For true believers and promoters of Web3, blockchain is about far more than cryptocurrency trading. In their eyes, blockchain technology is the veritable embodiment of the next evolution of the internet. Crypto’s many scandals, the unfulfilled hype, the incidents of fraud and regulatory evasion are seen as merely unfortunate collateral damage on the way to a more innovative and inclusive future.
The venture capitalist and Web3 advocate Chris Dixon captured this narrative neatly in his book, “Read Write Own,” by distinguishing two visions for blockchain and digital assets — the “casino” and the “computer.” For Dixon, the casino represents those focused on speculative, short-term financial gains. The computer, by contrast, is “the far more serious of the two, and it is motivated by a long-term vision. This group’s practitioners understand that the financial aspects of blockchains are only a means to an end, a way to align incentives toward a larger goal [which is] a better internet.”
What if, however, there was no way to divorce the two?
After all, today’s casinos use computers. Physical gaming halls are mostly rows of screens on network-connected slot machines, and the gaming industry is a leader in exploiting digital technologies to track and addict users. A growing percentage of the industry is entirely computerized in the form of online sports betting and casinos.
In the case of Web3, the connection between the casino and the computer is even tighter. The “alignment of incentives” that is supposed to undergird Web3 through tokens is a direct link between speculation and adoption. “Tokenomics,” the economic structures of digital assets, generally provide outsized returns to issuers and early acquirers. This creates pressure for speculative motivations to dominate. It also makes it likely incentives are not fully aligned: those lopsided returns mean token issuers and early investors have every reason to design arrangements in order to stack the deck in their own favor.
Waiting for the killer app
To some degree, that is an inherent economic dynamic where thin markets are created from scratch with limited information, ahead of the eventual usage that will — or at least might — justify prices. Just look at how early “whales” still hold dominant positions in Bitcoin, despite its highly decentralized and algorithm-driven design.
The Web3 vision is not, as crypto skeptics insist, merely a sly rebranding of speculation and fraud as innovation and openness. With smart contracts, increasingly high-performing blockchains and mechanisms such as DAOs, developers have indeed created functional decentralized applications that can compete with established offerings. Examples include the Helium wireless network, the Farcaster framework for social media, decentralized storage such as Filecoin and Storj, distributed AI training services such as Bittensor and Render, “play to earn” and NFT-based games such as Axie Infinity, and of course, an array of DeFi protocols such as Uniswap and Aave. And there are signs of real adoption. By mid-2024, the Helium network had over 20,000 wireless hotspots, while both Farcaster and Axie Infinity pushed 200,000 monthly average users.
These numbers, however, cannot hold a candle to Web2 platforms that boast hundreds of millions of regular users. That chasm remains as wide as ever, even after roughly seven years of Web3 development. Unsurprisingly, the vast majority of money flowing through Web3 continues to go into DeFi, either explicitly for investment activity, or the more speculative corners of other sectors. With Helium, for example, actual paying usage of the wireless networks is dwarfed by access providers and token traders speculatively seeking financial returns. Axie Infinity has experienced a 99% crash in the price of its main token, accusations of exploiting players and behavior that suggests the vast majority of users play for money rather than fun. User numbers for most Web3 applications closely follow crypto trading markets, with dramatic plunges during the crypto winter period of 2022-23, followed by a rebound as speculative investment returned.
‘The essential fact about Web3 as compared to Web2, therefore, is not decentralization but financialization.’
It could be that the killer apps for Web3 are out there and coming soon, or that continued maturation of blockchain platforms combined with the development of better user interfaces and wallets will allow Web3 to cross further over to the mainstream. But even if that happens, there is an intrinsic problem in separating the casino and computer uses. Because tokens are inherently tradeable on
exchanges (so long as regulators permit it), they always have market prices. The only way to tell someone who buys in for functional purposes — for example, acquiring DeFi governance tokens to influence protocol votes in order to enhance adoption — from one who buys merely to sell at a higher price is to look into their heart. Even those motivated by utility will always have the option to take speculative short-term returns when they look good enough.
