Why Web3 Is Here To Stay: A Reflection on Community

Note: This post was written and edited before the FTX bankruptcy unfolded the week of November 7th, 2022. The FTX implosion has been well-covered here, here, and here, though not referenced in this article.

Pretext

Writing this post became a necessity for me.

A few weekends ago, I took a long-needed pause and asked myself: What utility does this Web3 stuff give to the world? Little did I know that this question would lead me to second-guess myself and doom-scroll Twitter and Reddit, which only perpetuated my fears. I left a defined path to “success” in traditional finance to build up an ecosystem and internet paradigm that I may not believe in. Whoops.

To help me find solace in not knowing my motivations, I tried to revisit the first principles behind Web3 that led me to care so deeply. It’s only fair if I reflect on the good and bad behind this last bull cycle, before laying out my justification for why Web3 still matters and, as an investor, what I view as preconditions for Web3 builders to achieve mass adoption.

Current State of The World

This last Web3 bull market was insanity. As an investor, you’d be in one meeting, told the terms by minute three, then apprised that the round would close by the end of the day. This thing called diligence, which most VC firms engage in before investing, suddenly stopped being a prerequisite for deploying other people’s money into startups. The FOMO was real and doing the actual work of a VC was no longer in vogue.

It was a speculation hype house. There was too much money. Too much media attention. Too much temptation for software engineers to raise millions the week after writing what could loosely pass as a whitepaper.

What was the outcome of all the innovation new entrants brought to the industry, with the fresh funding they were armed with?

The most incredible flywheel: these startups optimized for extracting even more from the speculation and hype. In my newfound pessimism, I am unsure if anything was actually built besides better game-theoretic approaches to “make token go up.”

But not all projects are like this, as any informed reader would object. And you’d be right. Some value was built, most likely on the infrastructure side of things (e.g., zero-knowledge roll-ups, optimistic roll-ups, etc.). But after the dust has settled and the house of cards is no more, can we, with a straight face, justify the ~$30 billion VCs poured into ~1,300 Web3 startups over the course of 365 days — less knowing that VCs don’t work weekends or the months of July, August, or December — in 2021?

In my reflection, I had some fun, pessimistic thoughts on the industry:

• DeFi is a collection of repackaged, tech-driven Ponzi scheme

• The innovations of Web3 are limited to a self-serving echo chamber

• If it doesn’t make sense, how can it be useful?

It would only be fair if I explained why or how I came to these conclusions, so let’s ride.

Deep Dive on Defi Tokenomics: A Scheme of Ponzis

I will be leaning heavily on Matt Levine’s The Crypto Story, first, because it is an exceptionally well-written approach to Web3 first principles and second because it is a three-hour behemoth that I imagine few took the time to read (prove me wrong, people!).

By the end of this section, I hope you walk away with three conclusions:

• Web3 is a self-reinforcing, positive-feedback machine

• Owning digital tokens in DeFi is just yield-optimizing from one black box into another

• Web3 traders are looking more and more like the Wall St. Traders of the GFC

To start, let’s level set.

The components that make up DeFi are two-fold. Tokens and smart contracts. A token is just a virtual currency unit created by a smart contract. Sometimes it represents some underlying asset or utility, and sometimes, not?

To make tokens useful, like exchanging one token for another (e.g., swapping AAVE tokens for 1INCH tokens), coders created and implemented smart contracts: programmable agreements that are formalized and executed by code between two or more unknown parties. The rules in the smart contract govern interactions using a set of conditional if-then statements. When the conditions are met, the smart contract will execute, propagating a state change to the blockchain. A state describes how a system remembers. In the case of a blockchain, it reflects the history preceding actions in a database.

With these two primitives in place, a clever group of people realized that you could combine the tokens and the smart contracts to make a primitive, permissionless financial services layer run on a distributed computer network. This is DeFi (Decentralized Finance).

DeFi has merits. One day, it can be the conduit by which people who don’t have access to a traditional bank account or basic banking services, like borrowing and lending, can step into 21st-century finance. We are some ways away from getting there, but it ends up being a great narrative for why people choose to leave high-paying tech salaries to support a cause that’s larger than themselves.

But that’s not how DeFi was used during this last bull cycle. Thanks to Matt Levine, we have an entertaining and simplistic rendition of how an outsider views this positive-feedback, black-box approach to digital alchemy.

