Web 2.0 definitor Tim O'Reilly: Why is the excitement about Web 3 premature?

Author: Tim O'Reilly

Compiled by: Metaverse Wormhole

Editor's Note: O'Reilly's personal brand influence globally is undeniable. Wired magazine calls him a trend watcher, Inc. describes him as a Silicon Valley prophet, and the Huffington Post has named him a thought leader for several years in a row. He ranks 17th on eWeek's list of the "100 Most Influential People in IT." Former Google CEO Eric Schmidt said he has the ability to spawn an industry. As a definer of Web 2.0, he has some unique insights into the currently popular tech concept of Web 3.0, and the following are his views.

Recently, there has been a lot of discussion about Web3, and as someone who defined "Web 2.0" 17 years ago, I am often asked to comment. I usually avoid doing so because most predictions about the future are wrong. However, what we can do is ask ourselves some questions that help us see the present more deeply, which is the soil of the future. As William Gibson famously said, "The future is already here—it’s just not very evenly distributed." We can also examine economic and social patterns and cycles, with Mark Twain's observation being: "History doesn’t repeat itself, but it often rhymes."

Next, we will explore what comments can be made about Web3 using several subheadings.

Decentralization vs. Centralization

In 2006, Tim Berners-Lee, the creator of the World Wide Web, used the term Web 3.0 as a vision for the next stage of the web after Web 2.0. He believed that the "semantic web" would be at the core of this evolution. But that has not been the case. The reasoning now presented is that the next generation of the web will be based on cryptography.

What we today think of as "Web3" was proposed by Gavin Wood in 2014, who is one of the co-creators of Ethereum. Wood's succinct definition of Web3, as he stated in a recent interview with Wired magazine, is simple: "Less trust, more truth."

In making this assertion, Wood compared Web3 to the original internet protocols, the spirit of which can perhaps be summarized by Jon Postel's "Robustness Principle": "Be conservative in what you do, be liberal in what you accept from others." This spirit became the foundation of a globally decentralized network of computers, where as long as everyone made an effort to follow the same protocols and was tolerant of deviations, no one needed to be in charge. This system quickly surpassed all proprietary networks and changed the world. Unfortunately, time has shown that the creators of this system were too idealistic, failing to account for bad actors and, perhaps more importantly, not foreseeing that big data would enable massive power concentration, even atop a decentralized network.

Wood's view is that blockchain replaces trust in the good intentions of others with 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 afterward. The same mechanisms also ensure that all transactions are signed and executed with appropriate "permissions" (except for Alice herself, no one can send digital assets from Alice's account).

The documentation on Ethereum.org continues:

Web2 refers to the version of the internet that most of us know today. An internet dominated by companies that provide services in exchange for your personal data. Web3, in the context of Ethereum, refers to decentralized applications running on the blockchain. These applications allow anyone to participate without monetizing their personal data.

Cryptocurrency enthusiast Sal Delle Palme puts it more boldly:

We are witnessing the birth of a new economic system. Its characteristics and tenets are only just being designed and refined in a transparent manner by millions of people around the world. Welcome to participate.

I appreciate the idealism of the Web3 vision, but we have been through this before. In my career, we have experienced several cycles of decentralization and re-centralization. Personal computers achieved decentralization of computing by providing a commodity PC architecture that anyone could build. But Microsoft figured out how to re-centralize the entire industry around a proprietary operating system. Open-source software, the internet, and the World Wide Web broke the chains of proprietary software, but within decades, companies like Google, Amazon, and others have built massive new monopolies based on big data.

Clayton Christensen summarized this pattern as the law of attractive profit conservation: "When attractive profits disappear at one stage of the value chain because products become modular and commoditized, the opportunity to earn attractive profits with 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 site of centralization and control might be. By lowering the energy costs of computing, Bitcoin mining quickly consolidated into the hands of a few, indicating a form of re-centralization. There will be others.

Hype Cycles

Early articles from the Ethereum community provide a measured assessment of the trade-offs and future challenges of Web3, but today, most popular discourse is filled with the allure of 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 global economy— all built on blockchain technology promoted by Bitcoin.

Next comes a series of investments from cryptocurrency supporter Andreessen Horowitz, covering areas such as gaming, decentralized finance, NFTs, and decentralized social networks. The examples in the article focus not on the utility of what is created but rather on the potential for them to make investors and creators wealthy.

It’s not just mainstream media that is making a big deal about the money to be made, as if the actual creation of value doesn’t matter. The stories of those who have already entered the "cryptocurrency rabbit hole" are compelling when it comes to the question of wealth acquisition.

