Not yet another "Web 3 Themes for 2023"
There are a lot of market outlooks and themes - you can read some of them here - Coinbase, Messari, a16z. You can also read our fund’s detailed long term Web 3 thesis here.
We have been in a bear market since the time Fed indicated they will raise interest rates (Nov/Dec 2021). DeFi had already been on a downward trend by then.
However, this bear market is different. There is significant amount of capital on the sidelines that wants to deploy across venture and liquid, even if some of it may have changed post FTX. However, more than the capital, it has been heartening to see the continued users, transactions, and developers in the ecosystem. It may be significantly lower than a year ago but you need to have been in this ecosystem in the previous bear market (2018/19) to understand what I mean. In VC words, the digital assets space has established network effects, and has early product-market fit!
I hope that felt bullish and encouraging. The glass is definitely half-full here.
With that in mind, I have outlined a few topics below to provide my perspective. Reminder that this is my personal view, not fund view.
1. Macro
Price action mostly follows from Macro, whether we like it or not. As more institutions enter we will be more correlated to global markets, not less.
Stock markets are still fairly strong on 3 main reasons: a) Anticipation of Fed pivot and re-start of QE, b) Decent earnings, c) Strong unemployment and retail spending (ie demand)
I anticipate that inflation will reduce dramatically in 2023, demand will shrink (increased unemployment, higher savings), earnings will disappoint, we will enter a recession, stock markets pull back (S&P 3200-3400 range - and another leg down in crypto?), and then Fed starts easing again. All of this may take anywhere from 6-18 months. My detailed macro session here.
Key Insight: Will the Fed pivot before damaging the economy too much by keeping rates too high for too long? I won’t hold my breath on it.
2. Regulation + CeFi
Adoption in Web 3 (retail and institutional) will need more regulation. Of course the best regulation is that which protects innovation but the episodes of the previous 9 months from the “darlings” of the space have taken the decision out of our hands.
The 2 main areas that will potentially suffer the most are censorship resistance and privacy. While it is important to protect the ethos, we should not be blind to the serious misuse of these traits either.
Ideally, regulation is best implemented at the gatekeepers (CEX exchanges, custodians, payment gateways) and we will see a rise of licensed and regulated centralised actors (with an in-built moat).
Key Insight: ZK technology (along with DID/SSI) can play a significant role in maintaining the ethos at a transaction level, while we protect the world at a user level.
3. Bifurcation of DeFi into DeFi and ReDeFi (Regulated DeFi)
Permissionless DeFi will continue to be the hotbed of innovation where primitive ideas will spawn. However, the capital here is circular and primarily whale/VC driven with too much scope for rug pulls, scams, and hacks. All of which will keep serious capital away from it.
However, the tech underpinning DeFi is seriously efficient and will one day replace the archaic architecture of financial markets. However, such a change will require buy-in from regulators, financial institutions, and asset managers. The recent POC between Polygon and JPM/SBI using a fork of Uniswap V2 is a great example of the beginning of this transition.
I anticipate a lot more of these examples to emerge in 2023 whereby products in permissionless DeFi are repurposed within permissioned networks for creating products and markets for traditional assets.
Key Insight: It is a no-brainer for every regulator to initiate a regulatory sandbox to experiment with DeFi technology and products within their financial markets. And then use their CBDCs within such a framework (a personal project is in the making here….)
4. “Smart” investing and alpha in the public markets
Early stage in Web 2 (idea, MVP) gets a valuation of $5-10M tops, with exceptions being repeat founders with successful exits. Early stage in Web 3 is invariably $15-20M+ valuation which is bizarre considering that the market size is still fairly unknown, and the space is open source ie moats are difficult to build. The valuations are a function of hype, excess capital, and FOMO.
In that context, listed tokens provide a much better opportunity in this market. There is a lot of on-chain data to process (users, contracts, TVL, revenues, etc) and derive meaningful insights, to compare against competitors, and draw projections.
For ex: $SOL at an FDV of $5.3 Bn with network effects or $APT at an FDV of $3.5 Bn and pre-mainnet? A new options protocol at $35-50M with vesting and no traction, or market leader $RBN at under $200M FDV?
Key Insight: A lot of VCs have raised a lot of capital for “early-stage” opportunities but will have to deploy into public markets as risk-reward is better. I manage our Fund II that had in its mandate to invest into thesis-driven, long-only opportunities in the public markets as well.
