Written by Hugh Mc Girr & Pete Townsend, Investment Team, Techstars Web3 Accelerator
This thesis outlines our reasoning for investing in web3 as a future internet and in what we’re looking for in those founders building towards it.
We begin with a long societal arc of historical context on organised productivity and emergence of particular empires; by charting a course where amendments to company law meet with the internet, while also touching upon the history of the internet itself and the topic of representation.
We then outline the importance of decentralisation and of a decentralised internet and move into some of the notable events along that journey and, loosely, to where we are now.
We double down on thesis 1.0 and the general theory of a future internet being decentralised, a.k.a. ‘web3’. We speak towards some of our learnings along that journey, so far and towards what else is required to get us there, before finishing with what we are looking for from founders.
Whether you are a founder, investor, mentor, or simply interested in web3 and in early-stage venture, we hope you find our thesis helpful and informative.
The late 19th century marked a significant shift in the rate of technological progress. It was from this time onwards where history really learned of the productive power of corporations, of governmental research labs and of globalisation. Brad DeLong chronicles this in his book Slouching Towards Utopia: An Economic History of the Twentieth Century as he cites a dramatic increase in the rate of technological progress as the reasoning for beginning the book in 1870. Prior to this, the rate of technological progress was roughly 0.5% or less until it jumped to 2.1% in 1870; leading the following century to look markedly different from the previous century and centuries prior.
Up until the mid-19th century, companies mostly consisted of government-funded charters and joint stock companies. The earliest of businessmen often risked their lives as well as their fortunes, but there came a time -1830 in Massachusetts and 1862 in Britain- when companies were ‘set free’ from potential loss and government control. That is when shareholders were granted limited liability and when the technological prowess and liberal values of the company allowed the limited liability company (LLC.) to become one of the West’s great competitive advantages. The Company - A Short History of a RevolutionaryIdea by John Micklethwait and Adrian Wooldrige fantastically details the journey of the LLC from when it came to possess most of the legal rights of a human being, without the disadvantages of biology and with the privileges of immortality.
Since this time, the company has become a mainstay in our lives. On one level, you might consider the LLC to have become the basic unit of western society -ahead of the state, the commune, the political party, the church, the manor and the monarchy (while perhaps competing with the family)- and on another level, you might consider that some particular corporations have seriously challenged world order status quo beyond the state (since the Dutch and British empires, more recently the US and now China) and while some the world's largest countries are at (some variant of) war today, corporations have never been as powerful.
If you subscribe to Nassim Talib’s view in his book Anti-Fragile, you might agree that a bottom-up ownership leads to a healthier democracy because of the adaptable nature of having more skin in the game from a ‘grass-roots’ level. And the reason DeLong ends Slouching Towards Utopia’s Twentieth Century in 2010 is because that is when the western world took a turn, after a particular ‘boom-bust’ cycle. It is when the deregulated ‘bubble’ of irresponsible financial institutions burst and when rescuings for fear of too-big-to-fail followed - leaving a large scar (not only) on the financial system, but also within the frameworks which orchestrate the way in which we live and work, create and consume. A scar which regulators learn from and adapt and a scar which motivates innovators.
We believe in solving for fragility but we also believe in greater levels of representation; for contributors and consumers and for environmental and social stakeholders. The very mission of Techstars itself is to help entrepreneurs succeed, which we believe enables wealth distribution as well as economic development. As we learn from the 2008 financial crisis, we have also come to know of today’s tech giants who continue to magnetise billions of daily users like no corporation ever before.
These tech companies also operate in a world and in an age which is relatively new to us but which has totally transformed society. And that is the age of the internet. While these central figures can be admired for bringing so many users online, they hold a lot of leverage over how and over what we consume, over how we create and distribute and whether we agree with their capabilities and business models, or not, perhaps there is an alternative technology for expanded representation.
Stripe’s mission is to grow the GDP of the internet. Within the expanding empire of the internet, you might ask;
What should it do for us? and what should it not do for us?
How could it form our real-world for the better? Or what of it may we want to own?
And should it be centralised or decentralised?
Decentralisation is a pathway for greater representation.
Decentralised value can come in many forms. Ultimately it is skin in the game.
An internet with native asset- or utility-value can be a powerful technology for greater decentralisation and within that, an internet consisting of distributed, open-source, coded commitments (smart contracts) can have meaningful utility value. And smart contracts with embedded economics can provide a deeper level of skin in the game.
