a16z’s in-depth analysis of the current development, business boundaries, and regulatory innovations of Web3

a16z's Comprehensive Study of the Evolution, Limitations, and Regulatory Advancements in Web3

Author: a16z crypto

Translation: Cookies & bayemon.eth, ChainCatcher

a16z Note: The views expressed in this article belong to individual personnel of AH Capital Management, L.L.C. (“a16z”) and do not represent the views of a16z or its affiliated companies. The information provided is from third-party sources, including portfolio companies managed by a16z funds. Although the sources are generally reliable, a16z has not independently verified such information and makes no representation as to the continued accuracy of the information or its applicability in specific circumstances. This content is for informational purposes only and should not be construed as legal, business, investment, or tax advice.

A Recap of Cryptocurrency and Web3 Developments

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• CEO suddenly exits, where is OpenAI heading?
• In-depth analysis of the core mechanism of Celestia Under the modular trend, what should the estimated TIA be?

Andreessen Horowitz’s annual “State of Cryptocurrency” report shares data on Web3 activities and innovations. The November 2023 “Policy Focus” summarized insights from the report for U.S. policymakers and others interested in the current state of cryptocurrency policy. The report includes:

• Section 1: Why Web3 Matters

Web3 is a more consumer-centric form of the internet, with advantages and applications beyond financial services.

• Section 2: Cryptocurrency Industry Overview

Cryptocurrencies have become indispensable due to their ability to transcend partisan and identity restrictions, but the United States may be losing its leading position.

• Section 3: Policy Principles and Framework

How to maintain competitiveness in emerging technology innovation while protecting consumers?

Section 1: Why Web3 Matters

The internet is one of the most important technological innovations in human history. However, it often leaves its dependents, consumers, creators, and developers disappointed.

The adoption of Web3 technology is evolving in ways that benefit consumers

• Web1 (1990-2005)
  • Loosely governed open technologies (protocols) that anyone can build upon, such as email (SMTP-based) and the web (HTTP-based) Value does not accumulate in the network
• Web2 (2005-2020)
  • Managed by companies Centralized, isolated platforms where decisions can be made by individual entities (e.g., social networks) Value accumulates in a few large tech companies rather than in the value creators themselves
• Web3 (2020-present)
  • Managed by communities Decentralized, interoperable services owned and maintained by the network, such as Bitcoin, Ethereum, and other blockchains Value accrues to the users, builders, and community contributing to the network: developers, entrepreneurs, creators, fans, and other consumers.

Web2 technology giants aim to monopolize, while Web3 emphasizes “decentralization.”

• Only three companies, such as Facebook, Google, and Twitter, contribute to one-third of the global web traffic.
• Only five companies, namely Amazon, Apple, Facebook, Google, and Microsoft, account for 50% of the Nasdaq 100 index market cap (25% a decade ago).

Web3 transfers network value to more people through ownership.

Token: The cornerstone of Web3

• Token is the “unit” that measures ownership: Tokens can represent ownership of any item, whether it’s digital items like artwork, tickets, or in-game items, or physical items like clothing, experiences, or even real estate.
• Token is a fundamental building module: Tokens are not financial instruments, just like websites in Web1 and posts in Web2. Tokens are the basic building blocks in the construction process of the Web3 network.
• Token gives people rights: Tokens are a new way for people to control digital identities on different platforms and services, similar to the concept of property rights on the internet.

Tokens have more purposes than just speculation…

Blockchain should be a powerful computer, not a gambling den.

There is an essential difference between a world driven by speculation and a world where the world computer is the product.

Computer

• As a technological innovation, it drives the development of computer science.
• Hardcodes “do no evil” as a rule based on digital trust.
• High operational transparency.
• High resilience.

Gambling Den

• Gambling is financial speculation, not innovation.
• Based on profit-driven trust, it treats “not doing evil” as a changeable choice.
• Low operational transparency.
• Very fragile.

A community-managed network will be the next generation of the internet.

Advantages: What unprecedented abilities does blockchain have as a new type of computer?

Protecting consumers as artificial intelligence (AI) advances.

• Fighting high-quality AI-generated fraud: In a world filled with endless high-quality AI-generated fakes, encryption technology can help track the authenticity and origin of the things we encounter.
• Democratizing AI innovation: Unlike large tech companies that rely on having the most data and computing resources, encryption technology can democratize access to these resources, benefiting more builders.
• Unveiling the “black box” of AI: AI doesn’t have to be a black box where no one knows what happens or where the data comes from. Encryption technology can make the data used by AI more transparent and auditable while protecting data privacy.
• Data ownership belonging to individuals: Encryption technology can enforce data privacy in AI models while also helping companies incentivize consumers and creators for the data they contribute.

Upgrading traditional privacy systems.

