The pace of the pivots can feel almost frenetic. One Ottawa-based entrepreneur, worried the world was passing him by, surprised his employees on a company Zoom call by saying he was pivoting the entire company into Web3. “I said, ‘Guys, this is the future and this is where everything is going,’” he said. “‘If we miss this boat, I don't think we can ever get back on.’” (The company, which had been a print-on-demand platform, now helps creators build 3D NFTs to sell to fans in the metaverse.)“A lot of people are trying to get in on it, and a lot of people are more afraid of not getting in.”
The Web3 hysteria has continued this year even as the tech industry more broadly has struggled with rising interest rates and plummeting share prices. “In the last six months, it's gotten fairly ridiculous,” said one partner at a crypto-focused investment firm. In the first three months of the year, the top 15 venture firms poured more money into Web3 and DeFi early- and seed-stage deals than any other area, the third straight quarter they have done so, according to the research firm Pitchbook. In total, the early- and seed-stage Web3 world nabbed $2 billion from top firms last quarter, more than double what the next-highest sector, biotechnology, received, and triple what traditional fintech got. Those figures understate the total level of interest—and money—in the space. Blockchain companies have raised at least $9.5 billion after receiving $18 billion in funding in 2021, according to numbers the research firm CrunchBase provided to Motherboard. And more firepower is on the way. In late May, amid plunging crypto prices, one of Web3’s biggest institutional backers, the venture firm Andreessen Horowitz, announced it had raised a monstrous $4.5 billion crypto fund following a series of high-profile investments into Web3 projects like play-to-earn game Axie Infinity and the parent company of the Bored Ape Yacht Club.Have you worked or invested in Web3? We want to hear from you. From a non-work device, contact our reporter at maxwell.strachan@vice.com or via Signal at 310-614-3752 for extra security.
To some, like Andreessen Horowitz, what ties these innovations together is that they collectively offer a theoretical vision where people have “the ability to own a piece of the internet”—for example, through the use of NFTs, which are essentially tradable proof-of-ownership receipts. In such a world, people could use and even monetize their NFTs on multiple platforms, rather than just on, say, Instagram. Such a system, boosters believe—or, at least, claim to believe—will lead to a fairer, more communal version of the web, one that will wrest control back from technological giants that have profited off people’s data and creativity, creating a world where community comes before all else. Much of the ideological rhetoric hence involves talk of using Web3 “to truly empower financial inclusion” (again, Andreessen Horowitz’s words) by bringing people into the fold who have been marginalized by the traditional financial structure. Such arguments are inarguably alluring. Very few people feel the financial and internet structures that underpin society could not be vastly improved. But they also belie the fact that professional investors do not push their money into the middle of the craps table solely in order to better the world. As Hilary J. Allen, a law professor at American University, succinctly put it: “The reason why venture capitalists are pushing all of this is to make money.”“It’s like a collective Theranos. A wildly unproven product with nobody at the helm,” one venture capitalist said.
Inarguably, the hype cycle is back in full force. Kyle Samani, a managing partner at a crypto-focused investment firm, told me that although most of his limited partners don’t always fully understand the technologies behind Web3, they want exposure to “all of it.” A research report out of Citi estimated that one component of Web3, “the metaverse,” alone could have a total addressable market of $13 trillion within eight years and as many as 5 billion users. (For comparison, the entire California housing stock is currently worth $9.2 trillion; Citi is essentially claiming to believe that the metaverse will, or could, be bigger than all but three or four entire U.S. industries by the time current middle-schoolers graduate college.)“Web3 proponents are trying to solve real problems that need solving. I just don't think that Web3 is the solution.”
“I haven't walked into a single pitch with a Web3 company where the words ‘cost of customer acquisition’ or ‘payback period’ has been uttered. It's so new that people aren't worried about unit economics,” Tunguz said. (Raghavendra Rau, a Cambridge finance professor who helped discover the “dotcom” effect, agreed the Web3 industry’s underlying fundamentals were “tough to decipher,” as did others.)Tunguz knows that lack of focus on economic fundamentals will sound “crazy” to some people, and he does believe that a “significantly higher” percentage of Web3 ventures will fail than the typical crop of startups found in a venture fund’s portfolio. But he also sees Web3’s unclear valuation metrics as a financial opportunity compared to the world of Web 2.0, which has become so well understood that it has proven harder for investors to gain an edge.“Nobody has any idea how to value these businesses … It's so new that people aren't worried about unit economics,” one venture capitalist said.