Even if Tim Berners-Lee and others were posing these possibilities when an open-source Web1 came along, in the late 80s-early 90s, the internet was hard to use, hard to build within and there were far fewer engineers. Fast-forward to 2022 - we now have blockchain to deliver a decentralised internet, but parallel innovations in mobile and cloud have enabled the decentralised internet to evolve far faster than Web1. That being said, the decentralised internet is still hard to use, hard to build and there is a shortage of blockchain engineers.
A decentralised internet will consist of some integral foundational building blocks - some of which we may have been introduced to and some of which we have yet to encounter. Either way, the waves are increasing - in frequency and in depth.
First we saw decentralised money - bitcoin. Surfacing after the 2008 financial crisis, bitcoin may or may not become an everyday currency and may or may not become a reserve asset but it cannot be intrinsically tampered with or devalued by central entities. It is currently the most widely adopted decentralised network asset - akin to “the immaculate conception”, as claimed by one of our Techstars mentors. How right they could be!
In response to network shortcomings of bitcoin, ethereum has ignited the quest for the decentralised OS and we’ve since seen Layer 0s, Layer 1s, Layer 2s, Roll-ups and Zero-Knowledge Proofs expand active development base across protocols and build the foundations for dApps & projects to build upon.
The space got way ahead of itself during the ICO boom - a brief period of “venture decks with a lot of hopium” as Lex Sokolin calls it, which brought an abundance of speculation, noise, speculation and many empty projects. Similar can be said for VC pump-&-dump behaviour, which is another can of worms, but good protocols can survive.
Next came the DeFi and NFT Summers. Lending, borrowing and various yield strategies across numerous DeFi protocols (particularly with the introduction of stablecoins), and the promise of non-fungible assets provided more oxygen to the potential of a decentralised internet. And while both may have shown some throughput limits or broken models, we see some really functional applications across
Web3 consists of open-source engineering and open-source community coming together, underpinned by embedded economics and within systems which can speak to each other. The collective potential of inter-programmability and native, distributed ownership provides the basis for a holistic internet which could transform our economies like nothing we have seen before.
While we certainly experienced a web3 wave recently, it is fair to say that it has obviously consisted of a heavier introduction to such native financial systems (crypto) than the software and communities components.
So what else might we see heat up in the next wave towards a decentralised internet?
Perhaps we will see consolidation with some web2 plays (like Ticketmaster and Flow NFTs) incorporate primitives and wallets and naturally onboard millions more users. Perhaps some particular projects and protocols will set a greater precedent for what could be. Chainlink, for example, is a good example of a network in the top 20-ish of market caps with really notable flywheel traction. As a first-mover in solving the oracle problem, Chainlink data providers -who are required to stake the LINK token- are incentivised to accurately facilitate the transfer of tamper-proof data from off-chain sources to on-chain smart contracts.
Chainlink is used by most major DeFi protocols, hundreds of projects and many web2 companies have also launched oracle nodes to monetise their data. It is web3 in action!
Gaming is a very natural setting for web3, particularly as native assets designed to be used within a game can accrue value. Blockchain gaming was responsible for half of all unique active wallets connected to blockchain dApps on a daily average in 2021 and although the category leader Axie Infinity showed just how unsustainable Play-to-Earn can be, we are likely going to see a lot more from web3 gaming.
We expect to see a lot more out of NFTs organising people in a meaningful way in the real world, either on a truly decentralised basis or through the cross-over of the primitives of decentralisation back into a centralized construct. We’ve come a long way since CryptoKitties in 2017 to being on the cusp of NFTs as mainstream event tickets, as above. Unless NFTs have real utility, most will become the detritus of web3. Utility means different things to different people, i.e., utility can just be meaningfulness. Love them or hate them, if your Bored Ape profile pic provides you with a sense of community because you identify with that culture, it’s meaningful to you today. That same Bored Ape NFT may provide you with access to in-real-life experiences that are also meaningful to you in the medium-term. However, the 101 (or 1,001+!!) copycat projects trying to earn a few bucks on hype-driven speculation don’t have a hope of accumulating long-term utility. That’s where the intersection of media, sports and entertainment with NFTs excites us. Imagine your kid opening a $10 virtual pack of rap-hero digital collectibles on a smartphone app, and getting a virtual golden ticket to the next Kendrick Lamar gig? We’re looking for these true innovations to connect the passion of fans with the objects of their fandom in a way that web2 cannot. And we say “kid” on purpose here, as it’s the younger generations that could swipe before they could speak that will be voting with their fingers on how the primitives of decentralisation cross-over into centralised frameworks.
