a16z analysis: How will "decentralized identity" expand on-chain reputation value? What infrastructure is being established?

Authors: Scott Kominers, Associate Professor at Harvard Business School, Jad Esber, Co-founder of Koodos
Original Title: With Decentralized Identity, Your Reputation Travels With You Across Cyberspace, a16z
Compiled by: Richard Lee, Chain Catcher
Web3 has a premise that every internet user has a unique internet identifier (similar to an email address) that can be linked locally to any software while being stored on a blockchain network. As part of "decentralized identity," a person's online activities will be "on-chain," meaning they are public and can be easily searched through an individual's crypto wallet.
With such a decentralized identity—an accessible history unique to each individual—a person's crypto wallet will serve a role similar to a "profile" on Facebook or LinkedIn. However, unlike Web2 profiles, decentralized identities have concrete evidence backing them: permanent, timestamped records of a person's achievements, contributions, interests, and activities to date.
If decentralized identity is widely adopted, people will be able to carry and showcase their complete selves while traversing different cyberspaces: everything they create, contribute, earn, and own online on any platform reflects their preferences and experiences. This will bring us closer to how things operate in the material world—property and reputation are tied to ourselves, not to platforms, and we can carry and use them freely.
While this may sound far-fetched today, the real opportunity in this space lies in using on-chain reputation for off-chain purposes. For example, in the creator economy, we might see a Web3 version of YouTube, where videos do not belong to the platform but to the creators. Thus, creators can take their videos to any online space and gain any value associated with those assets. Similarly, on-chain data can be used to measure user engagement or interest levels in specific creators or brands. For instance, music artists can easily identify their top fans based on on-chain interaction data and reward them with privileges. In finance, decentralized identity can help achieve internet-native credit scoring, which could be used for issuing loans, user background checks, and building credit.
From Web2 to Web3: The Shift from Fleeting "Likes" to Building Long-term Reputation
Unlike most Web2 profiles, decentralized identities are not ephemeral. For example, this means that the diploma NFT in your crypto wallet will become a permanent academic certificate. Similarly, every piece of content you post online will be permanently linked to you (unless you choose to delete it). Furthermore, with a public historical record, you can prove that you were involved in a trend or project long before it became popular, such as being a fan of Taylor Swift before she was famous or reading this article when Web3 was still in its infancy.
This permanence establishes new incentives for building reputation: Web3 promotes long-term thinking rather than creating temporary profiles as we do in Web2. If people have the right to establish and maintain a permanent identity online, we believe on-chain systems can encourage individuals to manage their online footprints more carefully—these may be carried into future reputation markers. In this case, managing a permanent NFT library is riskier than posting a series of social media updates, as it serves as a reputation marker you will carry in cyberspace.
The Infrastructure Needed for Decentralized Identity
If decentralized identity is the future of the internet, then the contributions you accumulate in your crypto wallet—your written articles, curated content, or purchased items—will become very important. They will embody your online persona and serve as the foundation of your reputation.
However, to make decentralized identity mainstream, we must first establish systems that map people's relevant off-chain experiences to their on-chain social relationships. Then, we must create mechanisms to standardize and process the data streams that will be added to the chain and prioritize them. In this process, we need to address the unique challenges of decentralized identity, including the lack of contextual information about on-chain records and issues related to accessing decentralized networks.
On this basis, given the public and queryable nature of decentralized identity, we will be able to bring on-chain reputation into real-world activities, allowing us to begin exploring the many use cases it can trigger.
(1) Mapping Off-chain Experiences and On-chain Social Relationships
Currently, blockchain technology is mostly used for financial transactions and is often not user-friendly for the average consumer. To make decentralized identity practical and popular, it is important to introduce entry points for people to record their experiences and social relationships on blockchain networks, such as their educational achievements, professional accomplishments, or fan relationships. Some companies are already addressing this challenge. Violet is dedicated to verifying off-chain personal identity information on-chain. Rabbithole, Polywork, and 0xStation allow users to record their professional achievements on-chain. Koodos enables the aggregation of various on-chain relationships, allowing individuals to convert any content on the internet into customizable NFTs, creating a meaningful collection that reflects their online identity. (Conflict of interest disclosure: Author Esber co-founded Koodos, and Kominers provides market design advice for the company.)
There are two ways to record people's on-chain activities and social relationships: actively and passively. The Proof of Attendance Protocol (POAP) allows event organizers to generate tokens that participants can collect, which is a form of active recording. When people claim these tokens, they intentionally record a "life event" on-chain, making it part of their digital identity. Similarly, people may actively prove others' skills, character traits, or achievements by sending tokens, which can be verified through peer review or on-chain activity assessments.
Alternatively, when a person's wallet interacts with an application or website, information about these interactions may be passively recorded. For example, if your wallet is connected to Discord and you earn server badges, those badges can be added to your on-chain collection.
(2) Processing Reputation Data and Data Standards
Once all this identity data is recorded on-chain, we will need appropriate systems to organize and interpret it, ensuring that the data itself is meaningful to the wallet holders and those interacting with them. Since wallets are also used for ordinary content storage and transactions, this task is particularly challenging: wallets accumulate a large amount of mixed data.
