The Emergence of Web3 and the Metaverse
Decentralization has become both a rallying cry and a catalyst for all that Web3 promises. But beyond a buzzword for the media and a mantra for the true believers – what is Web3 and why does it matter? How will decentralized infrastructure and design principles be both an equalizer and a disruptor for the next generation of the internet? And how do digital assets and decentralized finance (DeFi) play a role in the emergence of the metaverse?
According to The Gartner Group, it’s projected that by 2026 about 25% of people will spend at least one hour per day in the metaverse. Further, they expect that 30% of organizations will have products and services ready for the metaverse. Web3 is foundational to enabling this new form of commerce and will be the engine driving the creation, storage, and exchange of value in the metaverse.
It’s sometimes difficult to distinguish between Web3 and the metaverse — they are not the same thing. They are not dependent, but they will be interdependent if the true vision of the metaverse is to be realized. The metaverse and Web3 meet in the middle at the intersection of online identity and digital assets, where users are not only participants in three-dimensional communities but owners in a shared digital experience.
Web3 is one part technology and one part approach to building an internet that empowers individuals and communities beyond the interests of centralized entities. Anchored largely in technologies like blockchain and IPFS (InterPlanetary File System), its foundation exists on the concept of decentralized infrastructure, design, storage, and access. This decentralized model seeks to manifest a digital experience that is more resilient, more inclusive and less prone to censorship, and prioritizes peer-to-peer connection over facilitation by intermediaries.
In Web3, value creation, storage, and exchange are not the exclusive realm of brands or platform providers. Users create and own digital assets, both creating and exchanging value in a decentralized storage model. Our identities are not validated exclusively by the platform on which we operate, but by tools such as digital wallets that allow us to validate ourselves.
The Centralization Conundrum
To fully understand this vision and why it’s become so compelling for the future, it helps to understand how we arrived at our current version of the internet. In the ’90s, we witnessed the emergence of the internet as one of the most important productivity tools of the modern age. Built first as a read-only resource, information was uploaded, catalogued, and accessed globally, similar to an online version of an encyclopedia.
But this model of the internet, which looking back we now label Web1, was a single direction resource and therefore limiting. Users consumed content created and served by providers, and the monetization methods were narrow. Advertisers flocked to this new medium to piggyback alongside content served up by emerging media giants. Search engines began to emerge as the central governing authority over content creation, aggregation, and discovery (the most notable use case for search engines) and the business model was advertising driven.
Slowly, the internet began evolving into its next iteration, Web2. It shifted from pure content and search providers to platform providers. “Free” services offering social connectivity, messaging, productivity applications, and other content creation tools became dominant on-ramps for digital access. Artificial-intelligence-powered platforms with integrated functionality and impressive, albeit 2D user experience also became hubs for e-commerce.
To benefit from the convenience offered by these “free” platforms, users allowed them, most of the time unknowingly, to collect data every time they logged in with their credentials, made a purchase, or simply engaged with any type of content or service. Identity, social engagement and preferences, even basic personal financial information, became centralized on fewer and fewer platforms. Not only did this place a tremendous amount of power in the hands of a few companies, it also created major security and privacy risks with so much personal data in the hands of so few.
In the face of this centralization and the 2008 financial collapse, blockchain and its first use case, bitcoin, were born. With visions of Web3 as their north star, the blockchain faithful proposed the idea of remaking the internet and the financial system itself, in a decentralized model.
Decentralizing the Future
Web3 seeks to decentralize control over the governance, infrastructure, and transactions that will make up our metaverse experience. And while a decentralized internet is not absolutely required for the metaverse to become a reality, it is “philosophically inconvenient” to have a metaverse only based on a centralized internet where one cannot absolutely own a digital asset (e.g., digital art, land, movie) free and clear as we do in the real world; the platform provider today could simply shut down the server or ban the user from the platform.
Built on the foundations of what came before, Web3 seeks to decentralize control over the governance, infrastructure, and transactions that will make up our metaverse experience. This new approach will present new risks and new challenges for financial services firms. These risks span from brand risk to firms that establish and manage their presence in a Web3-powered metaverse to how to they’ll protect the security and identity of users.
Users will want the ability to conduct commerce via Web3 in both familiar and new ways, leveraging its decentralized nature to place more power in the hands of consumers and creators. Decentralization can be defined as the lack of central control, whether that control is the method by which people communicate, how they consume content, or how they choose to do business with each other.
True decentralization for Web3 would include building critical components of infrastructure, including storage, in a resilient global network where no one person or entity could take down or otherwise control access. This is a core tenet of public blockchain infrastructure and its central design principle of Web3. This direction is in stark contrast to our current approach and has profound implications for the financial services firms that will build and support the rails of commerce in Web3.
Decentralized Finance and the Metaverse
Everything from identity to security to basic infrastructure must be reimagined for a decentralized model, including how financial services firms acquire and serve customers. A decentralized financial world begins with a foundation of digital assets. In some ways, the trading of these new assets in the form of cryptocurrencies and NFTs, as examples, has become a distraction to the underlying value of Web3. But nonetheless, digital assets form the cornerstone of how value can be created and exchanged in the metaverse.
Blockchain allows developers and the projects they support to tokenize value and create digital assets. This can be in the form of a cryptocurrency, a utility token for transactions on a blockchain network, stablecoins pinned to the value of a sovereign currency, or an NFT representing digital art or real-world benefits such as membership in an organization. A key distinction between these assets is fungibility. Can they be exchanged in kind for like tokens (cryptocurrencies) or are they unique like NFTs? These digital assets manifest their value based on the market economics of the blockchain they sit on and the perceived value of the asset by the broader market. No single centralized authority issues these assets or seeks to control their supply or value.