One of the great things about cryptocurrency is how it democratizes investment opportunities. For example, people can now easily access 95 vetted cryptocurrency assets through Kraken. If you are tech-savvy enough, you can directly invest in over 1,150 global crypto assets, each with a market cap of over $10 million (as of this writing)…. Traditionally, to get in on early-stage startup investment deals in tech, you needed to be recognized and connected in Silicon Valley. Theoretically, the only real barrier to entry into cryptocurrency should be knowledge….

Follow me as I repeat: Neither venture capital investment nor easy access to high-risk, highly inflated assets can predict the lasting success and impact of a company or technology. Remember the boom and subsequent bust of internet companies? Legendary Berkshire Hathaway investor Charlie Munger 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 effective, as there is a lot of smoke being blown. Yes, exchanges like Coinbase are making a lot of money, but unlike traditional financial exchanges, what is being traded is not a universal currency but a potentially severely overvalued speculative asset class. Blockchain has not replaced trust as Gavin Wood hoped. By trading volume, the world's largest cryptocurrency exchange, Binance, is under investigation for tax fraud and money laundering. A recent headline noted, "A small group of insiders is reaping most of the profits from NFTs." The interface between cryptocurrency and the existing financial system has matured, making it ripe for abuse.

If Web3 is to become a universal financial system or a universal system of decentralized trust, it needs to develop robust interfaces with the real world, its legal systems, and operational economies. The story of ConstitutionDAO illustrates how difficult it is to build bridges between the self-referential world of crypto assets purchased with cryptocurrency and the operational economic systems that connect the utility of Web3 assets with actual ownership or non-Web3 assets. If the DAO (Decentralized Autonomous Organization) successfully purchases a rare copy of the U.S. Constitution at auction, its members will not have legal ownership of the actual item, nor will they have clear governance rights over what may happen to it. It will be owned by a limited liability company set up by the people who initiated the project. And when the DAO fails to win the bid, that limited liability company may even struggle to return the money to its supporters.

Failing to think through and establish interfaces with existing legal and business mechanisms stands in stark contrast to previous generations of the web, which quickly became digital shadows of everything in the physical world—people, things, places, businesses—whose interconnections made it easy to create new services of economic value in the existing economy. The hype around cryptocurrency assets makes it easy to make money, which seems to distract developers and investors from the hard work of building useful real-world services.

This is not to say that there are no real opportunities beyond financial speculation in Web3. Cryptocurrency is very suitable for digital assets that can be valued and used in a standalone world, such as computer games or the much-anticipated metaverse. There may be opportunities in the digital art market and sports highlights. As Sal Delle Palme said, "New applications of cryptocurrency, such as NFT markets, DAOs, DeFi, DEXs, CeFi, charities, GameFi, DeSo, etc., are being invented, funded (often through crowdsourcing), built, and delivered at an astonishing pace." But we are still far from the birth of a whole new economic system.

Of course, cryptocurrency and Web3 are just a small part of today's speculative excess. Current valuations of startups are also absurdly high, and it is unclear whether these valuations accurately measure the actual value being created. They are likely just a scam that benefits a few insiders, much like the financial instruments that made 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 dog shit. The question is, compared to what?" The current economic system is rife with fraud and is manipulated to benefit insiders! The Web3 dreamers behind projects like Celo are right. We do need a new economic system.

Two Types of Bubbles

The Dutch Tulip Mania from 1634 to 1637 is a classic example of the vast difference between the nominal financial value of an asset class and its intrinsic value. After the bubble burst, tulips returned to being just flowers—beautiful but no longer valuable, with no lasting impact on the prosperous Dutch economy. Many speculative bubbles have appeared since then, most of which have faded into the background noise of history.

However, there is another type of bubble that economist Carlota Perez pointed out in her book "Technological Revolutions and Financial Capital." She noted that almost all significant industrial transformations in the past— the First Industrial Revolution; the age of steam; the age of steel, electricity, and heavy machinery; the age of automobiles, oil, and mass production; and the internet—have been accompanied by a financial bubble.

Perez pointed out that in these 50-60 year innovation cycles, each stage has four phases. In the first phase, there is foundational investment in new technologies. This gives way to speculative frenzy, where financial capital seeks sustained excess returns in a rapidly evolving market that is beginning to consolidate. After the speculative bubble bursts, there is a more sustained period of consolidation and market correction (including regulation of excessive market power), followed by a "golden age" of new technologies being integrated into society. Ultimately, the technology matures enough that capital shifts elsewhere to fund the next nascent technological revolution, and the cycle repeats.

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

Most of the construction of this infrastructure was funded during the bubble phase. As Perez states:

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

Thus, there was a canal bubble, a railroad bubble, and of course, a web bubble, just as Perez was finishing her book, the web bubble ended. A frenzy of inefficient investment left behind dark fiber, empty data centers, and a large pool of talent and technology ready to be reused in the consolidation phase.