We also anticipate a lot more to come from DAOs (decentralised autonomous organisations). DAOs empower open-source, bottom-up governance (typically via tokens) and enable individuals or entities -who consume, contribute, evangelise, create, design, collaborate, manage, invest and own like a traditional organization- to also operate with greater levels of transparency, openness, and democratic governance.
DAOs are at a very early stage in their development and while -at time of writing-, there have been over 700.3k active voters and proposal makers, 70.1k all time decisions made and 3.9M all time votes across all DAOs (source); if complex token-economy are to flourish, we can expect a lot more governance innovation from DAOs. MakerDAO, the largest DeFi protocol by TVL, is a good frontier example. The DAO has recently voted to spin-off core units into ‘MetaDAOs’ (read more about the ‘Endgame Plan’ here). A move that has attracted a lot of curious, watchful eyes.
In thesis 1.0, Pete envisioned the path back from 2045 and where it converges with the path from the past, and although the promise of web3 has so far seemed more speculatively-heavy, rather than utility-heavy, we still believe in the internet -as Packy McCormack calls it- “..owned by builders and users, orchestrated by tokens”. A system of networks which -in their own capacity- could effectively, be deemed mini-economies.
BUT.. building a decentralised token-economy is hard as the innovation is greater than a technical one. There is the engineering, there is the community and there are the economics. There are some totally novel mental models.
Pete raised some key focal points in our web3 thesis 1.0 (Accessibility, Community, Composability, Compounding and Incentivisation) which successful projects would need to address.
We still believe in the integral importance of these but there are some additional areas, we feel, that are critical to building successfully in web3 and where founders need to execute. We are going to dive deeper into what we’ve learned from these and more (including Education, Regulation and Perceptions), plus; into what else is required and what we’re looking for.
1. Incentivisation needs to be clear, elegant and simple.
As Buckminster Fuller once said, “You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete”. In many ways, the industry has been waving tokens in the air without completely demonstrating a new model to make existing models obsolete. Behaviors and incentives need to go much deeper in their value and utility compared to the simple promise of fungible or non-fungible tokens. And that’s just acquisition! Retention of users and developers requires genuine interest in the success of protocol and token ownership beyond speculation. The ability to incentivize production and consumption through governance, utility and token economics are the instruments upon which projects will live or die.
This is aimed at those who are working beyond the attitude of ‘build it and they will come’, as community growth still requires a certain level of product-market fit and typically requires a constant feedback loop for development. Converting 1-10 super fans into 100 or 1000 true fans requires a deep understanding of user profiling, behavior and incentives and a qualitative dialogue with your core users and contributors before many successful projects are able to decentralise. You could think of it as product-led growth on steroids (and LSD)!
This is where the lego blocks come in. Layer 0s like Polkadot, Cosmos and EVM-compatible chains lay the foundations for a thriving open-source mixing and matching of software components. The lego block analogy isn’t always one block on top of the next, rather the multi-sided lego that allows you to build out in a few directions - known in the Lego world as Lego SNOT (Studs Not on Top).
We see the most examples of composability in DeFi with the amount of dApps built on Maker’s and Uniswap’s protocols, for example. These examples are very primitive, however, and we have yet to see the power of composability at scale outside of DeFi. Imagine an NBA statistics Chainlink oracle integrated with an ultra-rare Jayson Tatum digital collectible minted as an NFT on Enjin, so that Jayson Tatum’s photo changes to him dunking over LeBron James when he, well, dunks over LeBron James. Taking it further, because you own that NFT, you get access to an exclusive post-game event with Jayson Tatum in Decentraland, or better yet, a one-on-one Zoom call. That can make for a great user experience.
If you manage to build for the above (community, incentivisation and composability), you will have an ecosystem that brings users to developers and which brings developers to users; driving your product development, and in turn, triggering your flywheel. Attracting users to your protocol/dApp will also bring developers who want to build their own solutions, which in turn, brings more users. This compounding effect of developers and users -both incentivized to build on and use your platform/protocol- accrues value within your network (typically via your token). Thanks to open-source composability, an even greater flywheel can then take shape.
