O'Reilly founder talks about Web 3.0: We will experience the internet bubble period of 1999 again

Original Author: Tim O'Reilly, Founder of O'Reilly

Source: The Way of the Metaverse

Recently, there has been a lot of discussion about Web3. As someone who defined "Web 2.0" 17 years ago, I am often asked to comment on Web3. However, I usually avoid doing so, as most predictions about the future have proven to be wrong. What we can do is ask ourselves some questions to help us see the present more deeply, which is the soil in which the future is rooted. As William Gibson famously said, "The future is already here — it's just not very evenly distributed."

We can also use Mark Twain's observation ("History doesn't repeat itself, but it often rhymes") as a lens to view economic, social patterns, and cycles.

Using these filters, what can we say about Web3?

Decentralization vs. Centralization

The term Web 3.0 was first used by Tim Berners-Lee, the creator of the World Wide Web, in 2006, as a vision for the next stage of the web beyond Web 2.0. He believed that the "semantic web" would be at the core of this evolution, but it did not develop as he envisioned. What people now consider the next generation of the web will be based on crypto.

The concept of "Web3" that we refer to today was proposed by Gavin Wood, one of the co-founders of Ethereum, in 2014. As Gavin Wood stated in a recent interview with Wired, his definition of Web3 is simple: "Less trust, more truth."

In making this claim, Gavin Wood compared Web3 to the original internet protocols, and Jon Postel's "robustness principle" may be the best summary of the spirit of the original internet protocols: "TCP implementations should follow the general principle of robustness: be conservative in what you do, be liberal in what you accept from others." This spirit became the foundation of a global decentralized computer network, where as long as everyone tries to follow the same protocols and tolerates deviations, no one needs to be in charge. Subsequently, the system quickly surpassed all proprietary networks and changed the world. Unfortunately, time has shown that the creators of the system were overly idealistic; they did not account for bad actors, and perhaps more importantly, they did not foresee the massive concentration of power that big data could bring, even on a decentralized network.

Wood's view is that blockchain replaces trust in the goodwill of others with built-in transparency and irreversibility in technology. As explained on Ethereum.org:

"Cryptographic mechanisms ensure that once a transaction is verified as valid and added to the blockchain, it cannot be altered. The same mechanisms also ensure that all transactions are signed and executed under appropriate 'permissions' (no one should be able to send digital assets from Alice's account except Alice herself)."

The documentation on Ethereum.org continues:

"Web2 refers to the version of the internet that most of us know today, which is dominated by companies that provide services in exchange for your personal data. In the Ethereum environment, Web3 refers to decentralized applications running on the blockchain. These applications allow anyone to participate without having to monetize their personal data."

Crypto enthusiast Sal Delle Palme boldly states:

"We are witnessing the birth of a new economic system, characterized and purposefully designed by hundreds of millions of people around the world in a transparent manner. Web3 welcomes everyone to participate."

I appreciate the idealism of the Web3 vision, but we have harbored such dreams before. Throughout my career, we have experienced several cycles of "decentralization" and "re-centralization." Personal computing achieved decentralized computing by providing a commodity PC architecture that anyone could build and that no one controlled, but Microsoft figured out how to re-dominate the industry around proprietary operating systems. Open-source software, the internet, and the World Wide Web broke the chains of proprietary software with free software and open protocols, but within decades, Google, Amazon, and others established massive new monopolies based on big data.

Clayton Christensen summarized this pattern as the law of attractive profit conservation:

"When attractive profits disappear at some stage of the value chain because products become modularized and commoditized, the opportunity to earn attractive profits through proprietary products typically appears at adjacent stages."

Blockchain developers believe they have found a structural answer to "re-centralization" this time, but I tend to be skeptical. An interesting question is what the next point of centralization and control might be. The rapid consolidation of Bitcoin mining into the hands of a few, through reduced computational energy costs, is one form of re-centralization, and there may be other forms as well.

Hype Cycles

The early writings from the Ethereum community provided a cautious assessment of the trade-offs and challenges for the future of Web3, but today, most popular accounts revolve around hype and financial speculation. A recent article in The New York Times provides an example:

"Venture capitalists are betting billions to create an alternative world of finance, commerce, communication, and entertainment on the web, which could fundamentally change the major elements of the global economy, all built on blockchain technology popularized by Bitcoin."

The article also mentions that crypto supporter Andreessen Horowitz (A16Z) has made a series of investments in areas such as gaming, decentralized finance, NFTs, and decentralized social networks. All the examples in the article focus not on the utility of the content created but merely on the possibility that they will make investors and creators wealthy.

Moreover, it is not just mainstream media that has suffocated reporting on the money to be made, as if creating actual value is irrelevant. The stories of those who have fallen into the "crypto rabbit hole" are compelling on the theme of acquiring wealth:

"One of the great advantages of crypto is how it democratizes investment opportunities. For example, people can now easily access 95 vetted crypto assets through Kraken. If you are tech-savvy enough, you can directly invest in over 1,150 crypto assets, each with a market cap exceeding $10 million (as of this writing) …

To gain access to early-stage venture capital deals in the tech sector, you traditionally had to gain recognition and connections in Silicon Valley. Theoretically, the only real barrier to entry into crypto should be awareness …"

Let me repeat: whether through venture capital investment or easy access to high-risk, highly inflated assets, one cannot predict the lasting success and impact of any particular company or technology. Remember the internet boom and the subsequent bust? Legendary investor Charlie Munger of Berkshire Hathaway recently pointed out that we are in a "crazier time than the internet era."

