a16z Annual Report: The Current State of Web3 Development, Business Boundaries, and Regulatory Innovation

Source: “a16z: 2023 state of crypto policy spotlight - What's really going on in crypto and web3?”

Author: a16z crypto

Compiled by: Biscuit & bayemon.eth, ChainCatcher

a16z Note: The views expressed in this article are those of individual personnel quoted from AH Capital Management, L.L.C. ("a16z") and do not represent the views of a16z or its affiliated companies. The information provided comes from third-party sources, including portfolio companies of funds managed by a16z. While the sources are generally reliable, a16z has not independently verified such information and makes no representations regarding the enduring accuracy of the information or its applicability in specific circumstances. This content is for informational purposes only and should not be construed as legal, business, investment, or tax advice.

Overview of Events in the Crypto and Web3 World

Andreessen Horowitz's annual "State of Crypto" report shares data on Web3 activities and innovations. The November 2023 "Policy Spotlight" summarizes insights from the report aimed at U.S. policymakers and others interested in the current state of crypto policy. The report includes:

• Part 1: Why Web3 Matters

Web3 is a form of the internet that is more beneficial to consumers, with advantages and uses that extend far beyond financial services.

• Part 2: Current State of the Crypto Industry

Cryptocurrency has become an indispensable presence due to its ability to transcend partisan and identity boundaries, yet the U.S. may be losing its leading position.

• Part 3: Policy Principles and Framework

How can we remain competitive in emerging technological innovation while protecting consumers?

Part 1: Why Web3 Matters

The internet is one of the most significant technological innovations in human history. However, it often leaves consumers, creators, and developers who rely on it feeling disappointed.

The Adoption of Web3 Technology is Evolving in a Consumer-Friendly Way

• Web1 (1990 - 2005)
• Loosely managed by various institutions Open technologies (protocols) that anyone can build on, such as email (based on SMTP) and the web (based on HTTP) Value does not accumulate to the network
• Web2 (2005 - 2020)
• Managed by companies Centralized, siloed platforms where decisions can be made by individual entities (e.g., social networks) Value accumulates to a few large tech companies rather than to the value creators themselves
• Web3 (2020 - Present)
• Community-managed Decentralized, interoperable services owned and maintained by the network (e.g., Bitcoin, Ethereum, and other blockchains) Value accumulates to users, builders, and communities contributing to the network: developers, entrepreneurs, creators, fans, and other consumers.

Web2 Tech Giants Aim to Monopolize, Web3 Emphasizes "Decentralization"

• Just three companies, Facebook, Google, and Twitter, contribute to one-third of global web traffic
• Just five companies—Amazon, Apple, Facebook, Google, and Microsoft—account for 50% of the total market capitalization of the Nasdaq 100 index (up from 25% a decade ago)

Web3 Transfers Network Value to More People Through Ownership

Tokens: The Cornerstone of Web3

• Tokens are the "units" of ownership measurement: Tokens can represent ownership of any item: digital items (such as artwork, tickets, or game items); or physical items (such as clothing, experiences, or even real estate).
• Tokens are foundational building blocks: Tokens are not inherently financial instruments; like websites in Web1 and posts in Web2, tokens are foundational modules in the construction of Web3 networks.
• Tokens empower individuals: Tokens provide a new way for people to control their digital identities across different platforms and services, similar to property rights discussed on the internet.

The uses of tokens go far beyond speculation…

Blockchains Should Be Powerful Computers, Not Casinos for Speculation

There is a fundamental difference between a world driven by speculation and one where a world computer is the product.

Computers

• As a technological innovation, they drive the development of computer science
• Based on digital trust, they hard-code "cannot do harm" as a rule
• High operational transparency
• Strong resilience

Casinos

• Gambling is financial speculation, not innovation
• Based on yield trust, "not doing harm" is a variable choice
• Low operational transparency
• Extremely fragile

Community-managed networks will become the next generation of the internet

Advantages: What Unprecedented Capabilities Does Blockchain Have as a New Type of Computer?

Protecting Consumers Amid Advancements in Artificial Intelligence (AI)

• Combatting high-quality AI-generated forgeries: In a world filled with endless high-quality AI-generated forgeries, cryptographic technology can help trace the authenticity and origins of what we face.
• Democratizing AI innovation: Unlike large tech companies that rely on having the most data and computing resources, cryptographic technology can democratize access to these resources, benefiting more builders.
• Unpacking the "black box" of AI: AI does not have to be a black box where no one knows what happens or where the data comes from. Cryptographic technology can make the data used by AI more transparent and auditable while protecting data privacy.
• Data ownership belongs to individuals: Cryptographic technology can enforce data privacy in AI models while also helping companies provide incentives to consumers and creators for the data they have contributed.