When we talk about ‘infrastructure’ in web3, we really mean accessibility, as the real infrastructure is made up of servers, satellites and fiber-optic cables. How users access web3 is still clunky; self-custody wallets, 12-word seed phrases, NFTs that you can’t see in your wallet without some copying and pasting of addresses, etc.. To onboard the first one billion users of web3 -because we’re somewhere between 2.5 million and 250 million users (if you count crypto addresses as indicative of a ‘web3 user’) today-, we have to get a lot better at onboarding new users. Whatever the ‘killer dApp’ is to get us to one billion users, we need the onramps, rails and tooling to be far less clunky and far more secure than they are today to facilitate the meaningful and sustained engagement with web3 dApps.
Also, many of us used to say “do we really need another Layer 1 blockchain” when we heard about the next big Layer 1 under construction. However, we’re seeing true innovators decide that their current options for Layer 1s won’t enable them to deliver their value propositions, so they build their own Layer 1s. Once we reach the stage where true cross-chain interoperability without the rickety bridges, that cringe-factor will be no more. If you need to build a new Layer 1 to enable universal accessibility like Odsy Network, go ahead. We live in a multi-chain world, and there will be no single blockchain ruling them all. In this context, safe and secure interoperability is a must-have, and we’d like to see a lot more of this.
We’re in the age of just-in-time education via YouTube when the uninitiated web3 user wants to learn about DeFi, NFTs and web3 in general, but should it really have to be that way? If some of our parents have trouble with mobile, email and general Web2 use, the thought of imploring them to use DeFi apps like Curve is unimaginable. Even though DeFi affords far higher yields on their savings than the local bank, the biggest advocates of web3 would not send their grandmother a YouTube link and suggest they drop $10K into Curve, Aave or Compound, as it’s very easy to lose everything by missing one step. We need some type of composable educational protocol to sit on top of web3 that protects and guides the uninitiated, while we work on the level of accessibility of web3.
When something is truly decentralised, like Maker and Uniswap, regulation is difficult, as Maker and Uniswap are software rather than entities or individuals. That being said, we’ve seen recently that the US Treasury can sanction software, with the addition of Tornado Cash to OFAC sanction lists. Sanctioning something or practicing regulatory enforcement in the absence of policy are far different approaches than regulatory supervision of entities that have been authorised under a specific regime. It’s critical to understand how founders are thinking about the impact of regulation on their projects or businesses given the regulatory headwinds that the web3 community, in particular crypto, is up against.
Nevertheless, centralised entities masquerading as decentralised crypto platforms should be regulated. The proper regulatory regimes do not exist yet to trigger firms like FTX and Celsius to strengthen their control frameworks, governance, compliance risk management and internal audit to the level required to adhere to a higher power, but they’re coming. ‘Proof-of-reserve’ and ‘Proof-of-liability’ tools and highly automated audit tools (way beyond code / smart contract audits!) are necessary to help restore confidence in some of the centralised players. Centralised platforms are needed to help drive mass adoption, but eventually, they’ll play less of a role.
Until the time when centralised platforms play less of a role, we need better regtech tools designed around transparent crypto-specific regulatory regimes to change the tide. However, as those regulatory regimes are under development, we’re in a catch-22 situation. Do crypto regtech startups frontrun the pending regulatory regimes like the EU’s MiCA to help drive the best practices that may become regulatory standards. Maybe some will, but an even greater challenge is achieving clarity when regulators in different jurisdictions have different views on right vs wrong. As the regulatory topic is such a can of worms, let’s just say that we’re very curious to hear from founders on how they’re thinking about crypto regtech, without putting the ‘tech’ too far ahead of the ‘reg’.
Unlike the LLC., currently, DAOs are also said to lack a distinct legal personality, meaning; DAOs should assume a legal ‘wrapper’ to avoid personal liability and address any gaps in governance, compliance, benefits and taxation, although such legal wrappers can naturally threaten decentralisation. So while Switzerland seems to be one of the most pro-active regulatory jurisdictions in a very narrow field, we can expect more regulatory clarity but it is important founders do their research and get proper legal advice on setting up ‘virtual organisations’.
When it comes to tokens for DAOs, for example, the SEC in the US has found that tokens offered and sold by a "virtual" organization known as "The DAO" are securities and therefore subject to the federal securities laws (source), although this may not apply where full network decentralisation is achieved (source).
Chris Dixon from a16z said “I’ve never met anyone in this space (web3) who is both informed and skeptical.”
As less than 3% of the world’s population are crypto users, the overwhelming majority of people are uninformed and perhaps skeptical of crypto and web3. The 2022 blowups of Terra Luna, Voyager, 3AC and FTX means we have even more skeptics.
With each of these blowups, while at a high level, we can point to a lot of bravado, what really happened at the detailed level was markedly different for each of the four. Collectively, many of the symptoms of these failures point to poor business practices that if addressed, could have prevented or at the very least, lessened the resulting losses.
