Many are claiming that the new era of the internet – web3 – will be the end of dominant Big Tech platforms like Google, Facebook and Apple. But this murky world of cryptocurrencies, blockchain technology and non-fungible tokens brings new risks – and policy-makers are right to be wary.
Associated with libertarian politics, arcane terminology and cartoon monkey avatars, the idea of ‘web3’ can be hard for outsiders to fathom. But beyond the obscurity and hype lie both opportunities and risks for the UK economy. So, what is web3? It very much depends on whom you ask.
For its advocates, web3 marks an important shift towards the next iteration of the internet. Its predecessor, Web 2.0 – the era of large, powerful social media platforms (such as Facebook) – is said to be characterised by asymmetries and injustices.
Dominated by a small number of Big Tech companies whose founders and investors have amassed unprecedented amounts of wealth and power, Web 2.0 has had consequences that are widely seen as damaging to society and democratic institutions.
This financial success seems to have been built off the backs of Web 2.0’s users. Professional creators of music, imagery and video receive only a small fraction of the revenues that their content generates for platforms like Spotify and YouTube.
Developers of apps have no option but to pay 15-30% of their revenue to the App Store (Apple) and Play Store (Google/Android) in return for distribution. At the same time, ordinary users supply the posts, engagement and behavioural data that are integral to the advertising-based business models of Instagram, Twitter and TikTok. Despite their role as ‘prosumers’ (producing as well as consuming), they receive no financial compensation.
By contrast, web3 is said to offer a more egalitarian, peer-to-peer vision of the web, giving all users 'skin in the game'. By using blockchain technology to decentralise the web’s technical, legal and payments infrastructure, web3 supposedly promises to sweep away today’s Big Tech companies, which are seen as abusing their market position as gatekeepers to extract economic rents.
In their place will be new protocols and platforms, constituted as distributed autonomous organisations (DAOs). According to web3 advocates, DAOs will be governed by their communities, transparent in their operations and immune from capture by narrow financial interests thanks to smart contracts (self-enforcing contracts programmed in computer code).
Transactions will take place in cryptocurrencies, with non-fungible tokens (NFTs) allowing intellectual property rights to be asserted over digital files, with benefits for creators and markets.
In time, these technologies will supposedly form the basis for a thriving economy in the metaverse – the putative 3D online world in which people will be able to work, socialise and play games in virtual reality. For now, the majority of web3 companies are focused on building the underlying ‘rails’, such as payments (for example, Ripple), technical infrastructure (for example, Aligned) and fraud detection (for example, Chainalysis).
Critics of web3 bring a very different perspective. Cryptocurrency sceptics – so-called ‘NoCoiners’ – see web3 as a cynical rebranding exercise. In their view, blockchain is a defunct technology and cryptocurrencies are scams that combine elements of Ponzi, pyramid and multi-level marketing schemes.
In such schemes, a constant supply of new marks is required to provide earlier investors with liquidity – and the inevitable conclusion is collapse. These critics say that web3 should therefore be understood as a story invented to make cryptocurrency investment appear more attractive to digital creators and those who otherwise dislike Big Tech.
Some within the crypto movement also have deep reservations about web3 – including former Twitter chief executive officer, Jack Dorsey. Here, the objection relates to the influence of venture capital investors. With more funds at their disposal than there are good investment opportunities, investors like Andreesen Horowitz – a venture capital firm based in Silicon Valley – have been highly active in developing the web3 market, through public relations and government outreach (as well as large investments in web3 companies like the NFT marketplace OpenSea).
Outsized returns for the same group of investors who have profited from the dominance of today’s Big Tech companies are clearly at odds with the libertarian project of radical decentralisation, to which Jack Dorsey and many other crypto enthusiasts subscribe.
What are some possible implications for the UK economy?
The criticisms levelled by web3’s detractors seem to be good reasons to reserve judgement on the overall vision for web3. It is also useful to break it down into its component parts, specifically cryptocurrency adoption, tokenisation and virtual economic growth.
‘Cryptocurrency’ is something of a misnomer. There are very few things that Bitcoin, Ether or DogeCoin can actually be spent on – illegal drugs and NFTs notwithstanding. While cryptocurrency exchanges report billions of dollars’ worth of trading, this is overwhelmingly financial speculation and barely touches the real economy. In fact, it is possible that such speculation is channelling capital away from more productive forms of investment.
Cryptocurrency prices are also extremely volatile. According to the Financial Conduct Authority (FCA), 2.3 million UK consumershave already invested in crypto assets, meaning that a market crash might lead to large losses for retail investors. This would inevitably bring adverse consequences for consumer confidence and spending.
The same goes for fraud, which appears to be endemic to the crypto space. Meanwhile, the anonymity afforded by cryptocurrency significantly increases cybercriminals’ economic incentives to mount ransomware attacks. Affecting three-quarters of UK businesses in 2021, these involve hackers encrypting an organisation’s data and demanding a Bitcoin ransom to decrypt it.
But UK regulators seem to be more concerned about the risk of financial instability. Most cryptocurrency is held by institutional investors, including hedge funds with leveraged positions. A collapse in crypto asset prices could force investors to sell off other assets to cover losses, reducing liquidity in the financial system and affecting investor sentiment. This could then have potential knock-on consequences for the real economy.