Upgrading Traditional Privacy Systems

• Apple charges up to 30% on purchases made by mobile consumers. Apple has significant pricing and decision-making power in mobile distribution. Cryptographic technology can lower the fee rates that platform owners charge users (as a percentage of platform revenue), increase competition, and provide consumers with more choices.
• People spend $647 billion annually on remittances, with an average cost of 6.25%. Cryptographic technology can eliminate unnecessary intermediaries and cut international transaction fees by up to $40 billion.
• Only 18% of social media users trust Facebook's data protection services. In Web3, people own their data—from the posts they create to the music they produce to the networks they build. More importantly, they can take their networks and data from one platform to another.

Cryptographic Technology Addresses Current Pain Points

• Identity Issues: Unlike relying on large platforms to manage user identities, Spruce empowers individuals to control and own their identities. Organizations can also manage the lifecycle of digital credentials (similar to how the California DMV is managing mobile driver's licenses).
• Monetization Issues for Creators: In streaming services, only 18,000 musicians (less than 0.2%) earn over $50,000 annually. Sound eliminates intermediaries, allowing artists to monetize directly with fans.
• Carbon Neutrality Issues: The voluntary carbon credit market is opaque and inefficient. Through Flowcarbon, more funding can flow directly to important environmental projects.
• Censorship and Deplatforming Issues: Biased platform leaders can dictate the rules and coverage of social networks. However, decentralized social network protocol Farcaster allows users to choose between applications while easily moving (and owning) their data.
• Infrastructure Issues: The lack of competition in the telecommunications industry leads to high prices and uneven coverage. Helium is working to provide 5G anywhere through decentralized wireless infrastructure at a fraction of traditional costs.
• Opportunities for Online Collaboration: Narratives, production, and responsibility division of intellectual property. Story Protocol and Adim provide open infrastructure to help people co-write, remix, collaborate, and create characters while protecting intellectual property and compensating creators.

Part 2: Current State of the Crypto Industry

The Web3 era has arrived: millions of Americans hold cryptocurrency, and usage continues to grow.

Over 40 million Americans hold crypto assets, with holders showing no clear partisan or identity restrictions

16% - 20% of American adults (approximately 40 to 50 million people) have purchased cryptocurrency

The use of cryptocurrency is increasing. Despite price volatility, we have seen the number of active users maintain at least double-digit growth for four consecutive years.

This data tracks the number of unique active (sending) addresses across all blockchains, including Ethereum, Polygon, Solana, Avalanche, Fantom, Celo, Optimism, Base, and Arbitrum. Note: 1 address does not necessarily correspond to 1 person. Source: Nansen Query, CoinMarketCap

The number of institutions researching cryptocurrency is increasing, driving progress in other areas. Over 21,000 crypto publications are dedicated to addressing key issues:

• Financial compliance that protects privacy: Using zero-knowledge (rapidly moving from theory to practice)
• Combating misinformation: Using cryptographic methods to prove authenticity
• Checks and balances for AI: Using blockchain networks and decentralization
• Blockchain performance and security: Cryptoeconomic game theory, networks, etc.

The Importance of U.S. Leadership

Leading Web3 innovation will help maintain U.S. competitiveness, which also involves national security issues.

The U.S. has been a beacon of technological innovation but may lose its leading position in the Web3 space

Proportion of U.S. cryptocurrency developers (left), percentage of global traffic to U.S. cryptocurrency websites (right)

More developers are working on crypto projects outside U.S. time zones

Number of independent cryptocurrency developers: When do they code?

• Most GitHub commits occur during U.S. working hours (9 AM to 9 PM Eastern Time)
• Most GitHub commits occur during UK working hours (9 AM to 9 PM British Summer Time)

The UK is actively leaning towards cryptocurrency, and a16z crypto startups have entered the UK ecosystem. Note: This analysis only shows directional trends; note overlapping time zones or other working hour factors.

Like semiconductors, the crypto industry may soon migrate out of the U.S.

The historical lesson we learn from industry innovation is that, using semiconductors as an example, today's manufacturing should not rely on foreign suppliers for critical technologies; excessive dependence on infrastructure will impact our daily lives. Similarly, where will the future of distributed computing infrastructure (internet, organizations, work) go? The U.S. should take the lead.

The status of the dollar is under threat from sovereign digital currencies

Current status of global central bank digital currencies (CBDCs): The development of China's central bank digital currency (CBDC) poses a threat to the dollar's status as the world's currency, with a total transaction volume involving digital yuan reaching $250 billion as of June 2023.

Innovation in stablecoins can strengthen the dollar's dominance

What are stablecoins? Stablecoins are a type of cryptocurrency whose price is nominally "pegged" to stable assets, such as the dollar. [For more information on collateral types, see this article in the Financial Times.] Stablecoins can help improve the efficiency of the U.S. payment system and solidify the dollar's position as the global digital currency.