To simplify logic (also because different aspects of a person's identity naturally overlap and interact), it makes sense to store a person's relevant activities and contributions in the same wallet. However, any specific person is not just a creator, builder, investor, or collector; they are many things at once. Therefore, we need a way to extract part of their decentralized identity and present it to different audiences in various digital spaces. Imagine a design where the overall content of the wallet is confidential, but accessing specific aspects of a person's reputation requires specific keys.
Having a more advanced version of Etherscan (the transaction search engine on the Ethereum blockchain) would also be useful, allowing users to view all interactions of a wallet in a specific category of activities, such as community service-related activities.
In addition to organizing raw data, it is important to have a system that can aggregate and simplify wallet information, making it clearer and easier to compare. A recent example is the DeGen score, a system for measuring users' "obsession with cryptocurrency," which aggregates all transaction information within wallets as a data source. At the same time, Ceramic helps applications track large volumes of variable data and encode relevant information on-chain, enabling viewers of the data to compare people's contributions to different projects at a higher level.
Managing reputation information also requires publicly accessible data standards—agreed-upon data formats, such as "what a proof of contribution looks like" or "how to represent an on-chain record." Structuring these input data ensures interoperability: (1) allowing people to meaningfully combine "identity" information from different services, and (2) minimizing friction that may arise when platforms interact with different aspects of an individual's on-chain reputation.
Challenges in Mainstreaming Decentralized Identity
Of course, establishing the aforementioned decentralized identity system presents inherent challenges. Existing technologies for recording input information are often very primitive—mostly limited to transaction history—while something as subjective and complex as "identity" will require more contextual information. Contextual information explains why you obtained or purchased a particular piece of art. For example, an NFT earned for contributions to a project should provide background information on why you were able to earn it and what skills you demonstrated. An event of purchasing digital art should include the reasons for your purchase, how it made you feel, or your thoughts.
A system built on permanence also poses challenges regarding evading past identities, which is evident in today's credit scoring and other long-term reputation mechanisms. It may mean you can never escape your mistakes.
Moreover, current crypto wallets are nearly incapable of preventing data loss or leakage. Before crypto becomes the mainstream repository for identity and reputation, it needs to provide the security protections we have come to expect.
More broadly, expanding access to sources of on-chain reputation information is also crucial. Currently, cryptocurrencies tend to favor the wealthy, male, and white. If the competitive environment for establishing on-chain identities is not fair, this new source of reputation will primarily benefit the privileged class, exacerbating existing social and socioeconomic divides.
Decentralized Identity Will Bring Downstream Opportunities
Despite these challenges, we still believe that on-chain reputation will unlock a wide range of use cases. The following explores some of these uses, but we believe many more are beyond our imagination. By moving "identity" on-chain, we can disrupt outdated financial processes and provide equitable access to capital, redesign how talent matches with projects, and offer a new paradigm for online identification and compensation for labor.
Traditional financial systems make it difficult to form or even access a person's credit record. Meanwhile, the portability and accessibility of decentralized identity can significantly disrupt how our reputations are used in the current financial system. For example, decentralized identity can help achieve internet-native credit scoring, unlocking various financial use cases such as issuing loans, user background checks, and building credit.
Additionally, unlike existing credit scoring systems, on-chain systems can easily traverse borders and applications. However, careful consideration is needed regarding how users can add contextual information and curate their permanent public historical information to avoid undue bias. Avoiding being expelled from the digital world is important, as it can hinder your ability to secure future housing.
In the talent recruitment field, decentralized identity, based on granular records of professional activities and achievements, guarantees "open CVs." This can provide a more comprehensive understanding of someone's past work and offer deeper insights into their skills and contributions.
While recording and storing this level of professional activity may be complex, aggregating such activity data on-chain will be executed faster than static user-generated professional profiles on LinkedIn. This opens up use cases for facilitating talent matching. Imagine another version of Behance—a designer's portfolio filled with projects that can be automatically tracked and verified, enabling direct hiring mediated by blockchain.
Moreover, there is an entire class of applications using on-chain reputation to incentivize new forms of creation or contribution. It has been challenging to identify leading projects so far. By tracking a person's contribution activities on the internet through decentralized identity, we will be better able to measure someone's early engagement with a topic or trend and the value of their contributions to that topic. For example, Startupy encourages experts to contribute entrepreneurial knowledge and gain reputation that radiates across the internet in specific fields.
The vast amount of information stored on-chain could even disrupt the search and discovery of massive markets. The public and queryable nature of decentralized identity will support a range of matching algorithms, whereas previously, matching algorithms could only be developed by those with access to our data. Furthermore, until now, we have only been able to measure how much value people associate with content based on basic engagement metrics, such as the time they spend on an app or whether they clicked "like." If we better understand people's willingness to pay for different content, we will better understand their engagement or interest levels.
Additionally, if every piece of content on the internet is truly combinable or remixable, it becomes possible to determine which content will inspire further creation or is the most meme-able. This will provide a new way to present content, similar to TikTok's system. Finally, perhaps the most disruptive aspect is that creators themselves can become new platforms for discovery—especially through token models for incentivization.
If we move towards an internet where "identity" is tied to individuals rather than scattered across isolated spaces, we will be closer to how things operate in the real world: our online property will belong to us, and we will be able to present our complete, authentic selves in cyberspace.
Note: This article is the second part of a series on Web3 reputation systems; the first part can be found in a16z's latest research: A Reputation-Based Dual Token Economic Model | Chain Catcher. Chain Catcher republishes for educational purposes and does not represent its views.