Cryptocurrency is likely the future of finance, but it is currently difficult to see what is truly working and how much smoke is being blown away. Yes, exchanges like Coinbase have made a lot of money, but unlike traditional financial exchanges, what they trade is not a universal currency but a class of speculative assets that may be severely overvalued. Blockchain has also not replaced trust as Gavin Wood hoped. Binance, the largest crypto asset exchange by trading volume, is under investigation for tax fraud and money laundering. A recent article's headline also pointed out, "A small group of insiders is reaping most of the rewards from NFTs."

If Web3 is to become a universal financial system or a universal system of decentralized trust, it needs to develop strong interfaces with the real world and its legal systems and operating economies. The story of ConstitutionDAO illustrates how difficult it is to build bridges between the world of Web3 crypto assets and non-Web3 assets. If this constitutional DAO (Decentralized Autonomous Organization) successfully purchased a rare copy of the U.S. Constitution at auction, its members would not have legal ownership of the actual object, nor would they have clear governance rights over what might happen. It would be owned by a limited liability company set up by the project initiators, and when the DAO failed to win the bid, this company even had trouble refunding its supporters.

The failure to think through and establish interfaces with existing legal and business mechanisms stands in stark contrast to previous generations of networks, which quickly became digital shadows of everything in the physical world—people, objects, places—where interconnected businesses could easily create new services with economic value in the existing economy. Speculative crypto assets are easy to make money on, which seems to distract developers and investors from striving to build useful real-world services.

That is not to say that there are no real opportunities in Web3 beyond financial speculation. Crypto is well-suited for pure digital assets that can be valued and used in a self-sufficient world, such as computer games or the long-desired metaverse. There may be opportunities in the digital art market and sports events, as Sal Delle Palme said, "New applications of crypto, such as NFT markets, DAOs, DeFi, DEX, CeFi, GameFi, DeSo, etc., are being invented, funded, and built, and are developing at an astonishing pace."

But we have a long way to go before the birth of a completely new economic system.

Of course, crypto and Web3 are just a reflection of today's speculative excess. Many startup valuations are also sky-high, and whether those valuations accurately measure the actual value being created is completely unclear. They are likely just a scam benefiting a few insiders, much like the financial instruments that made so many Wall Street people wealthy just before the world economy nearly collapsed in 2009. Therefore, as Matt Stoller recently wrote, "Web3 is a pile of bullshit; the question is, compared to what?"

The current economic system is also rife with fraud, and it also favors manipulation by insiders! The Web3 dreamers behind projects like Celo are right; we do need a new economic system.

Two Bubbles

The Dutch tulip mania from 1634 to 1637 is a classic example of a significant disparity between the nominal financial value of an asset class and its intrinsic value. When the bubble burst, tulips reverted to being flowers, and while beautiful, they were no longer worth anything, having no lasting impact on the prosperous Dutch economy. Many speculative bubbles have occurred since then, most of which have faded into the background noise of history.

However, economist Carlota Perez pointed out another type of bubble in her book "Technological Revolutions and Financial Capital." She noted that almost every major industrial transformation (the First Industrial Revolution, the age of steam power; the age of steel, electricity, and heavy machinery; the age of automobiles, oil, and mass production; and the internet) has been accompanied by a financial bubble.

In her analysis, Perez identified four stages in each of these 50-60 year innovation cycles. In the first stage, there is foundational investment in new technologies. This gives way to a speculative frenzy, where financial capital seeks sustained excess returns in a rapidly developing market that is beginning to consolidate. After the speculative bubble bursts, there is a more prolonged period of consolidation and market correction (including regulation of excess market forces), followed by a mature "golden age" where new technologies are integrated into society. Ultimately, as technology matures sufficiently, capital will shift elsewhere to fund the next nascent technological revolution, and the cycle will repeat.

An important conclusion from Perez's analysis is that a true technological revolution must be accompanied by the development of substantial new infrastructure. For the First Industrial Revolution, this included canals and road networks; the Second Industrial Revolution involved railroads, ports, and postal services; the Third involved electricity, water supply, and distribution networks; for the oil age, it was interstate highways, airports, refining and distribution capabilities, hotels, and motels; for the information age, it was chip manufacturing plants, ubiquitous telecommunications, and data centers.

Most of the funding for this infrastructure development comes during the bubble phase. As Perez states:

"Perhaps the key role of financial bubbles is to promote the inevitable over-investment in new infrastructure. The nature of these networks is that unless they achieve sufficient coverage for widespread use, they cannot provide enough service to be profitable. Bubbles provide investors with the necessary asset inflation, allowing them to anticipate capital gains, even when there are currently no profits or dividends."