• Apple charges consumers up to 30% for purchases on mobile devices. Apple has significant pricing and decision-making power in mobile distribution. Encryption technology can lower the fees platform owners charge from users (as a percentage of platform revenue), increase competition, and provide more choices to consumers.
• People spend $647 billion each year on remittances, with an average cost of 6.25%. Encryption technology can eliminate unnecessary intermediaries and reduce international transaction costs by up to $40 billion.
• Only 18% of social media users trust the data protection services provided by Facebook. In Web3, people own their data—from the posts they create to the music they produce to the networks they build. More importantly, they can take their networks and data from one platform to another.

Encryption technology addresses current pain points.

• Identity issue: Unlike relying on large platforms to manage user identities, Spruce empowers people with control and ownership over their identities. Organizations can also manage the lifecycle of digital credentials (similar to how the California DMV manages digital driver’s licenses).
• Monetization issue for creators: In streaming services, only 18,000 musicians (less than 0.2%) earn more than $50,000 a year. Sound eliminates intermediaries, allowing artists to monetize directly with fans.
• Carbon neutrality issue: Voluntary carbon credit market systems are opaque and inefficient. Through Flowcarbon, more funds can flow directly to crucial environmental projects.
• Censorship and deplatforming issue: Biased platform leaders can dictate the rules and scope of social networks. But decentralized social network protocol Farcaster allows users to choose between applications while easily moving (and owning) their data.
• Infrastructure issue: The lack of competition in the telecom industry leads to high prices and uneven coverage. Helium is striving to provide 5G anywhere at only a fraction of traditional costs through decentralized wireless infrastructure.
• Online collaboration opportunities: Narration, production, and division of responsibilities for intellectual property. Story Protocol and Adim provide open infrastructure to help people co-write, remix, collaborate, and create roles while protecting intellectual property and compensating creators.

Part 2: Current State of the Cryptocurrency Industry

The era of Web3 has arrived: millions of Americans hold cryptocurrencies and their usage continues to grow.

Over 40 million Americans hold cryptocurrency assets, with no clear party or identity restrictions on holders.

16% - 20% of U.S. adults (approximately 40-50 million people) have bought cryptocurrencies

The use of cryptocurrencies is increasing. Despite price fluctuations, we see that the number of active users has maintained double-digit growth for four consecutive years.

This data tracks the number of unique active (sending) addresses across all tracked blockchains, including Ethereum, Polygon, Solana, Avalanche, Fantom, Celo, Optimism, Base, and Arbitrum. Note: One address does not necessarily correspond to one person. Data source: Nansen Query, CoinMarketCap

There is an increasing number of institutions conducting cryptocurrency research, which is also driving progress in other fields. Over 21,000 crypto publications are dedicated to addressing key issues:

• Financial privacy compliance: using zero-knowledge proofs (quickly moving from theory to practice)
• Combatting misinformation: using cryptographic methods to verify authenticity
• Checks and balances for Artificial Intelligence: utilizing blockchain networks and decentralization
• Blockchain performance and security: cryptographic economic games, networks, etc.

The Importance of U.S. Leadership

Leading the innovation of Web3 will enable the United States to maintain its competitiveness, which also includes national security concerns.

The United States has always been a beacon of innovation in technology, but it may lose its leading position in the web3 field.

Percentage of cryptocurrency developers in the United States (left) and global traffic to US cryptocurrency websites (right).

More developers are focusing on developing crypto projects outside of the US time zone.

Number of independent cryptocurrency developers: When do they code?

• Most GitHub commits are made during US working hours (9 am to 9 pm Eastern Time)
• Most GitHub commits are made during UK working hours (9 am to 9 pm British Summer Time)

The UK is actively inclined towards cryptocurrencies, and a16z crypto startups have entered the UK ecosystem. Note: This analysis only shows directional trends; watch out for overlapping time zones or other working time factors.

Like the semiconductor industry, the crypto industry may soon migrate out of the US.

In terms of industry innovation, the historical lesson we have learned is: take the semiconductor industry as an example, modern manufacturing, the US should not rely on foreign suppliers for critical technologies, and the overreliance on infrastructure will have an impact on our daily lives. Similarly, the future of distributed computing infrastructure (the internet, organizations, work) will go where, and the US should take the lead.

The US dollar’s position is under threat from sovereign digital currencies.

Current status of central bank digital currencies (CBDCs): The development of the People’s Bank of China’s digital currency (CBDC) has posed a threat to the US dollar as the world’s reserve currency. As of June 2023, the total value of transactions involving digital yuan reached $250 billion.

Innovations in stablecoins can strengthen the dominance of the US dollar.

What are stablecoins? Stablecoins are cryptocurrencies that are nominally pegged to stable assets such as the US dollar. [For more information on collateral types, see this article in the Financial Times.] Stablecoins can help improve the efficiency of the US payment system and consolidate the US dollar’s position as the global digital currency.

