Everyone describes their initial look at blockchain and web3 as “going down the rabbit hole”. It starts simply with Bitcoin and cryptocurrency. Then they go to Ethereum. But then it quickly becomes a sea of confusing, contradictory, and usually half-baked topics. Such as:

• Decentralized vs. centralized platforms and systems.
• DAOs (decentralized autonomous organizations) and other more cooperative. forms of governance (and sometimes operations).
• Progressive decentralization (by a16z).
• Transparent and permissionless systems.
• NFTs and other digital assets.
• Token economics.

And this also gets mixed into a lot of ideology. Cryptocurrencies have always been an ideological reaction to centralized systems and fiat currency. Other areas of web3 are a reaction to web2 giants like Google and Facebook. This is really good for development. People are really dedicated. But it can also make the discussion somewhat irrational.

In five years, I think most of this will be forgotten. Go back to 2000-2005 and people were not talking about platform business models. The big concepts were getting eyeballs, flywheels, the bandwagon effect, and the sharing economy. Nobody uses those frameworks anymore. The same will happen with much of the current web3 discussion.

I’m trying to get ahead of the curve in terms of strategy and business models in web3. In these 2-3 articles, I’ll lay out my thinking about the important concepts and business models (thus far). 
However…

I am only looking at the business models that will be powerful when the dust settles. I want to know who is going to win? I am looking for structural advantages. In web2, that was mostly about getting there first and getting network effects. I think the playbook will be different for web3.

So much of what is going on right now is just building the technology stack for web3. Companies are building various components and trying to get the whole thing to work. It’s like a half-built iPhone. I am looking at what business models will win on the completed tech stack.

I’ll lay out 4-5 key concepts that I think will determine this. But first, here is a short test for assessing a web3 business model:

Two Simple Questions for Web3 Business Models

1. Value Creation Question: What is the most important use case and what value does this create for the customer?
2. Value Distribution Question: What are the short and long-term incentives for the builders and operators of this service? How is the created value distributed?

Bitcoin is simple example for this.

For question 1, Bitcoin has a powerful and simple use case. Customers can now own digital gold. They can store it and trade it. And it is not inflationary, and no government or bank can seize it. That is an increasingly valuable customer offering. Bitcoin has great product market fit. It wins big on the value creation question versus web2 offerings.

For question 2, Bitcoin doesn’t need much “building”. It doesn’t need to continually evolve. It doesn’t need many developers. It just needs “operators” for the protocol to function. Miners have been doing this and they have had powerful incentives (thus far). Longer term, these miner (i.e., operator) incentives may be an issue.

Compare that to Axie Infinity and lots of “shitcoins” we see.

• Customers don’t see much value in many of them (no product market fit). And those with value aren’t differentiated from web2. There is no reason to switch to this technology. The “Uber of web3” isn’t better than the real Uber. And the user experience is terrible. Most web3 video games suck. There is not enough value creation.
• Additionally, the long-term incentives for building and operating these business models don’t work. Developers may get in early, build the protocol and make some money on the token surge. But then they move on. The protocol stops functioning. Most of the builder and operator economics are short-term speculation, not long-term value distribution.

The best pure web3 business models (thus far) have been relatively simple utilities that don’t require ongoing innovation or evolution. Like Bitcoin, most of these have been in decentralized finance. Most of the other successful business models have been platform-protocol hybrids, like Coinbase and OpenSea. I’ll talk about these in Part 3, but these are really Web 2.5.

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Ok. With that, let’s get into the important concepts.

Big Concept 1: Protocol Networks (i.e., Blockchains) with Property Rights.

I’ve argued that platforms, networks, and network effects are different things.

1. Platforms are business models (built on networks).
2. Networks are assets. They can be:
   • Physical networks
   • Protocol networks
   • People and company networks.
3. Network effects are a phenomenon within these businesses.

But in web2, #1 and #2 have usually been in one company. Facebook owns the business model and the social network. So, we don’t separate them out. 

In web3, we separate them out, because the network is moving from a company’s servers to a public space available to everyone. These foundational assets are protocol networks, which means a network of connected and compatible devices (think Ethernet, ICP/TCP, fax machines). You can think about protocol networks as a distributed database (Bitcoin). Or as a distributed specialized computer (like a fax). Or even as a distributed programmable computer (Ethereum).

 

We are seeing lots of these protocol networks emerging and increasingly being optimized for different functions. Solana is a faster and cheaper blockchain. Bitcoin is the most secure but slow. Ethereum is the most broadly adaptable, but expensive. Youc an think of these foundational networks like Los Angeles, New York and Boston. They’re all cities but specialized in different things. And developers, content creators and companies are building on them in different ways.

That’s the technological foundation of web3. A new technology architecture based on protocol networks, also called blockchains.

I argue that the big concept here that matters for business models is protocol networks with property rights. It’s a big deal. And a game changer versus web2.

Protocol networks let you own digital assets directly. You can own Bitcoin. You can own NFTs. You can own your own domain name. You have a direct claim on these assets with no intermediary. This is within a specific blockchain but can also be across blockchains in some cases.