Tunguz has himself referred to token-based reward systems as “paying customers in ‘equity,’” writing that as “the network becomes more valuable, so does the user’s stake in the company.” Doing so provides a reason for initial users to be invested in the company’s success, sometimes even before the company knows what product it’s going to make. This is why venture capitalists have taken to saying things like “Web2 companies start with product. Web3 companies start with community.” The tokens bring the people. Inspired by Axie Infinity, for example, Alex Kehr adopted a token-based approach with his startup, Superlocal, a version of Foursquare for the 2020s where people earn “crypto when you go places.” The token, he said, would give people “something to do in our app when nobody's there yet.” (He considers play-to-earn tokens, in particular, less likely to be deemed securities in the future.)“You can think of the mechanisms by which these tokens capture value to be comparable to the equity of a startup,” said a partner at a crypto-focused investment firm.
“They've failed to find incentives in their Web2 companies. So building something in Web3, it's almost like a cop-out for some people. They're like, ‘Oh, we're just gonna ping a token on top of it.’”
Entrepreneurs and venture capitalists alike described companies that bolt on a Web3 element in order to raise a few more bucks as “grifters.” Venture capitalists say such companies are easy to spot. Even if that’s true for the most part, a founder told me he’s noticed bolting on a Web3 element adds investor interest, whatever its relevance. “Tack on Web3,” the founder said, “and investors will throw money blindly and inflate valuations 2-3x.”Gerard, the Norby CEO, dealt with real periods of “self-doubt” as he decided whether to pivot into Web3. Sometimes, he worried he was being stupid. But ultimately, he decided, if his customers weren’t clamoring for it, he didn’t see a reason to pivot.“If that's something that we start to hear from our customers, then it's absolutely something that we are going to take a look at and figure out what version of it makes sense for us,” he told me. But for now, he added, “We can't force people to want something that they don't want.”The question for now is how long the regulatory-arbitrage party will last. The regulators are encircling what many see as illegal financial activity. Repeatedly in recent months, SEC chairman Gary Gensler has reiterated that he believes many crypto tokens should be regulated as securities. “Let’s not risk undermining 90 years of securities laws and create some regulatory arbitrage or loopholes,” he said at the University of Pennsylvania’s April law conference.The rise of tokenization in particular has frustrated Web3 critics. Meta’s Obasanjo has said it’s a “mind-blowing” and “tremendous hack” that “it’s legal to effectively sell stock without regulation if you say it grants voting rights but not ownership.” Martha Bennett, a vice president at Forrester Research who studies blockchain technology and digital assets, described them as an “abuse of the system.” The English crypto critic Stephen Diehl has contended that the “crypto-token-as-equity-proxy scheme” put the financial rules of the 1920s back in play by allowing people to “insider trade, wash trade, and pump and dump” with impunity.“Tack on Web3, and investors will throw money blindly and inflate valuations 2-3x.”
Hilary J. Allen, the law professor who studies financial regulation, has spent much of her time recently studying the similarities between financial products that make up Web3 and the collection of instruments that led to the Great Recession. In tokens, Allen sees an innovation that is at its core comparable to the credit default swap. The two are different—credit default swaps allow numerous people to make a bet on a bond’s future performance—but at the end of the day, both help greatly increase potential leverage in the financial system, she said.“Leverage is great in good times, because it allows you to multiply your profits. But it means that the system is very much more fragile, because even small amounts of losses on your investments will wipe you out,” she said. “What we have with tokens is another way of creating leverage. But now, it's not about lots of contracts referencing the bonds; now, it's the asset itself that is synthetic—there's no limit on the number of tokens that we can create.”Allen doesn’t mince words when she discusses her worst-case future scenario: “major systemic implosion.” Treasury Secretary Janet Yellen has said the crypto industry is not yet at the scale to pose “financial stability concerns," and President Joe Biden has expressed support for “responsible” crypto innovation, but the rhetoric of financial democratization nevertheless reminds Allen of before the subprime housing bubble burst, when a collection of complex financial innovations like mortgage-backed securities and collateralized debt obligations were seen as avenues through which new swaths of people could have access to wealth. And now, Allen and others hope the Web3 system will be placed under regulatory control before history repeats itself. Tunguz, the pro-Web3 venture capitalist, is ready for such a day, but reaping the rewards until then.“There will be a Securities Act of 2033, whatever the year is,” said Tunguz. “Whenever the regulation comes out, we will respond to it. But I think there's definitely an opportunity here to make money in a way that benefits everybody within the ecosystem.”“What we have with tokens is another way of creating leverage. Now, it's the asset itself that is synthetic,” said a law professor comparing crypto tokens to credit default swaps.