This is not just to protect Silicon Valley startups, but also to maintain America’s global leadership position. America can win by using a free market approach, rather than a centralized planning approach. This bottom-up approach will bring about many new experiments and innovations. This may be the only way to defeat central bank digital currencies (CBDCs) from countries like China.

Part 3: Policy Principles and Framework

America’s innovation-focused policies can protect consumers and provide compliance pathways for businesses.

Regulatory activities remain a top priority

a. Cryptocurrency legislation passed in the House committee for the first time in history:

• Committees Introduce Financial Innovation and Technology for the 21st Century Act, introduced by Representatives French Hill R-AR, Glenn “GT” Thompson R-PA, and Dusty Johnson R-SD.
• Clarity for LianGuaiyment Stablecoins Act of 2023, introduced by Representative LianGuaitrick McHenry from North Carolina.

b. Courts making rulings on influential cases:

Court ruling in the SEC/Ripple enforcement action; SEC’s dismissal of claims against individuals and appeal of the initial court’s legal ruling.

c. Government agencies proposing new rules:

• IRS proposed rules on reporting requirements for digital asset brokers;
• CFTC’s proposed rulemaking notice on self-certification of derivative contracts;
• FinCEN’s proposed rulemaking notice on convertible virtual currency mixers under consideration by the SEC;
• Guardianship rule amendments, as well as the definition of “exchange”;

Effective regulation can combat bad actors and protect consumers

Former legislators, agency heads, and others recommend three actions for US lawmakers:

a. Protect consumers: Require registration and regulation of centralized companies: Regulatory agencies should investigate risks arising from custody relationships, conflicts of interest, and the illicit use of digital assets in finance.

b. Provide Compliance Pathway: Any legislation should provide disclosure-based compliance pathways for entrepreneurs who are continuously building decentralized networks and legitimate businesses (despite the uncertain environment).

c. Incentivize Community Ownership: Laws and regulations should appropriately incentivize power decentralization and community ownership – a core commitment of web3 technology to benefit the public and pave the way for future innovations.

Guiding Principles and Regulations for U.S. Cryptocurrency Policy:

a. Prohibit new business models or technologies that would harm American values and promote innovation and employment elsewhere.

b. Establish institution guidance and legislation with appropriate, clear rules. This not only protects consumers but also helps promote healthy competition for everyone, including allowing new innovators to challenge entrenched regulatory powers of centralized participants and existing businesses.

c. Legitimate businesses and their customers should have access to financial services and legal protections – from banking relationships to data privacy.

d. Companies should be the focus of regulation, not the broad, decentralized, autonomous software that forms the basis for innovation. (Regulate applications, not protocols)

Misconception: Cryptocurrency is only used for illegal activities

Total Transaction Volume vs Illegal Transaction Volume

Blockchain analysis companies estimate that illegal transactions make up less than 2% of total cryptocurrency activity. As of 2022, such activity accounts for about 0.10-0.24% of all cryptocurrency activity.

Activities involving fiat money laundering far outweigh those involving cryptocurrency. It is projected that by 2021, the annual amount of cryptocurrency money laundering in traditional financial markets will be 100-250 times higher [source: Nasdaq Head of Anti-Financial Crime Technology].

Fiat money laundering methods (cash, bank wire transfers, real estate, etc.) far exceed cryptocurrency in both quantity and percentage.

Fact: Cryptocurrency can help combat crime

Compared to cryptocurrency, criminals still prefer traditional financial products and services. While criminals and terrorists are looking for any means available (including emerging technologies) to fund and carry out their activities, the U.S. Treasury Department’s 2022 National Terrorism Financing Risk Assessment found that the “limited availability of other financial products and services” – the traceability inherent in blockchain, works against these groups.

Blockchain is public, traceable, and immutable. This makes it useful in investigations, prosecutions, and asset recovery. Fiat currencies, especially cash, are difficult to trace and are still more frequently used in criminal activities.

Cryptocurrencies play a role in combating crime. Compared to fiat currencies, law enforcement agencies are very effective in tracking cryptocurrency activities (using sophisticated analysis tools), and governments worldwide have demonstrated their ability to recover funds through this method.

Misconception: All cryptocurrencies are harmful to the environment

Estimated Annual Energy Consumption by Product/Industry

Currently, other industries and companies consume far more energy than Ethereum. Why? In September 2022, Ethereum transitioned to a Proof of Stake (PoS) consensus mechanism (many developers choose to build applications on this mechanism), reducing energy consumption by 99.9%. All blockchains require such consensus mechanisms because they are decentralized; the PoS method consumes much less energy than the PoW (Proof of Work) method used by Bitcoin.

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