As such, cryptocurrency markets can be compared to markets for derivatives such as futures and options: they represent a growth opportunity for the financial sector, but a systemic risk to the wider economy.
But were the Bank of England to launch a central bank digital currency (CBDC), other opportunities might open up. For example, in a future downturn, the government might want to use monetary policy to stimulate economic activity. If it were to issue stimulus payments to individuals and businesses in a CBDC, it could programme in rapid devaluation, creating a strong incentive to spend rather than save, and hence increasing the effectiveness of the policy.
Rather than issuing shares, web3 organisations issue tokens. These can offer rights of access to the organisation’s products, voting rights on aspects of the organisation’s decision-making, rights over digital property or a combination of all three.
As tokens are financial assets, they can be traded speculatively in secondary markets. Much commentary has focused on cases where tokens have been instrumentalised in ‘pump-and-dump’ schemes – a form of scam where token-holders hype an asset to drive its price up sharply (pumping), before selling off their holdings (dumping) and precipitating a crash.
Concerns have also been raised about the tokenisation of loyalty programmes and merchandise by UK football clubs, since it exposes fans to volatile crypto asset markets without obvious benefits over more conventional structures.
But from a purely economic perspective, tokenisation may prove to be an important innovation, in that it provides a new way for organisations to raise capital. The existence of the secondary market means that seed investors in web3 start-ups benefit from much greater liquidity than would be available if they bought equity.
This can reasonably be expected to increase the pool of capital accessible to early stage tech businesses, with favourable consequences for the development of the tech sector. Given the UK’s strength in financial technology (fintech), decentralised finance (or DeFi) seems like a particular opportunity.
Similarly, tokenisation could provide small and medium-sized businesses, which are ordinarily subject to banks’ fluctuating appetite for risk, with an alternative source of growth capital. Meanwhile, other types of organisation that typically have limited access to capital markets – including social ventures and community projects – may see issuing tokens as a scalable alternative to grant applications or crowdfunding.
Tokenisation is perhaps most advanced in the creative sector. Before the advent of NFTs, there were few incentives for producing monetisable digital artwork, as files could easily be pirated. By providing more or less immutable records of ownership for digital files, NFTs provide incentives and make it technically possible for artists to receive automatic royalties on re-sales of their work.
Combined with the ability to sell directly to the public without intermediation by commercial galleries, NFTs seem to be making it easier for creators to develop real businesses (although it is not yet clear whether current levels of demand are sustainable).
In general, if one subscribes to the view that greater supply of capital leads to productive investment, job creation and growth, the potential of tokenisation should be taken seriously.
Figure 1: UK consumer interest in cryptocurrencies and NFTs during the pandemic period, as measured by internet searches
Source: Google Trends
Virtual economic growth
The idea of a metaverse economy might seem particularly far-fetched, but a substantial virtual economy already exists. Sales of virtual goods inside ‘massively multiplayer online games’ (or MMOs) are estimated – admittedly by gaming industry market intelligence firms – to have amounted to $40-93 billion globally in 2019, and to be growing at a rate of around 15%.
Many games have native currencies that can be exchanged for skins (virtual goods such as clothes or armour, which alter a player’s in-game appearance). In the video game Elite Dangerous, for example, a currency called ARX can be bought or earned through game-playing and then used to purchase livery for the player’s spacecraft.
Advocates of web3 argue that the development of the wider virtual economy is held back by the absence of property rights. Currently, a dashboard ornament purchased in Elite Dangerous cannot be taken into World of Warcraft: it remains the property of the game’s developer, Frontier Developments, which could, if they wished, confiscate it from a player who had paid for it.
Replacing native currencies with cryptocurrency and minting skins as NFTs, on the other hand, would provide stronger incentives for third-party developers to create new ranges of virtual goods, and for players to increase their spending on them. This seems at least plausible and much more like real economic activity than cryptocurrency speculation (though it should be noted that many in the gaming community are unconvinced that it would be technically feasible or additive to the game-playing experience).
What is more certain is the contribution of the UK video gaming industry to the economy: around £1.8 billion towards GDP and around 40,000 jobs in 2018. Larger than any of its European counterparts, it is well-placed to benefit if web3 technologies do indeed drive gaming innovations.
Predicting the economic impact of emerging technologies is notoriously difficult. The biggest benefits from technological change often come from positive spillovers and the biggest risks from unforeseen externalities. Which of the stories about web3 sketched out in this piece will come true is anybody’s guess.
But increasing amounts of Silicon Valley’s abundance of capital and software engineering talent are being poured into web3 projects. And as the Web 2.0 era has shown, these decisions about where to focus energy will have repercussions for the economy and beyond.
Where can I find out more?
- Policy Brief: Crypto, web3, and the metaverse: A simple explanation of cryptocurrencies, blockchain, NFTs and the metaverse, together with discussion of web3’s policy implications, by the Bennett Institute for Public Policy.
- web3 policy handbook: US venture capital investors Andreesen Horowitz make a bullish case for web3 and suggest actions that governments should take to encourage its development.
- Line Goes Up – The Problem With NFTs: an entertaining if somewhat polemical video essay that aims to debunk claims that web3 technologies can form the basis of a more equitable internet.
- The Crypto Syllabus: comprehensive reading lists for studying web3 from social, economic and technological perspectives, with short introductory overviews.