So, to summarize. There are tokens. There are (not so) smart contracts. And there’s some VC funding. Putting those together, you have Decentralized Finance of 2020–2021.

The basic mechanism behind DeFi is that you start out with some tokens, say ETH, and put them in a smart contract, and out the other side is the yield from interest or accrued fees. Simple enough.

There are a few common ways to generate interest on your original token, and that is to earn liquidity-provider fees (which means you make it easier for others to exchange Token A for your Token B pooled with others who deposited both Token A and B) or lend out your token in exchange for interest. To earn yield, you generally have to “lock” your tokens into a smart contract, which DeFi protocols call “total value locked.” It’s the canonical metric for a DeFi protocol’s utility to the market.

But why are we talking about yield earned on an internet coin?

Because DeFi has a mechanism that allows you to double-spend (sort-of) these token derivatives (pundits will call it capital efficiency!). When you lock tokens up, whether as a liquidity provider, staker, or lender, you typically will get out a token that acts as a receipt of your locked tokens. So, you are earning yield on your original ETH, and now you have receipt_ETH. What do you do now? Well, as any DeFi trader would, you find protocols that accept the receipt_ETH to earn additional yield or borrow against because in computer-coin finance, a receipt of ETH is almost as valuable as actual ETH. Get it?

So now you have receipt_ETH. You now have options. You can sell the receipt (which also implies selling the underlying ETH), do nothing and earn the fees from receipt_ETH, or deposit that receipt_ETH into other DeFi protocols to earn even more yield. Then you’d get something like receipt_recepit_ETH or (receipt_ETH)².

I think you are starting to see where I am going: 2020–2021 DeFi wasn’t really about permissionless finance or bringing the rest of the world banking infrastructure. It’s more about how many times tokens can be turned into receipts which in turn can be reused to get more tokens, receipts, and yield. You can see why crypto taxes can be such a headache 😊.

This is the peak evolution of phi-nance: reusing, locking up, and reusing again, all in the name of yield.

If this sounds like collateralized debt obligations cubed, I wouldn’t disagree. DeFi really might be a digital coin derivative factory. Hence, DeFi traders are just Wall St. traders: the former wear conference swag, whereas the latter wear a suit and tie (nothing against either).

Game Theory: “Innovation” Meets Community and Memes

We can’t talk about how crazy DeFi really is without mentioning OlympusDAO. I may be lazy using the same examples from A Crypto Story, but the internet seems to support all things remixed.

OlympusDAO is the best example of where an echo chamber of marginal improvements is considered innovative. By throwing a few memes and game theory in the mix, you can drive mass adoption, even if few people know what is going on. This combination is a formula for success if I’ve ever known one.

So, let’s break down OlympusDAO. First and foremost, the founding team is completely anonymous. This is typical in crypto, as the ability to hide behind wallet addresses and convey reputation through recorded on-chain actions can be enough to inspire confidence. So, we are off to a good start: an anonymous team. Check.

Second, we have the value proposition. The main selling point for OlympusDAO is its attempt to become a decentralized finance reserve currency — basically the internet coin Fed — without being tied to a greenback. Instead, the reserve currency would be OHM, which acts as the protocol’s digital currency. Whereas most protocols “rent” their liquidity from users through incentives like interest, OlympusDAO would own its reserve of cryptocurrency assets, which would back the issuance and underlying value of OHM tokens.

With me? So, to own the underlying liquidity provided by users (OHMies as they’ve dubbed themselves), the protocol sells OHM at a discount in exchange for other crypto assets in a process called bonding. Now that the protocol owns its liquidity (the underlying crypto assets OlympusDAO exchanged OHM for), it can control the value of OHM in relation to the market value of the assets in reserve.

If the value of OHM were to rise and outpace the market value of the reserve assets, more OHM would be issued to dilute the price, like quantitative easing. Conversely, if the OHM value were to fall, the protocol would burn (destroy) OHM from the supply to boost its value, like quantitative tightening. What is interesting and confusing is that the OHM token is supposed to be a stablecoin of sorts. However, the value of OHM floats and is set by the market, so it’s not entirely stable. Stability enters the fray if the treasury’s reserve assets were to be liquidated, at which point each OHM would then be worth $1.

We just walked through the mechanisms behind OHM (the Fed of Web3), but that’s not even the coolest part of the protocol. And it barely relates to what we are discussing in this article. We are discussing how Defi is a Ponzi scheme hidden behind words like innovation and disruption.

