Originally published on the Variant blog. Join the conversation on Twitter.
By Li Jin and Jesse Walden
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Recent events surrounding FTX’s dramatic collapse have dealt a blow to the perception and trust of the crypto industry. We are heartbroken for those who suffered financial losses due to the reckless and fraudulent behavior of others, and are angry at the collateral damage this has done to the credibility of the industry. At the same time, overly negative media coverage — including proclamations that this is the end of crypto and that the industry should burn down — overshadows crypto’s potential as a tool for world-positive impact and demonstrates that outside sentiment is often out of touch with actual progress and fundamentals in web3.
Reflecting on these events, we turned to our founding thesis for grounding. Variant was started in 2020 with the belief that crypto would be the foundation of a user-owned web, where products and services would turn their users into owners. This idea has tremendous potential for how we can build new networks that better serve user needs, as well as broader implications on economic equity.
How do recent events affect our thesis about user ownership? It’s important to understand that FTX was the failure of a traditional financial institution and a reminder of why we need to move web3, and DeFi in particular, forward. We remain confident in the potential for crypto to build a fairer and more meritocratic internet, but as an industry, we need to refocus on the core principles of web3.
Starting from first principles, the foundation of web3 is open-source software running transparently on autonomous blockchains, like Ethereum, which minimizes the need for trusted third-parties. At the application layer, automated smart contracts obviate the need for human-run companies and institutions, whose opacity in decision-making can lead to systemic failures, as we’ve seen most recently with FTX.
Open, automated code is an unlock for a new way of building internet platforms that are credibly neutral and, critically, owned by users. User ownership is made possible by tokens — akin to packets of value that are encoded on blockchains. To be clear, when we say “tokens” we don’t mean speculative meme coins — we are talking about a radical innovation in ownership on the internet. Tokens are an internet-native property rights system: a way to own a piece of the internet itself, and they can represent any type of digital property, from artwork to music, to virtual land, to a piece of the internet products and services one uses. Like packets, tokens can be distributed instantly and programmatically to anyone, anywhere. One application of tokens is rewarding users for their participation in projects, incentivizing them to contribute to growth. This mirrors Silicon Valley’s decades-old playbook of granting stock options to incentivize and reward employees. In early crypto networks like Ethereum and Bitcoin, developers and technologists were rewarded with tokens for their contributions. And as with most technologies, what developers and technologists do first, the rest of the internet soon follows.
Today, we are still far from realizing the ideal of an internet dominated by token-driven, user-owned networks. Most token designs currently fail to align incentives sufficiently to unlock faster and more sustained growth than centralized companies. And in some cases, bad actors have leveraged tokens to propagate outright scams. But many experiments have made incredible progress, and to gauge the current status, we’ve found it helpful to explain tokens in the market today along a spectrum: from those that are critical to the functioning of a product or protocol, to those that offer a legitimate and compelling promise of utility, to extreme economic experiments, and finally, outright fraud and scams.
On one side are tokens that are indispensable to the user experience, including the operations of a product or protocol. For instance, ETH, Ethereum’s native token, is staked to secure the network and used for transaction fees, and more broadly, as a form of internet money in applications native to the ecosystem. In the middle of the spectrum are projects attempting progressive decentralization, aiming to give users ownership and control of products and protocols they use (e.g. Uniswap). There are also economic experiments in utilizing ownership as a bootstrapping or hyperscaling mechanism (e.g. DIMO), and tokens that function as quasi-equity, for fundraising or profit sharing, but without any investor rights (e.g. Constitution DAO). On the extreme end of the spectrum, some token design is so centralized that it can easily be exploited by issuers — a design flaw that introduces a single point of failure. FTX’s FTT token falls into the last category — but it wasn’t token design that brought FTX and Alameda Research down, it was the unsavory actions of those in charge. Just as in previous waves of new technologies, innovation hype cycles are marked by radical experiments, breakthroughs, and unfortunately, the presence of opportunists and charlatans that take advantage of users’ lack of information, until the former ultimately succeed and the industry matures.
As long-term investors, we spend our time with teams who are deliberate in leveraging tokens to distribute novel forms of ownership and control and to enable new product experiences. While many of these projects are iterating towards community-owned and operated networks, the playbook for optimally incentivizing behavior from users that can lead to long-term sustainability and competitive advantage is still being written.
The road to the user-owned web was never going to be easy or straightforward, but in the aftermath of the FTX collapse there are a number of clarifying lessons.
For users, the lesson that resurfaces is the adage “invest in what you know.” The world of user ownership is still very young, and there is no comprehensive guide on evaluating tokens from a user perspective, so being familiar with what one owns can be challenging. But whereas investing in the internet was previously limited to the world of professional VCs, web3 makes investing available to all consumers through tokens. While that comes with risks and necessitates research and responsibility, user ownership is a new type of internet-native job that dovetails with the broader trend of new opportunities for earning and wealth creation online.
For builders, we hope that this moment sparks greater first-principles design around tokens as products, with a focus on ownership experience. Tokens can be designed to unlock new product experiences for end users, where that product solves a key problem for the end user. Our philosophy is that ownership is a vast design space that should be rooted in user needs, whether that’s a desire for status, economic alignment, community, or something else. When tokens are launched without consideration of users’ needs, projects run the risk of confusing users about what the token is good for. And in parallel, token design needs to be coupled with accessible education to make it clearer to users what they actually own.
There is a lot of work to do to fully realize the potential of web3 as the next iteration of the internet that turns users into owners. Building decentralized systems that empower users is challenging, and the playbook is still being illuminated. But it’s clearer than ever that user ownership is a powerful new tool that warrants this effort to harness. Our commitment to true user ownership is what is why Variant was founded, and what we remain steadfast in researching, funding, and promoting.
Disclaimer: This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice or investment recommendations. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by Variant. While taken from sources believed to be reliable, Variant has not independently verified such information. Variant makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This post reflects the current opinions of the authors and is not made on behalf of Variant or its Clients and does not necessarily reflect the opinions of Variant, its General Partners, its affiliates, advisors or individuals associated with Variant. The opinions reflected herein are subject to change without being updated.
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Thanks for helping to keep us all honest, Li. The real question about web3 with recent events with FTX is whether it's more like what Pets.com did for web1 ... or more like what Chernobyl did for nuclear power.
Going back to first principles questions, we still have to ask how valuable is it really to rid ourselves of trust third-party intermediaries. For thousands of years, business has been the business of relationships. To believe we can escape that is disruptive but also ripe for hubris.
I still have some gnawing skepticism about purely transactional business relationships for the future of humanity. "Invest in what you know", but also "who you know", right? And as SBF showed, there's still a lot of trust required behind our faith in trustless networks.
Is the future of business on the Internet really making Amazon.com more like Tor and the dark web? 14 years after Satoshi's white paper, and I don't feel enough time has been spent addressing this question.
Yes, better models of ownership on the Internet are definitely missing. But is that a universal paradigm change? Is that a business model for a handful of orgs? Or that just a feature for a limited subset of the Internet ... as P2P services such as Napster were?
web3 is getting an overly bad rap now. The human impulses to scheme and profit from regulatory failures is innate, regardless of the arena. So it's a good time to be reflective, look inward, and remind ourselves of ther value we're building and expecting to come from all the damage around us.
Why do you suppose that a16z's Future publication failed? It's because you can't lie your way into creating a product that people actually need. As a Venture capitalist it's your job to support projects that meet real world needs not sell projects that aren't going to be useful or belong to tokens that are temporary.