Web3: There’s a Crack in Everything

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FOMO is driving people into Web3, but is the whole game rigged for VC money?

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Many in the industry worry the gold rush is akin to a “collective Theranos” that is warping the economy to the benefit of professional investors, one unnamed venture capitalist tells Vice. “A wildly unproven product with nobody at the helm.”

Much of the scamming centers around tokens, which crypto critics like Stephen Diehl contend puts the financial rules of the 1920s back in play by allowing people to “insider trade, wash trade, and pump and dump” with impunity.

Motherboard, the tech department of Vice, has done a deep dive into the financial wheeling and dealings of Web3 entrepreneurs and VC investors, and doesn’t give it a clean bill of health.

“It’s a gold rush for sure,” Dayton Mills, co-founder and CEO of remote-work startup Branch, tells reporter Maxwell Strachan at Vice.

Mills’ company had been struggling before he transformed it into a Web3 gaming platform. The moment he started talking about his Web3 vision, investor interest skyrocketed. He had planned to raise $2 million, only to receive $20 million in commitments in two weeks.

“Something big is happening,” Mills said. “A lot of people are trying to get in on it, and a lot of people are more afraid of not getting in.”

Nobody, it seems, wants to be Paul Krugman — the Nobel Prize-winning economist who predicted that the internet would ultimately become no more consequential than the fax machine.

Web3 hysteria has continued even as the tech industry has struggled with rising interest rates and plummeting share prices. In the first three months of the year, the top 15 venture firms poured more money into Web3 and DeFi deals than any other area, according to research firm PitchBook.

Blockchain companies have raised at least $9.5 billion after receiving $18 billion in funding in 2021, according to CrunchBase. Last month, amid plunging crypto prices, one of Web3’s biggest institutional backers, the venture firm Andreessen Horowitz announced it had raised $4.5 billion.

Those who have swallowed the Kool Aid espouse the idea that Web3 can be the savior of the internet and of society itself. It’s a vision, says Strachan, where people have the ability to own a piece of the internet (for example, through NFTs) and ultimately lead to a fairer, more communal version of the web, “one that will wrest control back from technological giants that have profited off people’s data and creativity, creating a world where community comes before all else.”

Such arguments are inarguably alluring but Strachan isn’t buying. As Hilary Allen, a law professor at American University, succinctly puts it: “The reason why venture capitalists are pushing all of this is to make money.”

And, in Web3, the venture class and other professional investors have found a uniquely appealing set of circumstances they believe will allow them to make a giant pile of money that does not rely on vast leaps in virtual reality or haptics technology.

“If there is any innovation in crypto assets, it’s not in software engineering but in financial engineering,” says Diehl.

And this is a problem, reputational at best for Web3 pundits, criminal at its worst excesses. Because as it stands, Web3 — the DAOs, tokens, blockchains and cryptocurrency building blocks of the next gen internet — is a largely unregulated marketplace “ripe for exploitation and stuffed full of unclear valuation metrics, arguable unregistered securities, peculiar financial products, ways to cash out, and a public-facing ideological mission statement,” says Strachan.

It’s at least possible that Web3 could bring about a better, more fulfilling version of the internet. It’s just as likely, though, to prove to be what its harshest critics fear: a “hyper-capitalistic” reframing of the web that “contains the seeds of a dystopian nightmare.”

Even those involved in Web3 are beginning to be disillusioned. One of them is Phil Libin, the CEO of the startup studio All Turtles and the virtual camera application mmhmm.

“Web3 proponents are trying to solve real problems that need solving. I just don’t think that Web3 is the solution,” he said. “It doesn’t make sense to me as a programmer.”

Another is Tomasz Tunguz — but he is ploughing on with Web3 because he’s candid enough to admit there’s money to be made. And lots of it.

Tunguz is a venture capitalist at Redpoint Ventures who became active in the Web3 market in the first half of 2021. The closer he looked, the greater the investment opportunity seemed.