Thus, we have seen canal bubbles, railroad bubbles, and of course, the internet bubble. The frenzy of inefficient investment has left behind dark fiber, empty data centers, and a wealth of talent and proprietary technology that can be reused in the consolidation phase.

In Perez's narrative, many smaller technological cycles are merged into one cycle. Considering the history of modern digital computing, it has gone through several stages, each dominated by a new generation of technology: mainframes, personal computers, the internet and the World Wide Web, smartphones, and now possibly cryptocurrencies and the metaverse. Each has its own cycles of innovation, speculation, bust, and maturation.

So, is what we call Web3 the foundational investment phase of a new sub-cycle, or is it the bubble phase of the previous cycle? In my view, one way to judge is the nature of the investments. Is abundant financial capital building useful infrastructure in the way we saw in previous cycles?

I am not sure if NFTs meet that criterion. However, there is no doubt that the disruption of finance (just as the internet has disrupted media and commerce) will represent the next significant phase of the current technological revolution cycle. Particularly, if capital can be effectively allocated without the trust and authority of large centralized capital providers (what could be called "Wall Street"), that would be a fundamental advance. What I am looking for in this regard is evidence of capital being allocated to productive investments in the operating economy through cryptocurrencies, rather than evidence of capital being allocated to fictitious assets. Let me know if you have good examples.

To clarify what I am saying, let me set crypto and Web3 aside and look at another technological revolution: the green energy revolution. It is clear that bubble valuations are currently funding the development of lasting infrastructure. Elon Musk has been a master of Tesla stock speculation (a year or two ago, Tesla stock was once valued at 1,500 years of the company's profits!), transforming it into an international electric vehicle charging network, battery gigafactories, and autonomous driving capabilities, and has been pushing the entire industry to chase his vision of the future. Jeff Bezos has also leveraged Amazon's massive valuation to build new instant commerce infrastructure. They are both investing in the infrastructure of the commercial space industry.

When assessing the current market's hype around Web3, I would also compare the use of cryptocurrencies for other functions in the financial system (purchasing, remittances, etc.) with traditional banking networks and other emerging technologies. For example, are Ripple and Stellar's cross-border remittance platforms more successful than bank transfers, credit cards, or PayPal, just as Google Maps is better than Rand McNally or first-generation GPS pioneers like Garmin? There is some evidence that crypto is becoming a meaningful player in this market, although regulatory hurdles are slowing its adoption. What about payments more generally? How does the growth compare with non-crypto payment startups like Melio, which focus on small business use cases? Given the interest of companies like Square (now Block) and Stripe in crypto, they could tell us a lot about crypto's progress relative to more traditional payment mechanisms.

Similarly, if Web3 is to become the future of identity or social media, we need to ask ourselves what evidence exists to show that adopting Web3 is genuinely better than previous generations of internet technologies. And I believe that current reporting in this area has covered very little of such information.

Where Are We in the Cycle?

Some may ask whether the current stage of Web3 is more like 1995 or 1999 (i.e., the early stage of the bubble or the end stage)? Given the current valuations of crypto assets (compared to typical tech startups), it is hard to argue that it is in the earlier period.

I would like to remind people that I once mentioned in my article "What is Web 2.0" that five years after the internet bubble burst, its explicit goal was to explain why some companies survived while others did not. Similarly, I suspect that we will not truly understand the components of Web3 (if any) until after the next bubble bursts.

Since the last bubble, in addition to the technological and business model changes I attempted to capture in "What is Web 2.0," I can offer some pragmatic observations:

1. All the surviving companies are making money, and while their valuations are also high, they are supported by reasonable models of future earnings and cash flow.

2. By today's standards, they did not need to raise massive amounts of capital. (Yahoo's total investment before its IPO was $6.8 million, Google's was $36 million, and Amazon's was $108 million.) When you see some companies repeatedly seeking funding from investors without ever achieving profitability, they may not be real businesses and are better viewed as financial instruments.

3. They all had millions, then tens of millions, then hundreds of millions (eventually billions) of daily active users for new services that changed the world.

4. They all established unique, substantial, and lasting assets in the form of data, infrastructure, and differentiated business models.

5. The next generation of companies dominating the tech space were not all newcomers; Apple and Microsoft easily transitioned to the next generation, with Apple even leading that transition.

Keep in mind that it was still early when the internet bubble burst. Google Maps had not yet been invented, nor had the iPhone or Android. Online payments were still in their infancy. There was no Twitter or Facebook. No AWS or cloud computing. Most of what we rely on today did not exist.

I suspect the same is true for crypto; there is still much to be created. Let us focus on the parts of the Web3 vision that are unrelated to easy wealth and concentrate on solving the challenges of trust, identity, and decentralized finance. Most importantly, let us focus on the interfaces between crypto and the real world of people's lives, as Matthew Yglesias said when discussing housing inequality, "Over time, society becomes wealthy by accumulating a stock of long-term capital goods."

If, as Sal Delle Palme said, Web3 heralds the birth of a new economic system, then let it be a system that truly increases wealth, not just paper wealth for those fortunate enough to benefit, but real goods and services that will make everyone's life better.