In a Web3-powered metaverse, assets can be traded freely and directly in a peer-to-peer manner, without the need for intermediaries. Proof of ownership of the asset exists decentralized across the blockchain, providing resiliency, privacy, and security. Assets can be programmed with smart contracts to automate financial transactions.
To understand DeFi as a whole, we need to talk briefly about smart contracts. Smart contracts codify shared business logic that runs autonomously on a blockchain network – needing only a transaction to execute functionality. The automation offered by smart contracts empowers blockchain builders to encode “trust” into the blockchain, defining if-then transactions. Execute a sales contract on your home and a smart contract automatically records the new owner on the blockchain. This became foundational to the creation of digital assets.
It’s this combination and connection of smart contracts and digital assets that underpins the next evolution and lets us apply different financial models to these assets. Builders of DeFi started with replicating traditional financial models like exchanging and lending on blockchain but are now creating entirely new financial models and instruments (e.g., perpetuals) not possible in traditional finance. The global, public, 24/7/365 access from anywhere the internet is available also presents a very different operating model from traditional finance.
Challenges and Opportunities for Financial Services
While some see this as complete freedom from the traditional financial system, it will more likely be a hybrid melding of today and tomorrow. Driven by regulatory guidance and the need to protect both consumers and businesses, Web3 operators have adopted, and will continue to adopt, know your customer policies to understand who they are doing business with. DeFi providers seek to free individuals from a reliance on intermediaries and put more control in the hands of consumers.
It is in this model of decentralized finance where both the opportunities and challenges for financial services firms exist. How will financial services firms make money if just being in the middle of a transaction is no longer enough? If sovereigns issue digital currency, which banking services are still necessary? Will trust in blockchain technology really supplant the trust built by institutions over hundreds of years? And ultimately, how will governments regulate all of this?
The decentralization of resources and services driven by Web3 will change the nature of finance in meaningful ways. Both the risk of disruption and the opportunity for leadership exist. For example, decentralized exchanges for digital assets operate connecting asset owners directly to each other for transactions. Ownership can be validated and transferred directly via the blockchain, removing the need for traditional clearing or brokers. These exchanges rely on liquidity pools, funded by independent owners of digital assets, and provide fees directly to them for facilitating the transaction. Traditional exchanges cannot compete with the efficiencies of a smart-code-powered transaction or a distributed fee structure.
Lending is another place Web3 models are transforming business as usual. Blockchain-powered lending anonymizes credit and lending, where any user who can pledge collateral can borrow. No credit checks are necessary, and risk is “self-managed” in the form of smart contracts that liquidate assets on chain when loans meet risk criteria. While recent struggles in the crypto lending space have become high profile and contributed in part to the perceived “crypto winter,” the mechanism for identifying risk worked, shining light on structures that posed greater risk to the overall system. This more direct lending model challenges the dominance of traditional banking both in risk calculation and inclusiveness.
The Metaverse and Web3 Convergence
To many skeptics, the metaverse is simply the application of gaming technology to make online experiences more immersive. There is some truth to that statement. Technologies such as virtual reality, augmented reality, and extended reality are creating opportunities to interact with brands and individuals in ways much more compelling than two-dimensional images. But realizing the full value of the metaverse as defined by metaverse visionaries may be tied to or even accelerated by Web3 technology.
The value of digital land in the metaverse, for example, is dependent on the ownership rights conferred via smart contracts on the blockchain. Rich and diverse experiences are created in Decentraland and The Sandbox precisely because they are user driven, albeit currently without a governing authority to monitor or censor. In the future, digital assets will move seamlessly across metaverse(s) via a mesh of blockchain networks powered by smart contracts.
The open-source, collaborative nature of Web3, leveraging public infrastructure, will support innovation and accelerate adoption of the metaverse at a speed far greater than the centralized development model of Web2. In addition, the very nature of Web3-based decentralized metaverse platforms means that the environments are persistent and resilient, more immune to outages than centralized systems. Functionality providing security and resiliency can be designed into open-source infrastructure where the entire ecosystem can benefit, instead of a reliance on each individual platform provider.
All of this unlocks opportunities for a myriad of financial services to help users leverage their value. In the end, the real value of the metaverse may be that Web3 facilitates user-driven economies with less friction, rather than a curated, centralized experience controlled by intermediaries.
Embracing the Decentralized Future
Many see Web3 as the true and defining characteristic of a fully functional metaverse. What is certain with Web3 is that the financial services industry is at an inflection point. In this new digital realm, our avatars will buy digital goods and build wealth through digital assets. We’ll extend and accept credit through assets encoded in smart contracts. Institutions will engage customers and employees in new ways. Behind all of this will be a next generation of decentralized financial infrastructure providing the rails of secure commerce for Web3 and the metaverse.
To stay ahead of the curve, financial services firms must begin exploring the opportunities and challenges presented by the decentralization of the metaverse. By understanding the evolving role of digital assets, smart contracts, and DeFi, they can position themselves to thrive in this new era of user-centric, peer-to-peer commerce. Embracing the principles of Web3 and collaborating with the broader decentralized ecosystem will be key to unlocking the full potential of the metaverse. As the digital and physical worlds converge, the financial services industry must be ready to support and empower the decentralized future. Visit https://itfix.org.uk/ to explore more insights on navigating the evolving technology landscape.