This is not just about protecting Silicon Valley startups but about maintaining U.S. global leadership. The U.S. can win through leveraging free markets rather than centralized planning. This bottom-up approach will yield many new experiments and innovations. This may be the only way to overcome the central bank digital currencies (CBDCs) of countries like China.

Part 3: Policy Principles and Framework

U.S. incentive innovation policies can protect consumers and provide compliant pathways for businesses

Regulatory activity remains a top priority

a. Cryptocurrency legislation has passed for the first time in a House committee:

• “Committees Introduce Financial Innovation and Technology for the 21st Century Act,” from Representatives: French Hill R-AR, Glenn "GT" Thompson R-PA, and Dusty Johnson R-SD.
• “Clarity for Payment Stablecoins Act of 2023,” from North Carolina Representative Patrick McHenry.

b. Courts are making multiple rulings on influential cases:

The court ruled in the SEC/Ripple enforcement action; the SEC dismissed claims against individuals and appealed the legal ruling of the lower court.

c. Government agencies are proposing new rules

• Proposed rules for digital asset broker reporting requirements by the IRS;
• Proposed rulemaking notice by the CFTC regarding self-certification of derivative contracts;
• Proposed rulemaking notice by FinCEN regarding convertible virtual currency mixers that the SEC is considering proposing;
• Amendments to custodial rules; also the definition of "exchange";

Good regulation can combat bad actors and protect consumers

Former legislators, agency heads, and others suggest U.S. lawmakers do three things:

a. Protect consumers: Require centralized company registration and regulation: Regulators should investigate risks arising from custodial relationships, conflicts of interest, and the use of digital assets in illegal finance.

b. Provide compliant pathways: Any legislation should provide a disclosure-based compliance pathway for entrepreneurs who have been building decentralized networks and legitimate businesses (despite an uncertain environment).

c. Incentivize community ownership: Laws and regulations should appropriately incentivize decentralization and community ownership—this is the core commitment of Web3 technology to benefit the public and pave the way for future innovation.

Guiding Principles and Regulations for U.S. Cryptocurrency Policy

a. Prohibiting new business models or technologies that would undermine U.S. values and drive innovation and jobs elsewhere.

b. Establishing appropriate, clear rules for agency guidance and legislation. This not only protects consumers but also helps promote healthy competition for all, including allowing new innovators to challenge entrenched centralized participants and existing companies' regulatory power.

c. Legitimate businesses and their customers should have access to financial services and legal protections—from banking relationships to data privacy.

d. Businesses should be the focus of regulation, not the broad, decentralized, autonomous software that underpins innovation. (Regulate applications, not protocols)

Misconception: Cryptocurrency is only used for illegal activities

Total transaction volume vs. illegal transaction volume

Blockchain analytics firms estimate that illegal transactions account for less than 2% of total cryptocurrency activity. As of 2022, such activities accounted for approximately 0.10-0.24% of all cryptocurrency activity.

Money laundering through fiat currency far exceeds money laundering activities through cryptocurrency. By 2021, the amount of money laundered through traditional financial markets was expected to be 100-250 times that of cryptocurrency [Source: Nasdaq's head of anti-financial crime technology].

Fiat money laundering methods (cash, bank wire transfers, real estate, etc.) far exceed cryptocurrency in both quantity and percentage.

Fact: Cryptocurrency can help combat crime

Criminals still prefer traditional financial products and services over cryptocurrency. While criminals and terrorists seek any available means (including emerging technologies) to fund and carry out their activities, the U.S. Treasury's 2022 National Terrorism Financing Risk Assessment found that compared to other countries, the use of "limited other financial products and services"—the traceable nature of blockchain is inherently unfavorable to these groups.

Blockchains are public, traceable, and immutable. This makes them effective in investigations, prosecutions, and asset recovery. Legal tender, especially cash, is difficult to trace and is still more frequently used in criminal activities.

Cryptocurrency plays a role in combating crime. Compared to traditional methods, law enforcement is very effective in tracking cryptocurrency activities (using complex analytical tools), and governments have proven their ability to recover funds in this way.

Misconception: All cryptocurrencies are harmful to the environment

Estimated annual energy consumption by product/industry

Currently, other industries and companies consume far more energy than Ethereum. Why? In September 2022, Ethereum transitioned to a PoS ("Proof of Stake") consensus mechanism (many developers choose to build applications on this mechanism), reducing energy consumption by 99.9%. All blockchains require such consensus mechanisms because they are decentralized; the PoS method consumes far less energy than the PoW ("Proof of Work") method used by Bitcoin.