Builders of Web3 systems can help create a decentralized economy by making careful design choices that lead their systems to collect “value” from a wide range of sources, such as information, economic value, voting rights, and other things, and then distribute that value fairly among system stakeholders based on what they have contributed.
The possibility of decentralization has been extensively studied, from its importance to the more important problem of who will be in control of Internet software. These inquiries are crucial because, as we’ve seen, when a small group of individuals wield significant influence, freedom, choice, and privacy are often infringed. When the CEO must decide between two strategies, the phrases “don’t be evil” and “can’t be wicked” have quite different connotations.
But making the Internet less centralized has always been hard. Decentralized systems have struggled to keep up with centralized systems, which are more efficient and stable. New cryptography and Web3 technologies, like programmable blockchains, smart contracts that can be combined, and digital assets, make it possible for decentralized systems to reach levels of coordination and operational functionality that have never been seen before. This change has led to new ways of governing and organizing, networks and services owned and run by the community, strong economic systems, and many other new ideas.
We’ve seen categories like decentralized finance (“DeFi”), and core infrastructure projects take off, and soon we’ll see decentralized versions of existing web2 categories like social media, video games, music, and marketplaces. The success of these systems will depend on how well they deliver the practical benefits of decentralization, such as fairer ownership among stakeholders, less censorship, and more variety. But the familiar decentralization models used for DeFi might not work for these more complicated systems (i.e., systems with more UI features, richer client experiences, centralized products or services, or licensed IP).
So, it would be helpful to share specific models and principles of decentralization that I’ve learned from working closely with crypto project founders over the past few years. This will help Web3 builders understand what decentralization means in different situations.
Challenges of Web3 Decentralized Design
You can think of decentralization as a single design challenge that involves three different but related parts: technology, economics, and the law. Understanding the differences between these elements is important for designing Web3 systems because decisions about one component can affect other aspects.
Spreading Out Technology
Technical decentralization is mostly about how the Web3 development company system handles security and structure. The main innovation of programmable blockchains is that they can help decentralize technology by creating an ecosystem where value can be transferred and, more importantly, where Web3 products and services are built.
This means that products and services can be used and run without a trusted central intermediary. This opens up a huge world of possibilities. Because of these things, technological decentralization is the basis for both economic and legal decentralization.
The economy of the Web3 system is related to the decentralization of the economy. Programmable blockchains (like Ethereum, Solana, and Avalanche) and digital assets (like ETH, SOL, and AVAX) made it possible for open-source and decentralized systems to eventually have their decentralized economies (i.e., autonomous freedom and market economy).
This is a huge step forward. In the past, open source and decentralized protocols (like HTTP, SMTP, FTP, etc.) of technologies like web1 have stalled because they needed a way to encourage continuous development or put more important resources back into their systems. This makes it easy for Web2-centralised companies to start up and do well since they can use their efficiency and resources to make products and services that go beyond Web1. But this centralization has also led to many cases of user rights being violated and rake rates that are too high.
Now, the technologies that support Web3 make it possible to create more complex open-source and decentralized systems and allow a decentralized economy to grow around them. This will enable Web3 products and services to compete with and surpass those of web2 services.
Builders of Web3 systems can help create a decentralized economy by making careful design choices that lead their systems to collect “value” from a wide range of sources, such as information, economic value, voting rights, and other things, and then distribute that value fairly among system stakeholders based on what they have contributed. In order to do this, Web3 systems need to give system stakeholders real power, control, and ownership (via airdrops, other token distributions, decentralized governance, etc.). This gives stakeholders the power to decide how to treat and reward their contributions, making them more likely to make contributions with real value.
A constant balance of incentives between developers, contributors, and consumers can encourage more value to be added to the system, which is good for everyone. In other words, all the benefits of modern network effects without avoiding the problems of centralized control and captive economies.
The Spread of Legal Power.
The legitimacy of the Web3 system is linked to how legally decentralized it is. This post mostly discusses how and if Web3 systems can use their native digital assets based on U.S. securities laws. There is no written standard for the “decentralisation of legal power.” Still, a first-principles analysis of U.S. securities law, case law, and SEC guidance (including the SEC’s final guidance from April 2019) can help us develop practical standards.
First, the main goal of U.S. securities laws is to create a “level playing field” for trading securities by making it harder for people with more information to take advantage of people with less information. This is the idea behind asymmetric information, and U.S. securities laws often get rid of asymmetry by requiring disclosure in certain securities transactions.
This concept is included into the Howey test, a method for determining whether or not U.S. securities regulations need to be applied to transactions involving digital assets, such as:
- Currency investments.
- Ordinary businesses.
- With reasonable profit expectations.
- Based mainly on the efforts of others to manage them.
The fourth section will discuss information asymmetry. When depending on “managerial effort,” it is believed that there may be a substantial danger of knowledge asymmetry between managers and outsiders, necessitating the employment of securities legislation.
Based on what we’ve seen so far and what the SEC has said, we may presume that a Web3 system will be “sufficiently decentralized” if it can:
(a) prevent significant information gaps, and
(b) stop relying on the basic management work of others to determine the success or failure of the business.
In this article, I will call these systems “legally decentralised.” Even though most businesses can’t meet the legal threshold for decentralization, I’ll explain below how Web3 systems’ unique features make it possible for them to do so.
