The crypto juggernaut is gathering speed and at a breakneck pace. What was once the sole domain of crypto enthusiasts is now entering the mainstream with a vengeance.
It seems that nowadays everybody is talking about crypto and itching to get in on the action.
In particular, the focus and excitement is in the explosive areas of Web3 and DeFi.
In this article, we are going to look at some of the fundamentals and longer-term investment opportunities presented by the major technological shifts taking place in the world of web3 and Defi.
It’s 2009 and Bitcoin arrives on the scene
It all began in 2009 with the arrival of Bitcoin, a revolutionary decentralised digital currency without geographical barriers or any form of central government control.
The pioneering blockchain technology running under the covers planted the seeds for where we are today.
Bitcoin itself is still purely a means of holding and transferring value, much like a traditional fiat currency like the dollar or euro or a valuable commodity such as gold.
Bitcoin does not serve any other extended purpose. The arrival of Bitcoin however introduced a breakthrough technology, the blockchain which has opened up a multitude of possibilities that have the ability to disrupt virtually every industry and in particular finance.
Welcome to DeFi and Web3…
From its earliest beginnings, the crypto world has evolved at rapid speed and has in recent years spawned an entirely new industry known as decentralised finance or DeFi for short.
DeFi mainly runs on the second largest cryptocurrency network, Ethereum. Ethereum has gone from being a cryptocurrency like Bitcoin to becoming a broader ecosystem for DeFi projects mainly due to the availability of smart contracts.
Smart contracts are agreements or contracts written in software that are not open to interpretation, discussion or adjustment.
They execute exactly as per the instructions written into the smart contract and provide an ideal instrument on which to build sophisticated businesses in a trustless environment.
In DeFi a smart contract sits in the middle as the authority, as opposed to a centralised institution as is typical in traditional finance and most other businesses.
What is Web3?
Web1 was the original bare-bones internet, simple, informational websites mainly. You can get a taste of Web1 by looking at ancient search engines like Lycos, hotbot and webcrawler that are still lurking around on the internet.
Web2 was commerce-driven and spawned the internet giants we all know today, Google, Amazon, Expedia, Facebook and so on.
Web3 is the new kid in town and one that is creating quite a ruckus.
Web3 has the potential to truly shake up and revolutionise the world we live in, create entirely new industries and potentially level the playing field, especially in finance.
In essence, Web3 is the next major evolution of the internet, one that is decentralised and based on peer-to-peer technologies such as public blockchains.
Take an organisation like Amazon, which is a centralised profit-driven Web2 business, it provides a centralised platform and infrastructure on which things can be bought and sold on the internet.
In a Web3 world, there is no centralised Amazon, but rather a highly sophisticated blockchain technology using smart contracts that provide the software protocols and required levels of security needed to enable transactions without requiring a physical intermediary. Sorry, Jeff Bezos!
This Web3 model is extending into banking, trading, insurance and more. Just as there was an explosion in commerce-driven websites during the Web2 phase, we are seeing the same again with Web3 and this is presenting investors and novices alike with opportunities to get in early on the Web3 superstars of tomorrow.
Investing in protocols and the fat protocol thesis
Below every significant technology there are usually key protocols. There has been a fundamental shift in the way protocols are being monetised.
Our current web technology is dependent on protocols like TCP/IP and HTTP and billions of emails rely on POP/IMAP protocols to enable sending and receiving.
The crucial protocols that have enabled much of the technology we rely on today have been in effect given away for free by the developers who generously created them on an open-source basis.
They are free to use and exploit and exploited they have been without a shadow of a doubt and one can argue with good effect. Imagine if every email cost money! (more on that later..)
Thin protocols/fat applications vs fat protocols/thin applications
In Web2, there are what are known as thin protocols and fat applications where the vast majority of the value is in the applications built on top of the protocols, think Google, Amazon and Facebook running on top of the core internet protocols.
The value in Web2 is on the application side, not the protocol side.
In Web3 this has fundamentally changed and has been flipped around, the protocol is fat and where the bulk of the value is and the applications running on top are on the thin side.
Bitcoin’s creators cleverly invented a protocol and system that has an inherent value system and which rewards its participants at the core.
If we were to look at POP3/IMAP, commonly used to send and receive millions if not billions of emails every day there is no financial reward.
This on the one hand is great as emails remain free, but those that developed this essential protocol did not make a fortune from it.
As a crypto investor, investing in protocols should be considered in addition to investing in the individual applications that are running on top of the protocols, a fundamental difference when compared to Web2.
The name of the game is to be able to identify and invest in the protocols and applications of the future.
There is something called the fat protocol thesis which says that the total value of all the apps running on top of a protocol such as Ethereum will never exceed the total market value of Ethereum.
Thus according to this theory, Ethereum should continue to grow in value as the ecosystem it supports grows.
The fat protocol thesis seems to be holding and provides a reasonable rationale on which to invest in protocols/blockchains for the longer term.
Web3 is the gold rush of the 21st century
One can liken the current Web3 boom to that of the famous gold rush of the 1800s.
The pursuit then was gold and attracted hundreds of thousands of prospectors to California and South Africa.
In a similar way, DeFi has exploded onto the scene with almost limitless possibilities, unlike gold however which is limited in quantity, DeFi projects are virtually limitless in scope.
However, not all projects will succeed and could be as useless as a hole in the ground so the secret is to know which tokens to pick and invest in and that isn’t easy even for seasoned crypto investors.
Web3 money markets and how to earn a passive income from DeFi
Speculation is not the only way to profit in the crypto world.
Just as with traditional financial markets, it’s also possible to earn a modest passive income by putting crypto assets to work.
With interest rates still at a historical low there is a need for ways in which one can earn a reasonable passive income in DeFi from crypto assets by way of yield farming, staking, becoming a liquidity provider and through the lending of crypto.
In very simple terms one can use their crypto assets to earn income in the form of fees or interest rather than profit from the growth of the underlying Web3 asset.
In the simplest terms, imagine having the chance to invest in Amazon, Facebook and Google when they were first starting out. Sadly, that boat has already sailed, however, the next generation of Amazon, Facebook, and Google are on the sidelines, fueling up and ready to make an impact. Just as with the web2 era, only a handful will become major players, the challenge is figuring out who the future DeFi and Web3 giants might be and get in on the action early!