5. Web 2 leaders in Middleware
“Middleware” is the software that lies in the middle of protocol and applications, or multiple applications. It is interoperable and essential to abstract away the underlying tech and improve consumer experience.
In Web 2, this would be your AWS/Azure (cloud storage and computing), Bloomberg (price feed aggregation), Google analytics (data indexing and querying), Experian/Equifax (identities and credit scores), etc.
While we have our market leaders in middleware in Web 3 (Chainlink/Band, Graph/Covalent, Filecoin/IPFS, etc) it would be imprudent to not expect the Web 2 leaders to enter into this space either directly or through executives. Most of the Web 3 storage still goes through AWS/Azure, Google is rumoured to be entering the RPC space, and some ex-Google executives have started nxyz, an indexing start-up.
Key Insight: A lot of Web 2 behemoths control hardware as well, and it is becoming more and more important that we begin decentralising the hardware stack as well. Although I am not extremely confident that this can be done…
6. AI’s moment appears to be here
While ChatGPT is all the rage right now, it cannot really solve real world problems yet, and it cannot be relied upon as the gospel. Regardless, between ChatGPT, Dall-E, Stable Diffusion, and the like, it is becoming apparent that AI will start impacting our lives in a direct manner.
Think of the following fields - content writing, customer service, creative designing, marketing, data analysts - while these have been getting disrupted with tech, these AI engines can change their paradigm rapidly.
Also, are we at the beginning of the disruption and unbundling of Google Search?
How does this impact Web 3? All the above fields can help market and present Web 3 better, but at a deeper level, generative art (Art Blocks), generative music (Hume), intelligent NFTs (Alethea), data-driven decision making (Delphia), etc, are all interesting ways in how AI can influence Web 3.
Key Insight: He who controls the data, controls the AI. Google and Facebook have been influencing our lives much more than we believe and these are through AI/ML algos that have been built on the data sets they control.
7. Bullish
I am excited about a few themes (non-exhaustive) and waiting to see how it evolves and how I can participate:
Re-staking → Pioneered by Eigen Layer, still early, but can help improve security across multiple protocols in the Ethereum network (extendable to other POS networks as well) by re-staking ETH (or other POS native tokens).
Account Abstration → Converting a non-custodial wallet into a smart contract and allowing for better UX of private key management, and enabling finer payments related use cases such as subscription payments.
DID → Decentralised identity is the key to living a thorough and permanent life in Web 3. It can help with access, uncollateralised borrowing, gaming interoperability, online privacy, pseudonymous work and pay, sybil resistance, meaningful (DAO) governance models, tokenisation, etc. DID+ZK is the key to maintaining the ethos of Web 3 while keeping the system safe.
Virtual Worlds → Roblox + Minecraft + Fortnite have close to 400M MAUs, with average age under 15, and over $50Bn was spent within virtual worlds. There are challenges across the stack in building Web 3 virtual worlds but the market is there and the economics are proven so we will find the way. Will write in more detail on this topic.
In addition, I anticipate a lot of consolidation across the ecosystem. Too many solutions for the same problems imply merger, acquisition, or closure.
8. Not so bullish
Bridges → Technically it is quite challenging to build bridges as the technical standards are different on either sides, and these are loaded vaults that attract the hackers like moths to fire. If bridges aren’t the solution then the problem statement needs to be asked again - will the world be multi-chain?
Permissionless DeFi → We have to ask some serious questions here - where will the next wave of capital come from? How will regulators come down on DeFi? Is there a market for sophisticated products such as options, insurance, etc? How will tokens accrue value?
Bitcoin → Without transactions the miners/validators are hoping for price increase to make their businesses profitable. The growth of transactions is limited by the fact that Bitcoin is still volatile to be used for payments, and it is not easy to program upon. There is a lot of work being done here but it is not yet a thriving ecosystem. It wont go away anywhere soon but I anticipate the importance of Bitcoin to the overall ecosystem to reduce over the next cycle, and that’s not necessarily a bad thing.
9. Final word
I am super excited about the next cycle and I can’t wait to be at the forefront of it. To anyone who is passionate about Web 3 as an ethos (and not just price) this is the time to double down.
I will be a lot more actively writing hereon, ask tough questions, and provide my insights - and hope that will help all of us.
Cheers,
Prashanth