Perception and reality
The essential fact about Web3 as compared to Web2, therefore, is not decentralization but financialization.
Framing Web3 as a story about building a new internet rather than a cash grab has other consequences. It leads to a downplaying of the massive losses from crypto hacks, fraud and scams, as well as run-of-the-mill trading losses in highly volatile markets, as mere sideshows to the main thrust of activity. People lost their life savings on over-inflated dotcom stocks and shady investment schemes during the initial building of the internet economy in the 1990s — you need to break a few eggs to make an omelette, after all. It might be that the shorter-term costs of the phase of blockchain market development are worth it for the massive benefits of a better next-generation internet. But we need to evaluate both those costs and benefits rationally. Not all speculative booms are worth the attendant harms and subsequent busts.
Furthermore, how Web3 is perceived has public policy consequences. Activities that are to a material extent about investment and prospective financial gains are the domain of financial regulation. The dividing lines between securities and other kinds of transactions — manifested in US law under the seminal Howey Test — have seen a bitter fight between crypto firms and regulators for years. While there is now a serious effort by policymakers and regulators to provide greater clarity in the US, and bespoke legal regimes for digital assets in other jurisdictions, the distinction still matters.
Financial regulation addresses the information asymmetries, criminal activities and systematic risks that inevitably emerge in financial markets. Every time there have been significant financial markets with insufficient regulation, the result has been both large-scale abuses and calamitous crashes. Regulation also has negative consequences, potentially limiting innovation and restricting freedoms. The particulars of regulatory regimes and enforcement efforts matter.
However, if there is no clear firewall dividing the broader regime of business from the territory of regulated finance, incentives for regulatory arbitrage will become overwhelming. If adding some blockchain elements to an activity makes it
Web3 — and no longer financial speculation — the protections against harms from financial activity will dissipate. This doesn’t mean all Web3 applications should automatically be classified as securities trading or banking activities subject to heavy regulatory burdens. But it does mean that we should not be so focused on the prospect of a better internet that we ignore the financialization in the meantime.
And while decentralized blockchains may diffuse power and wealth away from the dominant digital platforms of the Web2 era, the financial incentives of tokens could just as well have the opposite effect. One reason is that, as previously mentioned, those who design the tokenomics of protocols often keep a disproportionate share of tokens for themselves, or give themselves an artificial leg up on maintaining their control of a supposedly decentralized platform. With some platforms, early wealth inequality may simply persist, as with Bitcoin whales. The Web3 community pays ideological fealty to decentralization.
When push comes to shove and money is at stake, however, not everyone behaves altruistically, or is willing to trade their own short-term gains for larger benefits across the community in the uncertain long term.
Arms race
To quote the Bible, “the love of money is the root of all evil.” Incentive-compatible mechanism design, such as Bitcoin’s proof-of-work system, can in some cases harness selfishness for the common good. However, that alignment is very difficult to achieve, and there are significant side effects even when it is successful. Talking about the functional side of Web3 while dismissing the speculation as a preliminary means to an end is inherently misleading.
There may be a way out. But it comes with its own risks. The concept of Web3 emerged during the crypto boom of 2017-18, driven by Ethereum and other smart-contract blockchains. The realization that these platforms allowed for the creation of a virtually limitless number of tokens which could be issued and traded prior to substantial adoption or even creation of the associated application led to the first flurry of non-financial decentralized applications. The subsequent boom of 2020-21, driven initially by DeFi and then by NFTs, saw the emergence of the major categories of Web3 activity that are prominent today, including games, DePIN, social networks, collectibles, the metaverse and DAOs.
Despite the growth and development, all of these were fundamentally extensions of the financial dynamics of blockchain ecosystems going all the way back to Bitcoin. Tokens are volatile because they are not backed by any traditional assets or institutions. And the financial incentives are split between block producers expending significant resources to capture initial issuance of cryptocurrencies and traders speculating on their secondary markets. Once Bitcoin started to gain traction, the arms race between miners rapidly took that work out of the capabilities of ordinary users, leaving most people only the speculative activity centered on trading.