So, the conclusion on the value proposition is that this barely makes sense, and all it did was repackage a known concept (Federal Banking) into an alternative that no one needed or benefited from. So why are we talking about it?

Because of memes. Game theoretic memes.

How is it that a protocol that can’t be explained in simple terms or used by normal people who don’t run protocols rake up $3 billion worth of protocol-owned liquidity in months?

They offered yields of 7,000%.

No, it is not a typo.

They “owned” their liquidity, which meant they were free to mint (print) these tokens, ad infinitum. But the 7,000% APY wasn’t the most enticing part. And this is where we get to the meat of this article: It wasn’t about the yield — it was about memes.

You see, getting insane yield on your internet coins is good fun, but what if you could pour lighter fluid on the fun, where it’s so fun that no one pokes their head under the hood to see what is going on? OlympusDAO accomplished just that. They applied game theory and speculative recklessness to drive reserve assets and evangelists to their protocol.

How? By championing the (3,3) meme.

If you are familiar with game theory, you know there is a payoff matrix based on the actions of another agent in relation to your own. OlympusDAO convinced OHMies that if they all locked their tokens and no one sold, the payoff would be the most optimal (3,3). Conversely, if people sold, the payoff would become (-3,-3) or (bad, bad).

The outcome was incredible. People, first and foremost, didn’t understand what the protocol did. Secondly, people only cared for the potential to earn 7,000% APY on an internet coin. Thirdly, people believed that if they bought in and never sold, they directly benefited themselves and the OHMies (3,3).

To conclude this rant, OlympusDAO was pretty much a Ponzi scheme that masqueraded itself as a community, creating the single most compelling approach to marketing in Web3.

But it’s not replicable.

It’s largely just repackaged greed and a lack of willingness to read and think critically (I bought OHM @ $950, so I’m mostly talking about myself). You can see the results of my good judgment in the price graph below.

But I am not writing this essay to discuss the “what” behind OlympusDAO. I am writing this essay to talk about the “why” — the reason Web3 still matters:

Crypto only exists and will continue to exist insofar as it continues to make people feel more human. The most exciting breakthrough of Web3 won’t be because of tokens or the blockchain but because it expands on the concept of what it means to be human.

People will shy away from Wall St. because the financial industry at large makes little, if any, attempt at making investors feel like they are a part of a community. Even if Web3 is riddled with scams, hacks, and ponzis, there’s at least an element of doing it as a tribe. It’s something outsiders aren’t supposed to understand.

To prudent investors, if the writing is on the wall for the outcome of a project (e.g., quite literally, how to convince people to stay loyal and incentivized to a ponzi scheme), it still doesn’t matter. The feeling of the community and contribution just hit differently.

Because of tokens and memes, the lines have blurred as owner, contributor, and user are combined into a hodgepodge of people unified behind some mission: whether to make money, move the internet into the next paradigm, or just vibe.

It doesn’t need to make sense because it’s not for the rest of us — it’s for them.

To close out thoughts on OlympusDAO, I hope there are a few points you walk away with. The first is that things in Web3 don’t have to make sense or be useful to anyone, so long as people find social coordination and memes as a conduit to believing in something. The second is that you’d be hard pressed not to see the same elements (e.g., ponzi scheme + game theory) in some of the other, popular DeFi protocols that emerged over the last twenty-four months. For builders looking to create something enduring in Web3, there’s a clear message to extract from all of this, covered in the next two sections.

Deep Dive on Community

I second-guessed my role in Web3, only to recognize that I was missing a huge point about the whole experience: it’s about community.

At the heart of it all, people are looking for a tribe. People crave a form of belonging and validation. For many new entrants, this means an opportunity to scratch the itch around what went wrong with Web 2.0. Web 1.0 started openly and required social coordination and experimentation to make it usable. Today, we take the search bar for granted. And now, how we experience the internet is defined by only five companies.

The ability to affect change and the opportunity to do it with a value-aligned tribe may be one of the few ways Web3 technologists feel like they can think and act for themselves. The thing about thinking and acting for yourself is that it takes a prudent individual to rely on the wisdom of those who have come before and to learn from those whom they walk alongside. Crypto is nascent, and given that the former isn’t possible, the durability behind this space becomes the latter: the community.