These three parts of decentralization—technical, economic, and legal—must be considered a single design challenge because decisions made about one part of decentralization affect the others.
Generally, the relationship between technology, the economy, and the law is additive, not subtractive. When one improves, it opens up more opportunities for the other two. a decentralized economy by prioritizing decentralized ownership among stakeholders, value appreciation from decentralized sources, and value distribution to decentralized stakeholders to help move the system toward legal decentralization. All of this makes it less likely that there will be a need for more information or that each manager will have to do their work.
How to use the Web3 system’s parts to get decentralization
When a Web3 system is set up well, decentralization becomes a good cycle instead of a bad one. Now that we have a plan for the decentralization design challenge, let’s quickly go over how builders use the following new parts of the Web3 system to drive decentralization:
The Smart Contract Protocol and the Blockchain Network
Fundamentally, smart contract protocols and blockchain networks enable the dispersion of technology. They might, however, also be developed in a way that makes the division of political and economic power easier.
Anyone may observe where the most digital assets are deposited and where the most fees are earned by permitting transparency.
As an open-source, public product, anyone can use and test features for free to ensure security, promote a decentralized economy, etc.
Web3 users keep control of their data, purchases, and content by allowing data portability, mobility, and interoperability.
By focusing on how different parts can be programmed to work together, these programs can be used as building blocks by anyone.
Together, these properties reduce the risk of information asymmetry, lessen the importance of any Web3 system knowledge, and make the system’s network of contributors and users more important than its developers.
In other words, these features move the system’s value from its technology stack to its network. Since the web is more open and decentralized than proprietary systems, this change shows why Web3 systems are better for decentralization than Web2 systems.
A combination of two factors drives the Web3 system’s decentralized economy:
Intrinsic incentives, based on the system’s core features like user base, network effects, technology, etc., make it natural for third parties to want to be a part of such systems.
External incentives include giving out digital assets, splitting profits, etc.
Digital assets are the most important tools Web3 builders need to make their decentralized economy work and keep it running. This is because they balance the incentives for developers, contributors, and consumers.
So, if digital asset distribution is done right, it could lead to a “flywheel” of network effects, in which the whole system becomes more valuable to more users as more people join the network. But unlike Web2’s network effects, Web3’s digital assets let users shape their own experiences and benefit from their contributions.
Successful user acquisition and retention can increase the intrinsic motivation of developers and contributors to a Web3 system by a large amount. This makes the system more valuable, which brings in more users, etc. The growth of Ethereum over the past two years is a good example: From early 2020 to early 2022, the value of digital assets deposited in Ethereum DeFi protocols went from just over $600 million to just over $150 billion. But that’s not a story about volume and how much it’s worth in money. Instead, it shows how developer activity can lead to products and services that bring in users, which then bring in more developers, products and services that bring in more users, and so on.
The network effects of Web3 systems could also create flywheels and give builders a way to stop competitors from copying and redeploying their infrastructure, which is all open source. How so? Because more than replication is likely to get users to switch to a new system in a system with strong network effects.
This shows again that a Web3 system’s real value will come from its stakeholder network, not its technology stack, closed or proprietary systems, or other traditional moats.
Only some power is in one place.
An example of a decentralized organization is a Decentralized Autonomous Organization (DAO), which manages the majority of blockchain networks and smart contract-based protocols.Decentralized governance and DAOs have benefits along the three decentralization standards we’ve already discussed.
Decentralized groups give technical control to Web3 systems, boosting their security. Because of this, it is more difficult for one entity to have an impact on the system.
Ensure that stakeholders’ long-term incentives are in line with one another and give them a significant role in decision-making. Together, this feature and the improved security make decentralized governance more effective, which helps the Web3 system’s decentralized economy stay healthy and strong.
It supports the decentralization of legal power by making it less likely for stakeholders to depend on the management of a single person or group. This lowers the risk of information asymmetry.
When making decentralized governance for any Web3 system, we can learn from the different models made and used in the DeFi space. E.g. subDAO (sub DAO) (sub DAO). Some days permit sub-days to do certain actions to make decisions easier (e.g., legal, financial, development, etc.).
Government is reduced. Some have recommended reducing the amount of final choices made by a DAO or creating a hierarchy where more significant decisions need more votes.This would make DeFi protocols more reliable and solve the problem of low DAO participation.
Incentivize participation. Some DAOs encourage active participation by paying delegates to ensure that DAO governance works well. Note that grant programs need to be revised here. Still, retroactive reward programs can be very effective because they wait to evaluate and reward contributions until after the value has been delivered. If they are made right, they can also help increase competition and open up markets.
More people are sharing power.Many DAOs use “progressive decentralization” to stop malicious attacks. This is when the development company gives more control to the community as protocol and network security improve.
People who build Web3 should be careful to give only a little power to those already part of it. Greater responsibility should be provided to the community in its stead. Web3 developers should search for methods to decentralize power via delegation where there is an unequal distribution of it.
To find this balance, the people who build the Metaverse development company should also consider protecting against malicious attacks, such as people trying to use decentralized governance to make money. Using off-chain governance mechanisms and multi-signature (control requires multiple multi-signature holders, each with their key to authorize actions) are common ways to protect against this. Still, they have recently come under a lot of fire, especially because they could make powerless distributed.