Stablecoins and staking
Two significant developments are now shifting the environment. The first is the rise of stablecoins. The most prominent stablecoins today, Tether and USDC, were created in 2017 and 2018, respectively, and both accumulated tens of billions of dollars of issuance with the DeFi and crypto trading boom prior to the 2022 crash. Yet it is only now, with other developments in payments infrastructure and regulation, that their true potential is coming into focus. A stablecoin uses backing from some other valuable assets, or algorithmic supply management, to keep its price pegged at a stable level, typically the value of one US dollar.
Though algorithmic stablecoins, most notably Terra Luna, have often de-pegged or collapsed, stablecoins backed by high-quality liquid assets such as US Treasury bills, real-world assets such as precious metals and over-collateralized digital assets (in the case of MakerDAO, recently renamed as Sky) have largely remained stable despite crypto market volatility. Today, stablecoins are mainly used for DeFi as the on-chain equivalent to the cash leg of transactions, and as the paired asset in many custodial crypto trading markets. However, their real potential is twofold: as a seamless bridge between the traditional and crypto financial worlds, and as a new set of financial rails that are more efficient and programmable than the complicated siloes of traditional global payments infrastructures. What holds back stablecoins are regulatory concerns, including uncertainty about how the US GENIUS Act and the European Union’s MiCA regulation will be implemented, as well as questions about how national regimes will interact globally. As these issues are resolved, traditional financial institutions such as banks and digital payments platforms will become major stablecoin issuers, and the surviving pure-play stablecoins will evolve into full-service financial institutions.
The second important development is the rise of staking. With the exception of Bitcoin, virtually all the major layer-one blockchains have moved away from computationally wasteful proof-of-work consensus, predominantly to proof-of stake systems. These mechanisms invite digital asset holders to “stake” some of their assets as a guarantee of accurate block validation in return for a flow of reward payments. A complex ecosystem of providers, such as Lido and Eigenlayer, have grown up around these staking mechanisms, controlling a substantial portion of assets in their smart contracts.
‘Stablecoins and staking transmute the financial incentives in the Web3 world from trolling for a massive pop to more predictable yield structures.’
Stablecoins and staking change the financial landscape in which Web3 operates. They shift some of the financial opportunities around crypto from purely trading to earning yield from staking or holding stablecoins. The biggest current stablecoins are not interest-bearing, but competitive pressures will undoubtedly push toward something more like the traditional banking market, where parking cash, especially in large amounts, entitles a return for the benefits provided to the bank. Stablecoins and staking also allow the functional benefits of digital assets — decentralized ownership, robust security, privacy, common transaction platforms and programmability through smart contracts — to be decoupled from the speculative opportunity to buy low in hopes of selling high. Stablecoins in particular could help spur Web3 adoption significantly by removing barriers to transiting between traditional finance and crypto.
Most importantly, stablecoins and staking transmute financial incentives in the Web3 world from trolling for a massive pop — if you get in early and sell before everyone else — to more predictable yield structures. This does not mean the various concerns about digital-asset markets, such as fraud, hacks and crime, will go away. But it provides a pathway to separate the pathologies of wildly speculative markets from the milder ones in conventional finance. The attractions of a new decentralized internet will remain, but less strongly anchored to the temptations of getting rich quick.
Shifting Web3 away from its current financialized state will take time — and it will have side effects. The rise of stablecoins and staking, along with developments in DeFi, are inevitably re-creating some aspects of the traditional financial system. Yet that was already happening. Web3 and crypto have created new wealth and promoted innovation, but they cannot change human nature. Finance has evolved in characteristic ways not only to serve the needs of its dominant power centers, but also as a series of next-best responses to unsolvable tensions. The problem of Web3 lies in assuming that we can have all the benefits of the status quo, and those of decentralization to boot, without costs that might overwhelm the benefits.
The brute reality of a casino is that, however much you hear the jangling of coins paying out big winners, the house always wins. Even if the casino is just a stop along the way to something better, its corrupting effects can’t be ignored. The more that the opportunities of Web3 can be disentangled from the casino of token speculation, the closer we’ll get to the better internet we would all like to see.