That is a big change from web2. Most assets like domain names and videos are rented. Even content you “buy” like shows on iTunes are not really yours. You don’t have custody of them. And your only claim is by their terms of service.

In web3, you do own the digital assets on the blockchain. And while you can’t take custody, you have property rights by “rule of protocol”. Your ownership is written into the code.

This has sweeping implications.

• The first use case for digital ownership was Bitcoin.
• This rapidly spread to other cryptocurrencies and financial instruments.
• It then spread to NFTs, which are (in theory) a much broader B2C use case. Artists and brands have been leading the way here.
• Now we are talking about virtual worlds, where you can own pieces of land. And parts of the economies of these worlds. Protocol networks with property rights (like Decentraland) are a web3 version of what Meta is trying to build in web2.

If you go on to OpenSea today, you can buy:

• Art
• Domain names
• Virtual worlds
• Collectables
• Tokenized physical assets (coming soon?)

This is a big idea. And it ties right into my first two questions. Offering real ownership changes the value proposition to customers dramatically. And it also creates lots of new mechanisms for value distribution.

Big Concept 2: Composability (i.e., Building Blocks) at Global Scale

Composability and complements get mixed together as concepts. I’ve talked about complements a lot (see Concept Library).

But composability is really becoming important with web3. It is usually discussed in terms of open source. One developer writes code and posts it for others to use under free license. Others can then write code that runs on top of this. And so on. That is why composability is sometimes called building blocks. Sangeet Choudary is using this term to describe it. You build stuff like Legos, with everyone adding.

And this is somewhat like complements. Composability is usually about creating one customer offering, like a good piece of video editing software (i.e., Da Vinci). But it can also get you lots of software and complements that all works together. Like apps that are built to run on operating systems like Linux or RedHat. App stores are a form of complements.

Composability, complements, ecosystem building, and “distributed innovation” can all get mixed together. The term modularity is also used.

But within web3, the big concept is composability at global scale. Maybe it’s for building a product. Maybe it’s for building an entire ecosystem?

Think of how powerful that is in terms of innovation. Facebook and Microsoft may have tens of thousands of employees working on the next version of their products. But they don’t have hundreds of thousands of coders around the world working on them. And they don’t have tens of thousands of developers creating products that are complements, increasing their product’s value. In my SMILE marathon, I listed S as “sustained innovation”. Composability at global scale can be very powerful marathon in sustained innovation for a company.

Blockchains / protocol networks are designed for composability at global scale. They are technology platforms that cross-borders and are beyond most government control. They are also mostly permissionless, without a corporate head deciding what happens. Anyone can build on them. That is why we are seeing such a surge in L2 protocols, Decentralized apps, NFTs, etc. Think about that as a type of value creation.

Look at the short history of Ethereum.

• It was conceived in 2013 by Vitalik Buterin as an open-source blockchain with smart contract functionality. It allows anyone to deploy permanent and immutable decentralized applications onto it, with which users can interact. The network went live on July 30, 2015.
• CryptoPunks was launched on Ethereum in June 2017 by the Larva Labs studio. This was a collection of 10,000 non-fungible tokens (NFT) collection on the Ethereum blockchain. This crypto art project was an inspiration for the ERC-721 standard for NFTs and the beginning of the modern crypto art movement.
• CryptoKitties was launched on Ethereum shortly after as a blockchain game, developed by Canadian studio Dapper Labs. In the game, players can purchase, collect, breed and sell virtual cats. It became so popular that in December 2017 the game congested the Ethereum network.
• In 2017, OpenSea was founded by Devin Finzer and Alex Atallah as an NFT marketplace to trade cryptokitties. It is based on the Ethereum ERC-721 standard, the Polygon layer-2 scaling solution, the KIP-7 standard for Klaytn, and the SPL standard for Solana. In January 2022, the company was valued at $13.3 billion.

Composability at global scale is pretty awesome.

But why didn’t this happen with open source?

The big weaknesses of open source and composability have been value distribution and the “tragedy of the commons”. Open source was very powerful in terms of value creation. But it relied on free labor. There was no way to distribute the value. Red Hat gets donations. Wikipedia and Quora are always begging their editors to stay active. Android went open source but Google kept certain critical components under paid licenses, specifically maps.

It looks like web3 solves this problem.

Outside of the technology, the big problem for composability at global scale is probably the tragedy of the commons. First described by British economist William Forster Lloyd in 1833, this is when individual users have open access to a resource but act according to their own self-interest and, contrary to the common good of all users. He was talking about the destruction of farmland because uncoordinated action led to its depletion. But we have the same problem in global protocols.

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Ok. That’s it for Part 1. I’ll get into another 3 topics in Part 2. And then detail specific business models that take advantage of these.

Cheers, jeff

I write, speak and consult about how to win (and not lose) in digital strategy and transformation.

I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.

My book series Moats and Marathons is one-of-a-kind framework for building and measuring competitive advantages in digital businesses.

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