This is the secret ingredient behind why Web3 matters. Looking at this as a progressive movement rather than a technological innovation (though it is) provides a framework for self-actualization. Web3 provides a playground by which one person can be around others who are better than you in some way (typically at coding), inspire you, and spur action toward a greater goal. If these tenets make up the formula for a fulfilling life, it’s a good formula for mullah (mullah being love, contribution, and belonging, rather than money, but that too).

Builders and Community

At the end of this thought exercise, I returned to some of the things I said in the introduction. Was anything tangible with clear, real-world utility built during the bull cycle? Maybe? I don’t think that matters as much as what was built intangibly: a community.

Web3 matters because of the community. What are the implications for builders? You need to know the audiences in this space and decide which you want to build for.

Most people who play in the space are here for a few reasons (listed from the largest group to smallest):

• They made money early and what to make more. Clear loyalty.

• They made money recently and want to make more money. More loyalty.

• They didn’t make money, but they want to make some. More of a mercenary-type of loyalty so it is fleeting (I wouldn’t be surprised if this group is also dabbling in AI, since that’s more exciting at the moment).

• At the heart of all of this, and naturally the smallest group by a large magnitude, are people who actually like the product.

The last group is the only one builders should care about because it takes courage to be a Web3 user. Hacks, scams, and exploits are the norm in Web3. The new frontier of the internet requires skin in the game from those willing to experiment with an unproven technology that appears to have no practical applications (at least, initially). I view the willingness to play in the space as courage.

Courage is when you sacrifice your own well-being for the survival of a tribe. That’s how I describe Web3 users because to be one, you must be willing to endure some suck.

Take, for example, Axie Infinity. Much of 2021’s media craze for Axie was predicated on the phenomenon that users in emerging markets could finally earn more than in traditional jobs by playing a game. Yet, we fail to admire the courage these users had to demonstrate to merely sign up and play:

• An interested person can’t just use their credit card (assuming you have one!) and start playing a game; there are some extra steps involved:

• Complete some KYC requirements on a centralized exchange

• Buy some digital tokens on a centralized exchange (risky)

• Send those digital tokens to a bridge (risky 2)

• Connect those bridged tokens to a game’s proprietary wallet

• Trade that token (risky) for a different token from the game itself to buy digital asset characters for the game

• At some point, they are supposed to remember that they started this whole process to play a game

Writing that whole thing was agonizing. I can only imagine the drop-off rate for new customers who just wanted to experiment with playing a Web3 game for the first time. That takes courage. This whole process isn’t ideal, and it’s probably a component as to why Web3 currently doesn’t fit the bill for onboarding the next 1 billion users. It’s too cumbersome, too unproven, and too effortful.

The message for builders is to return your focus to building for this small, courageous group. Make the product and its experience matter. Reward the courageous for taking the leap.

If you build in DeFi, you also probably recognize that there are only 5,000 DeFi power users. Build for them and no one else. And build on their experience. They deserve a reward for their courage in leveraging unproven tools (your tools) when no one else would.

In other words, return to design thinking principles to achieve product-market fit (PMF). Get to PMF for the 10 people who still use Web3 today because they love being at the forefront of the cutting edge. You aren’t building for the 50k randoms in your Discord who clamor for “make token go up.” You are building for the random dev you connected with at a crypto meet-up, whose eyes light up when you paint a picture for the future you are building.

I’m not a builder, so maybe recommending this call to action doesn’t have much weight. But I am an institutional investor, and I’ve seen what works: there’s a recognizable pattern when you have this much visibility. Building for one person, just like writing, is what creates an enduring, memorable impact.

One caveat. Product market fit in an open-source economy supports producing and shipping a half-baked product. Heck, that’s what Ethereum was in 2015, and still, now, there’s a backlog of product developments that are years ahead from being tested and brought to market.

So, in that case, in the role of builder, it may not be your responsibility to create a delightful experience for the average user. Still, if you build for the courageous, the product and ethos behind it must be compelling enough that people — contributors, developers, and users — care so deeply that they choose to finish the second leg: making the product a delight.

If the so-what behind Web3 is a return to building delightful experiences and altering the internet paradigm with a collective, community-driven set of believers alongside you, then that is worth paying attention to.

Thank you to Eric Chen, Samuel Wheeler, and Zoe Enright for their contributions to this post.

References:

1. https://www.bloomberg.com/features/2022-the-crypto-story/