many other cryptos, including stablecoins, and with the ERC-20 token standard, developers can build token apps that are interoperable with various products and services.
Why Are There Alternatives?
Bitcoin and Ethereum are the two biggest names to date among crypto enthusiasts, but there are thousands of altcoins available in the crypto market. Different cryptocurrencies solve different issues, such as lowering gas fees, or the cost to transact on the blockchain. Like individual stocks or fiat currencies, the crypto world is not a zero-sum game where there is only one winner.
2. Non-Fungible Tokens (NFT)
Non-fungible tokens, or “NFTs,” are unique digital assets encoded on blockchains, such as one-of-a-kind artwork. “Fungible” assets refer to items like Bitcoin or the U.S. dollar, which are not differentiated and are interchangeable.
With NFTs, anyone can have equity ownership in digital assets:
- Artists can sell their work from anywhere around the world, allowing for broader wealth distribution across countries and possibilities for innovations that physical art does not have, such as generative art or async art.
- Musicians can sell their music without paying a label or get pennies per listen on streaming services like Spotify and Apple Music.
- Gamers can play video games to make money on play-to-earn crypto games like Axie Infinity and eventually transfer paid items from one game to another.
- Creators can have greater ownership over the way they distribute their content, make profits, and reward supporters.
- … and the list goes on!
With NFTs, there is space for new technology and higher levels of community input and transparency. As a consumer in the community, you can communicate directly with organizations that are building publicly on Discord, Twitter, etc. By participating, you have the power to influence the product direction and potentially talk to the next Jeff Bezos or Elon Musk.
Why Do NFTs Have Value?
You may be wondering, why people spent hundreds of thousands or millions of dollars on Crypto Punks, Beeple, Magic: The Gathering, or Crypto Kitties? After all, you can take a screenshot of the art or get a digital file for free.
But, you can also do the same to physical items of value — why do millions of people fly across the world to see the Mona Lisa each year when there are digital copies online?
Branding, cultural relevance, and community give NFTs value. Like the branding and cultural mindshare the Mona Lisa occupies, NFTs derive value from the discussions made, the project’s market, and the emotional attachment investors have to them. Brands are powerful status symbols. Why do people shell out a quarter million dollars for an Ivy League diploma or $1.9M for The Hermes Birkin Bag by Ginza Tanaka?
NFTs aim to reduce inefficiency and increase equitable access in the long run. With NFTs, you easily verify if someone has a genuine copy or not through its built-in authentication. By cutting out rent-seekers and high transaction costs, artists have unprecedented access to profit off their success and take control and ownership of their work. NFTs also have long-term value and permanence, meaning they will not degrade like physical objects.
Purchasing NFTs
To get started, you will need a crypto wallet compatible with the right crypto for the NFT you want. For example, to buy and sell NFTs on Opensea, you need ETH (Ethereum). To buy and sell on Magic Eden, you need SOL (Solana). You can buy some ETH or SOL from an exchange such as Coinbase and send them to your wallet. Once you set that up, you can choose from an NFT market, such as OpenSea or Magic Eden, to connect your wallet to.
Once you have funds, you can start browsing through the NFT markets for items you like. Some are sold through auctions, while others have set prices. You will need to pay a gas fee to buy and sell NFTs, which vary depending on how busy the network is. Once you purchase an NFT, you can access it through your crypto wallet.
3. Metaverse
If you have been following tech news, you may have seen Facebook change its parent company name to Meta to signal its business shift towards bringing the metaverse to reality. The easiest way to think about the metaverse is to think of it as “cyberspace” or “virtual reality.”
While still in their early days, meta platforms want to shift how we interact with technology by creating multi-platform digital worlds. In the future, we would have a collective virtual open space that mixes virtual reality with our physical reality, allowing people to socialize, attend events, play games, and more together.
Examples of future capabilities include augmented reality (AR), artificial intelligence (AI), flexible work styles, IoT, 5G, and other technologies. Real-life use cases include:
- Online games such as Fortnite and Roblox
- Virtual co-working spaces and classrooms
- Digital land and virtual houses such as Decentraland
- NFTs, such as digital art, collectibles, and avatars
- Online shopping
- Concerts, conferences, and live events
4. Decentralized Autonomous Organizations (DAOs)
Decentralized autonomous organizations, or “DAOs,” are a revolutionary new way for people to organize and operate like companies, but with more access, transparency, flexibility, and ownership. Depending on who you ask, there are multiple definitions. In simple terms, think of a DAO as a business, but on the blockchain and governed by self-executing code.
Typically, a DAO consists of a group chat, crypto tokens, treasury, governance (voting system), and on-chain cash flow (i.e. NFT drops). All conversations are open, so anyone can contribute to a DAO without needing to get hired onto the team first. As a contributor, you can support the community in whatever way the DAO needs. For example, you can create marketing content, develop on the blockchain, manage partnerships, design merch, etc.
Because transactions get built on the blockchain, anyone can see where the money is going, and members or contributors can vote on decisions on the blockchain. Investors can participate in several DAOs simultaneously without committing full-time to any one DAO and have ownership through tokens, allowing everyone to have skin in the game.
What Types of DAOs Are There?
Launched in 2016 after a crowdfunding campaign, The DAO is the first known DAO. Its goal was to provide a way for investors to receive tokens proportional to how much ETH they invested and vote for projects to fund, similar to a venture capital firm, but one run by its investors. The source code was completely open-source and available on Github. In June 2016, the DAO got hacked due to vulnerabilities in its codebase, with unstoppable code posing a huge security issue.
Other types of DAOs include:
- Social DAOs: similar to a digital country club where members who hold tokens have access to special events
- Protocol DAOs: tied to specific DeFi protocols
- Investment DAOs: focused on investment opportunities
- Media DAOs: focused on content creation
- Collector DAOs: pooling funds with other investors to buy NFTs together
Unlike most companies today, DAOs take a community-first mentality where the people in the community are the most valuable assets rather than the product or services.
Vetting Web3 Investments
Here’s a few things to look for when vetting web3 projects:
- Founding team: Who are the founders? What are their backgrounds? Have they had successful exits in the past or are they first-time founders? Are they doxxed (publicly known) or anonymous?
- Problems the project is solving: What is the goal of the project? What is the team trying to solve? Are they providing a viable solution for an existing problem?
- Product or service offering(s): Does the product or service provide value to its users or customers? What are the benefits of the product or service?
- Community: Who is backing the project? What types of people are supporting the project? Is the community open to criticism and suggestions? Do they take feedback seriously?
- Roadmap: Does the project have a public roadmap? Is the team keeping the community updated on changes? Is the team delivering what they promised?
While this list is by no means an exhaustive list of what to look out for when vetting projects, this should give a good start on how to evaluate projects.
The Bottom Line
There are many ways to invest in Web3, and the best option for you depends on your goals, experience, and what you are interested in. If you are just getting started, you may want to invest in a few foundational projects like Ethereum or Bitcoin. These projects will give you exposure to blockchain technology while also allowing you to make some money if their value increases.
Alternatively, if you’re looking for a more active role in Web3 investment, there are many options for that as well. You can buy into individual tokens or coins that represent specific applications or platforms within Web3, invest in whole companies that are working on new blockchain-based products and services, start a DAO, and more! Whatever route you choose, remember that doing your own research is key to investing in any projects and to stay informed!
Additional Resources
Ethereum, Smart Contracts, and the World Computer
NFTs 101 — Why NFTs are a generational innovation
NFTs: A Primer for Newbies – a.k.a. Equity Ownership of Anything, and a New Digital World
What Is the Metaverse, Exactly?