In Perez's narrative, many small technological cycles are rolled into one. Consider the history of modern digital computing. It has several phases, each dominated by a new generation of technology: mainframes, personal computers, the internet and the World Wide Web, smartphones, and now, perhaps, cryptocurrencies and the metaverse. Each technology 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, as we have seen in previous cycles, building useful infrastructure?

I am not sure if NFTs meet this requirement. However, there is no doubt that the disruption of finance, just as the internet has disrupted media and commerce, will represent an important next stage of the current technological revolution cycle. Especially if it becomes possible to effectively allocate capital without the trust and authority of large centralized capital providers (what could be called "Wall Street"), this would be a foundational advance. In this regard, what I am looking for is evidence of capital being allocated to productive investments in the operating economy through cryptocurrency, rather than being allocated to hypothetical assets. If you hear of any good examples, please let me know.

To clarify what I am saying, let me step out of cryptocurrency and Web3 and look at another technological revolution: the green energy revolution. There, it is clear that bubble valuations are funding the development of lasting infrastructure. Elon Musk is a master at leveraging the excessive speculative price of Tesla stock (a year or two ago, Tesla's stock was valued at the equivalent of 1,500 years of profits for the company!) and turning it into a nationwide electric vehicle charging network, battery gigafactories, and autonomous driving capabilities, while catalyzing the entire industry to follow him into the future. Jeff Bezos has also leveraged Amazon's excessive valuation to build a new just-in-time business infrastructure. Both of them are investing in the infrastructure of commercial space.

When assessing the progress of Web3, I would also compare the other functions of cryptocurrency in the financial system—purchases, remittances, etc.—not only against traditional banking networks but also against other emerging technologies. For example, in cross-border remittances, are Ripple and Stellar better platforms than bank transfers, credit cards, or PayPal, just as Google Maps is better than first-generation GPS pioneers like Rand McNally or Garmin? There is some evidence that cryptocurrencies are becoming a meaningful player in this market, although regulatory hurdles are slowing adoption. But what about remittances, how does the more general payment situation look? How does it compare to non-cryptocurrency payment startups like Melio in terms of growth? Given the interest of companies like Square (now Block) and Stripe in cryptocurrency, they are fully capable of telling us about the progress of cryptocurrency 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 there is that it is being adopted— is it really a better mousetrap, as previous generations of internet technologies have proven? I criticize the reporting on this field for its almost complete lack of coverage of this information.

Where Are We in This Cycle?

People might ask whether the current stage of Web3 is more akin to 1995 or 1999—the early stage of the bubble or its end? Given the current valuations of crypto assets (and tech startups in general), it is hard to argue for the earlier date.

I like to remind people that I wrote "What is Web 2.0" five years after the collapse of internet companies, with the explicit goal of explaining why some companies survived while others did not. Therefore, I suspect that we will not truly understand what Web3 includes, if anything, until after the next downturn.

From the last bubble, aside from the changes in technology and business models that I attempted to capture in "What is Web 2.0?", I can also offer some pragmatic observations.

1. All surviving companies are making money—lots of it. (In the case of Amazon, it is free cash flow rather than profit, but the numbers are huge, just like the business and economic insights behind it.) Their valuations, while high, are supported by credible future earnings and cash flow models.
2. By today's standards, they do not need to raise large amounts of capital. (Yahoo's total pre-IPO investment was $6.8 million, Google’s was $36 million, and Amazon’s was $108 million.) When you see companies repeatedly seeking funding from investors without ever reaching profitability, they may not be real businesses; they may best be considered financial instruments.
3. They all have millions, then tens of millions, then hundreds of millions (ultimately billions) of daily active users for new services that change the world.
4. They have all built unique, substantial, and enduring assets in the form of data, infrastructure, and differentiated business models.
5. The companies that will dominate the next generation of technology are not all newcomers. Apple and Microsoft easily transitioned to the next generation, and in Apple's case, they even led the next generation.

Keep in mind that it was still early when the web bubble burst. Google Maps had not yet been invented, nor had the iPhone and Android systems. 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 cryptocurrency will be similar. There are many things that have yet to be created. Let’s focus on the parts of the Web3 vision that are unrelated to easy wealth, tackling the difficult issues of trust, identity, and decentralized finance. Most importantly, let’s focus on the interface between cryptocurrency and the real world of people's lives, as Matthew Yglesias said when discussing housing inequality, "A society becomes wealthy by accumulating a long-term stock of capital goods." If, as Sal Delle Palme said, Web3 heralds the birth of a new economic system, then let’s make it a system that can generate real wealth—not just the paper wealth of those fortunate enough to get in early, but actual goods and services that change lives and make everyone’s life better.