Is Web3 still all about the Tokenisation of Everything?
This week's post marks a big milestone — it's now been 12 months since I embarked on writing my weekly essays on the web3 and blockchain landscape. That's over 55,000 words of content on this subject, where I'm sharing my thoughts and learnings as they evolve in this fascinating area of technology. The second piece that I published last year was on the tokenisation of everything, and given the events of the past 12 months, I believe it’s a great time to revisit this narrative to reflect on how my beliefs have evolved during this time.
Tokens in 2023
Tokenisation in Web3
At its heart, the tokenisation narrative is helpful to think of in the following framework which summarises the essence of each generation of the web.
This idea of ownership is the essence of web3. The key technology innovation underpinning web3 is the distributed ledger, which takes the trust layer that has previously been the responsibility of organisations and individuals and moved it onto the internet as a decentralised network.
In order to have a stake in this trust layer, cryptocurrencies and tokens were created. This stake in the network is a form of ownership, as it provides the holders of cryptocurrencies and tokens with a way in which they can participate in governance and influence the state of the network in the future. This may be as trivial as sending a transaction into the network altering its stake through to participating in governance decisions that affect the fundamental way in which the network operates. This model doesn't simply apply to the DLTs or blockchains underpinning these networks, but also to the applications that have been developed on top of them.
This mutual trust layer provided by the ledger facilitates the creation of smart contracts which allow anyone to launch decentralised applications and token-based governance models to support them. Prior to web3, the only part of the web that could be owned in a manner analogous to a token — i.e. an internet native digital asset were domain names. When we view domain names through the web3 lens they have some parallels with NFTs insofar as they have an owner, are unique and can be bought and sold. However, the infrastructures upon which this ownership and trading takes place are centralised, unlike the smart contracts that facilitate the trading of web3 NFTs.
Tokens in 2023
In the past year, we saw a number of high-profile failures in cryptocurrency projects (LUNA), investors (3AC) and exchanges (FTX, BlockFi). This caused the value of many tokens and cryptocurrencies to plummet and investors to flee web3. This is a good thing for the builders.
However, this cycle of speculation and growth followed by crashes is not helpful in supporting the broader 'tokenisation of everything' narrative for web3. Vinay Gupta summed it up nicely when he said we need to get out of this cycle of "hype and destruction, hype and destruction, …".
For tokens to succeed properly, we need to remove the speculation premium that exists in most tokens and cryptocurrencies. Price speculation is inversely proportional to the utility of tokens. I.e. the more speculative the price of a token is, the less real-world utility it has, as its subject to a lot of price volatility. This speculation premium is one of the three core challenges coupled with the need for more regulation and UX are the biggest issues impacting web3 adoption. I still firmly believe that we will see widespread tokenisation of assets, but it will not become a normal part of our everyday lives until these three issues are addressed.
The regulatory challenges and the UX challenges are already well understood. However, we can illustrate the issues with the speculation premium with a simple example. Take a web3 infrastructure provider for example (you can learn more about these here). Our example provider has a token that is used to pay for bandwidth on its decentralised network that we'll call bandcoin. When the speculation premium is high, bandcoin tokens become more valuable to their holders and they're more likely to keep them and let their price appreciate. This makes their core service (provisioning of bandwidth) more expensive and less desirable to users.
However, the bandcoin team is happy as everyone is becoming richer in the process and they are able to invest more in their products and services and make a great margin on the provisioning of their service.
Conversely, when the speculation premium is low, the service becomes really cheap and more attractive to its users. However, it's a much lower margin business for the bandcoin team, as they're suddenly far less asset rich and likely be to getting concerned about the sustainability of their core proposition.
Therein lies one of the key challenges with the token model in web3. When the key measure of success of a project is the price of its token, the utility token model falls apart, as whilst it does have utility, the price premium removes much of its utility.
This is where we find ourselves stuck in this continued hype cycle with web3 projects. So how will we break this cycle?
The simplest way is to prevent tokens from having intrinsic value outside of the use case they're being used for. While the topic of private-permissioned blockchain networks is a divisive one. The assets being created on them tend to have limited extrinsic value outside of the network itself.
On public networks, a potential approach is to peg the value of utility tokens to more stable form of value such as a stablecoin or cryptocurrency. Such an approach significantly diminishes the value of project tokens in the first instance, and this isn't a bad thing, especially when one considers what happened with FTX and their FTT token. The challenge any project faces with abandoning these types of tokens is that they're sacrificing the ability to get a potential 10-100x return for their investors. Unfortunately, when we're at the height of a bull market, the FOMO generated by such opportunities is very real and it's a hard trend to break away from.
However, for tokenisation to become more widely accepted on public web3 networks, this speculation and mania have to dissipate. Otherwise, it will be the permissioned network implementations that don't rely on cryptocurrencies that will thrive in the nearer term, as they are able to remove the association from speculation and genuine utility.
For those who want to continue to build in web3, I would discourage you from having a token unless there really is no other way. As unless you can separate utility from the price speculation of the asset, without a dominant market share such as those that you see with leading protocols such as ENS, Uniswap and Aave, your token is only ever going to be a vehicle for speculation, and instead of contributing fundamental value to web3, you're reinforcing the next big hype cycle, and we know were that ends up.
If the token is to be the primitive of web3, like the website was the primitive of web1, we need to ensure that it is utility driving adoption not speculation. I still firmly believe tokens will be this primitive, but we need them to be taken seriously by people first and foremost, so they can appreciate their real-world value. Once we have that, the real potential of widespread tokenisation will emerge and that’s where web3 truly becomes mainstream.