Trend ONE: Web 3 After the Annus Horribilis

2021 brought forth a new wave of interest in the potential value to be created in web3 and ‘the metaverse’, amongst builders and investors alike. However these expectations were destined not to be met, with a series of major structural downfalls severely damaging confidence in web3 as a mature, responsible industry.

2022 may long be remembered as an annus horribilis for the web3 world. Late 2021 had seen new all-time highs in the token price of mainstream cryptocurrencies. This then brought forth a new wave of interest in the potential value to be created in web3 (as well as its sister concept ‘the metaverse’) amongst builders and investors alike.

However these expectations were destined not to be met, with a series of major structural downfalls severely damaging confidence in web3 as a mature, responsible industry. First in May, the Terra-Luna collapse undermined confidence in the concept of algorithmic stablecoins; and caught many investors out (both institutional and retail) as having significantly mispriced the risk they were taking on.

More recently, the collapse of FTX, the world’s third-largest cryptocurrency exchange, was driven by revelations the exchange had misused customer funds by lending them to its sister company and hedge fund, Alameda Research. Beyond the potential US$3B+ FTX is yet to repay its creditors, the downfall of a company once considered the ‘adult in the room’ of crypto markets (with FTX’s founder Sam Bankman-Fried having previously been held up in lights and even compared to J.P. Morgan) was seen as the end of the libertarian, deregulated, halcyon days of crypto.

2023 will be dominated by the reaction to the downturns of 2022. A focus on regulation will emerge, either mandated top-down (here in Australia Treasury is openly canvassing consultation ahead of expected legislation next year) or adopted voluntarily from major stakeholders such as exchanges providing ‘proof of reserves’. Meanwhile, true believers will see the horrors of 2022 as further proof that greater decentralisation is needed to see off the foils of human nature and the bad actors that sat behind the worst of the 2022 scandals. Expect more of a focus amongst those ‘in the know’ on decentralised exchanges, non-custodial wallets, and consolidation of focus onto proven, stable protocols that interface with the web2/tradfi world with maturity and sobriety.

Likewise, a bear market often spells the greatest opportunity to invest in building the key enablers and infrastructure that will power the next cycle. Glass-half-full founders see themselves as freed from the short-term pressure to continue chasing users/deposits in favour of long-term investment in technology and strategy. Expect to see generational web3 companies emerging over the coming years (it goes without saying the tricky part will be knowing which those will be in real time). Looking at the current structural issues suggests where this value might be built: most noticeably creating mass-market UX and on-ramps for crypto applications, better security to create investor and user confidence in projects otherwise vulnerable to hacks or scams, and more efficiency in on-chain services to reduce the (de-facto) cost-to-serve for projects.

It’s worth reflecting that these opportunity areas are largely the same structural issues that were required to catalyse the massive growth in web2 applications and the adoption of e-commerce. From a VC perspective, we hope founders of web3 projects will return to describing their business using the first principles logic that has defined early stage value creation long before the invention of web3 (or even web2). Where companies focus on the application layer; founders should avoid talking in protocol speak, instead starting from a problem and a customer before layering over the nature of their solution, and only then how web3 happens to be the right enabler.