USV Partners Reflect on FTX: Web3 is Going Through a Tough Time, but Important Fundamental Innovations Continue

Authors: Fred Wilson, Katie Haun

Compiled by: Alpha Rabbit

The events surrounding FTX have shaken the confidence of many. So, how did one of the largest cryptocurrency exchanges collapse so quickly? Why do similar collapses in the crypto world seem to keep happening?

At this moment, we need to take a longer-term view of the entire Web3 industry. This is not just about a forward-looking perspective on the future, but we need to discuss the origins of Web3 and what the underlying story is.

As a long-term investor in Web3 and a board member of Coinbase (also a personal shareholder in Coinbase), I believe that we can share some thoughts, given that Coinbase is one of the longest-operating and most well-known companies in the Web3 space.

Web3 is software-driven innovation that has its own built-in financial system. This composition is both an advantage and a disadvantage. How to understand this? On one hand, tokens enable developers and users to contribute to open-source protocols and participate in earning corresponding economic benefits, thereby fostering a strong developer community. This model is a positive aspect compared to past methods of software development, monetization, and management. On the negative side, tokens can lead to cycles of boom and bust, which is why many people view Web3 as merely a speculative attempt, lacking any real substance behind it.

Regarding the viewpoint that "Web3 is merely a speculative attempt," there are indeed many companies and individuals building Web3 projects solely for the purpose of profiting through leveraged trading and speculation, sometimes even outright fraud. This group quickly makes a lot of money, and such phenomena only deepen the public's perception that "Web3 is merely a speculative attempt."

Most of the collapse cases people have heard about regarding Web3 can be traced back to Mt. Gox, including the failures we have seen and witnessed this year, such as 3AC, Celsius, and Alameda/FTX. These collapses occurred in centralized companies that typically engage in trading, lending, and speculative activities.

Many of the failed companies are based outside the United States and have essentially faced no regulation. The failures of these companies have tarnished the reputation of Web3. Of course, we have also seen centralized companies like Terra fail, but their failures were due to design flaws, and these cases collapsed transparently in public view. I believe this model (due to design flaws) is healthier than the failures of centralized companies.

In contrast to regulated Web3 enterprises operating in the U.S. like Coinbase, Kraken, and Anchorage, you will find that those companies that comply with rules and behave properly have weathered these storm cycles. Coinbase's early innovations created a secure, user-friendly, regulated channel for converting fiat to cryptocurrency, as well as a safe place for storing crypto assets. Coinbase has provided many important services that have allowed the Web3 ecosystem to develop and thrive.

The most significant software innovations of the past decade began with the Bitcoin white paper 14 years ago. The emergence of open-source software and decentralized protocols is the foundation of Web3, and these protocols have survived recent market fluctuations. It is precisely because the software is not controlled by overly centralized companies but rather by the open-source community, with built-in safeguards, that they offer increased transparency compared to today's technology and financial systems, which gives us confidence in the future of Web3.

These Web3 protocols are actively being developed, and industry builders are working together for gradual adoption by mainstream users. However, some key features still need further optimization. For example, according to the original architecture, blockchains are default public. However, I believe this is not suitable for most applications. Imagine if your email, banking, and social data were publicly visible on the blockchain for everyone to see—would you agree to that 100%?

Additionally, current blockchain networks are slow and complex, and improvements in performance, scalability, and privacy are being made at the infrastructure level of the Web3 technology stack. Emerging technologies like zero-knowledge proofs and rollups are beginning to address these issues without compromising decentralization. These breakthroughs are still in the early stages and are gradually being refined by a small portion of the developer ecosystem. This important behind-the-scenes work has not received any coverage. But it is these developments that are preparing Web3 for mainstream adoption.

As the infrastructure of Web3 improves in the future, the experience gap between users storing assets themselves and storing crypto assets with centralized entities will continue to narrow. More users will develop their own custody solutions to control their assets and manage the keys to access their assets. This is how many Web3 users interact with decentralized applications (such as NFT marketplaces) today.

When Web3 becomes a reliable alternative to Web2 for the general public, centralized companies like Facebook, Apple, Amazon, and Google will have to compete with Web3 for how people access data. This will redefine how we use the web. Software development will become more open-source and more composable. Traditional monopolistic financial institutions like banks and lending companies (including FTX) will no longer control our assets and will not be able to lend our assets arbitrarily without our permission.

Ironically, Web3 aims to return control of data and assets to the people and reclaim it from large centralized companies. However, the transition from Web2 to Web3 will be slow and chaotic, with many early Web3 companies merely replicating previous companies, which is a risk within the Web3 ecosystem and a place we need to move away from.

The recent events should not lead policymakers to think that Web3 is bad and must be restricted. Instead, it should highlight that pushing innovation overseas is not good.

We need trustworthy, well-regulated centralized entities to survive and thrive, and we also need decentralized Web3 protocols to develop and provide a pathway to a fully decentralized network.

Both are possible, and the good news is that we are already on the path to achieving both. We need to stay the course, provide a healthy environment for Web3 development in the U.S., and stop pushing U.S. users toward risky and opaque offshore companies, many of which will adopt unclear, unbalanced, and unfair policy actions.

Now is another tough moment for Web3, and people will see negative headlines about "cryptocurrency" for some time. But it is important to remember that these headlines are about the speculative/trading aspects of Web3, while the more important foundational software innovations continue. And that is what we are looking forward to; we will continue to fund and support these foundational software innovations that are solid and responsible.