Beyond the contagion risk to a number of entities that could leave a trail of destruction worse than Bernie Madoff and Enron’s lovechild, we will have the increased negative perception towards crypto for months and perhaps years ahead. Crypto has always recovered though, and it will again this time. We’re radically changing the internet as we know it and enabling virtual societies, so influencing perceptions and informing the skeptics have been par for the course since 2008, and will continue until 2045 (at least!).
The last wave of crypto (incl. 2021 NFTs) came at a time of a ton of speculative froth in financial and asset markets. Right now, crypto and web3 aren't as shiny, so the need to demonstrate genuine utility incentive is reinforced.
In addition to tokenomics and governance; security, nodes, primitives, storage, communications, devtools, oracles, analytics all play major roles as critical infrastructure in helping onboard the first billion users to web3.
While Arweave (Techstars company) and Filecoin compete for storage and Chainlink (as previously mentioned) leads the frontier when it comes to offchain-onchain oracles, some key infrastructure can also include web2 plays and primitives. Companies such as Chainalysis (Techstars company) are pioneering blockchain transaction analysis, Ramp (a noncustodial, full-stack payment infrastructure that lets users buy crypto assets inside decentralised applications and websites), Thirdweb (no-code and low-code tools for web3 builders to create their own apps) or DFNS (Techstars company which splits a wallet's private key, or password, and distributes the pieces so it no longer exists in a single place) are great examples of centralised companies pushing us closer to a better and more prominent decentralised internet.
We can have a small impact on how web3 develops with our own discipline, and this starts with asking a few questions that help to distinguish between those building decentralised vs centralized propositions. How do we do that as an early stage investor in web3? It starts with a few questions:
Are you building a company or an economy? If you’re building a company, how are you enabling those building economies?
How will your network become decentralised over time? If you’ll remain centralized, how are you enabling the decentralised internet?
How will the value of what you’re building accrue to a network and/or community?
If this is through a token, how does the token incentivize users to consume services on your platform and incentivize developers to build on your platform, protocol or network?
If the value of what you’re building accrues to a centralised company P&L, and you’re also launching a token, how will the value of what you’re building accrue to the company and to your network / community over time?
If the value of what you’re building accrues to a centralised company P&L and you have no plans to launch a token, see point 1.
Across all three, we are looking for founders who are obsessed with what they are solving for. This comes across in what you can show and not just tell. Your ability to execute, to turn assumptions into a hypothesis and into further proof points is enormously important. We look for those who are already engaging their Super Fans or exercising business models with their target users. The innovation is going to be more than a technical one so if you are pre-revenue, we’re seeking out a high level of empathy and traction with your target users. You will also get a lot more out of a Techstars accelerator if you have got real users to interact with.
Focus is important but vision is crucial. Vision informs focus and we get excited by a founder who is both able to focus and unfocus, to articulate a compelling vision which will help navigate through the natural headwinds which lie ahead for any startup. We call this mental agility.
Micklethwait & Wooldrige claim “the idea that the company will retreat to the periphery of the economy looks farfetched”, but it is becoming easier than ever before to engage with your customers and ever more tempting for entrepreneurs to enter into loose relationships with other entrepreneurs. We are getting closer to a decentralised internet but we have a long way to go. Pete wrote in our recent program announcement that “builders gotta build” and that’s who we are here for; those bottom-up builders who are bringing the next wave of users and contributors to web3.
- Hugh & Pete
With acknowledgments & appreciation to Liang Wu, Matthew Guidarelli, Deane Barton, Caleigh Kimberley and Krist Sokoli for their considerate assistance throughout composing this thesis.
If you’re interested in learning more, please get started on your application here, and then get in touch by email at firstname.lastname@example.org and/or at email@example.com to set up some time for Web3 Office Hours. Also, check out our dashboard and follow us on Twitter and LinkedIn to learn about upcoming live events, video podcasts and AMAs. We can’t wait to hear all about what you’re building in web3, so get in touch!
At Techstars we have invested in more than 3,300 early-stage startups. As one of the largest pre-seed investors in the world, our portfolio is as diversified as our 7,300 founders are unique - from HealthTech and FinTech, to Web3 and CleanTech; from Miami and Silicon Valley to Lagos and London. We support many of the world's best entrepreneurs with access to capital, mentoring, finding customers, hiring talent, choosing the right infrastructure, and much more. www.techstars.com