Read-Write-Own: How to Invest in the Web3 Ecosystem

At the peak of 2021, the global cryptocurrency market was worth $2.8 trillion — up nearly 6x from the year before. This growth was catalyzed by the hyper-adoption of crypto sectors like DeFi, where users can earn 100x more yield than a savings account, NFTs, which allow you to create one-of-a-kind digital collectibles, and DAOs, enabling online communities to deploy billion-dollar treasuries. 

The version of the internet that became available to everyday consumers in the '90s is called Web1. Because one of the first use cases for the internet was digitizing print media, Web1 sites were mostly limited to static content like news, telephone directories, and classified ads (think Craigslist, Yahoo!, and AOL). 

Increased internet speeds and developer tooling gave rise to Web2 after the dot-com boom, with the primary differentiating factors of Web2 being interactivity and socialization. Web2 made it so that everybody could create content through personal websites and social media, even though most users made little to no money off their work. Instead, Web2 giants like Google, Facebook, and Apple found ways to extract value from users by selling their personal data, and third-party developers by charging hefty commissions on app purchases. These monopolies have been criticized for limiting, censoring, and banning users on a whim while facing zero to no repercussions for privacy violations and data leaks.

Okay, a quick recap: Web1 gave users read-only content while Web2 allowed users to read and write at the expense of their privacy and fair compensation. This is where Web3 comes in.

The next iteration of the internet, Web3, is empowering users to read and write content while fully owning their data and assets via blockchain technology. 

This shift introduces a number of benefits, like Web3 users being able to selectively share or monetize their own data. And instead of relying on centralized parties, Web3 users can now own tokens that give them voting power over their preferred platforms. 

Now one of the main arguments against Web3 adoption is that end-users don’t actually care about digital ownership. The thing is, the Web3 revolution doesn’t hinge on consumers suddenly cozying up to decentralized ideals. 

On the contrary, it’s developers, entrepreneurs, and creators who will gradually bridge consumers over to Web3 (in some cases without them even knowing). Just think about it: Why would any founder want their business to be at the mercy of Web2 monopolies that can censor, ban, limit, and extort them? Only if there’s no cost-effective alternative. But with VCs like A16z’s pumping over $7.6 billion into this space, it's possible that infinitely scalable Web3 technologies are only years away now.

So now that we understand the monetary power Web3 holds, let’s take a look at the types of protocols, networks and applications that are building it out.  

Beyond ownership, the power of Web3 lies in its composability and interoperability. The chart above from Coinbase shows how this works. Composability refers to the ability to leverage protocols and assets as building blocks for higher-order applications. For instance, taking advantage of TCP/IP to build the Ethereum network, and then using its blockchain to create the ERC-20 token MANA, which in turn enables users to trade in Decentraland’s virtual world.

As you can see, composability allows developers to build great products faster, which ultimately draws more users to the space. All this is to say that investing in the Web3 ecosystem requires you to understand its composable building blocks.

Layer 0

Layer 0 (L0) consists of platform-agnostic protocols and virtual machines that provide the necessary capabilities for building blockchain networks. 

Examples include Inter-Blockchain Communication Protocol (IBC), which allows blockchains to talk to each other, and WebAssembly (Wasm), a virtual machine for running blockchain code in web browsers. In most cases, Layer 0s aren’t directly investable assets, but they can point you in the direction of platforms with high adoption. IBC, for instance, is part of the Cosmos ecosystem.

Layer 1

Layer 1s (L1s) refer to blockchain platforms like Bitcoin and Ethereum, which maintain a distributed ledger while allowing applications and tokens to be built on top of them. 

Most blockchain developers today are working on Layer 1s for one of two reasons. The first is that Layer 1s capture most of the value in the Web3, as evidenced by the top 10 list of cryptocurrencies by market cap. The second reason is that all Layer 1s are all currently limited by the blockchain trilemma, which is the main bottleneck to crypto’s mainstream adoption.

Layer 2

Layer 2 (L2) refers to add-on technologies that primarily make Layer 1s more scalable. Bitcoin, for instance, has the Lightning Network for faster and cheaper transactions. Ethereum, on the other hand, has a range of scaling solutions like Polygon, Arbitrum and Optimism. Cross-chain bridges that allow other platforms to port their tokens to and from Ethereum or another network are also considered L2s.

Layer 3

Layer 3 consists of decentralized applications (dApps) that are highly reliable at doing a specific task. In some cases, these are stand-alone apps that users can interact with directly (e.g. Uniswap). But for the most part, Layer 3s function as components that developers can choose to incorporate into their consumer-facing apps.

A few of these L3s include:

• Lending protocols: Compound, Aave
• AMMs: Uniswap, Bancor
• Storage solutions: Arweave, Filecoin
• Identity solutions: Ethereum Name Service, Spruce 
• DeFi Aggregators: Yearn Finance, 1inch Network

It’s also worth noting that most of these components are built on Ethereum. 

Layer 4

Layer 4 is the top-most layer of the stack and usually serves as the entry point in a user’s Web3 journey. To that end, many Layer 4s try to compete on the best UX and customer support rather than technological capabilities.

This layer is made up of apps like:

• Browsers: Brave, Opera
• Wallets: Metamask, Phantom
• Games: Axie Infinity, Decentraland
• Social platforms: Lens Protocol, Twitter (with their NFT profile pictures, BTC tips)
• Marketplaces: OpenSea, Rarible
• Discovery sites: DappRadar, Coinmarketcap
• DeFi dashboards: DeFi Saver, Instadapp

As you can gather from the ecosystem map above, Web3 doesn’t only involve cryptocurrencies but traditional companies too (e.g. MetaMask).

This means that Web3 investors have two overarching asset classes to choose from: equities and digital assets. But there’s no need to limit yourself to one asset class or the other though since adding a bit of both has diversification benefits. 

Here’s a four-step process you can use to construct your Web3 portfolio:

1. Decide whether you want to be a passive or active investor.
2. Choose the individual companies and projects you want to invest in.
3. Choose your asset allocation based on conviction or risk tolerance.
4. Monitor and rebalance your portfolio on a regular basis.

Let's dive into each step.