As explained by Strachan, Web3 businesses had no clear metrics by which they could be valued. That’s in stark contrast to the relatively reliable and standardized financial models that allow investors to value traditional software businesses.

“In Web3, that’s not the case,” Tunguz says. “Nobody has any idea how to value these businesses. I haven’t walked into a single pitch with a Web3 company where the words ‘cost of customer acquisition’ or ‘payback period’ has been uttered. It’s so new that people aren’t worried about unit economics.”

He is describing an asymmetry of knowledge, where the edge is with the VC and not with the private investor. If you’re in the “know,” you can make money; and there is a lot of smoke and mirrors in Web3’s unregulated market.

“One of the ways of making lots of money is to have information asymmetry,” Tunguz said. “If you know something I don’t about a company and you trade on that information, you’re gonna make a bunch of money, right? In the stock market, it’s illegal. In the private markets, you can.”

The counter argument to all of this is that Web3 is still in its infancy. Of course, the way it all works seems a little opaque; it takes time for anything new to develop and mature and to be stress tested.

But in case of Web3, it is not just a new way of doing business that need getting used to it’s the suggestion that the process is being masked from scrutiny by an ideological layer that marks itself as the antithesis to the capital markets, rules and regulations that has gone before.

That creates cynics like Martin Kenney, a professor at the University of California. “Whatever the new thing is, it’s absolutely in the VC’s interest to hype it,” he says. “You feed it to the press. You tell everyone it’s going to change the world, that it is the best thing since sliced bread, whatever it is that will convince the investors that they need to have it.”

 

Nick Gerard, the CEO of Web3 developer Norby, is also skeptical. He tells Vice that he started to believe that tokens, rather than the ideological “future of a fully decentralized internet,” were behind a lot of the investor interest in Web3.

As he sees it, an investment firm could invest in a startup in exchange for equity and inside information and then negotiate a hoard of early tokens. “What I have now is asymmetric access to information,” Gerard said. “I have a direct line to a founder… I have access to financial information. I know if user adoption is tanking. I know if usage is skyrocketing. I know if the founder is depressed or hooked on Adderall or is spiraling out of control.”

Then, at the first internal sign of trouble, the investor can dump the token on the “quote-unquote community,” Gerard said. “Some of them are quite transparent about it, but they’re still able to couch all of this in language that revolves around ownership and the community.”

Vice reports evidence of start-up firms making the switch to Web3 simply because doing so made it easier to raise money.

“A venture capitalist who asked that I not use his name admitted with concern that one of his own portfolio companies did the same, and other founders and CEOs similarly said they’d noticed startups cynically bolting on Web3 elements after running out of other options and needing more funding to survive.”

What everyone can seem to agree on, Strachan adds, is that the boom has created a lot of vaporware and useless entrepreneurial attempts to get rich quick, even if no one wants to name names on the record.

“Tack on #Web3 and investors will throw money blindly and inflate valuations 2-3x,” one start-up founder told Strachan.

There’s even a term for companies that bolt on a Web3 element in order to raise a few more bucks. They’re called “grifters.”

The question for now is: how long will regulators remain hands-off? SEC chairman Gary Gensler has reiterated that he believes many crypto tokens should be regulated as securities.

“Let’s not risk undermining 90 years of securities laws and create some regulatory arbitrage or loopholes,” he said at the University of Pennsylvania’s April law conference.

While crypto markets may offer new ways for entrepreneurs to raise capital & for investors to trade, we all still need investor & market protections.

Let’s not risk undermining 90 years of securities laws & create some regulatory arbitrage or loopholes. 

Tunguz, the pro-Web3 venture capitalist, is ready for such a day, but reaping the rewards until then.

“There will be a Securities Act of 2033, whatever the year is,” said Tunguz. “Whenever the regulation comes out, we will respond to it. But I think there’s definitely an opportunity here to make money in a way that benefits everybody within the ecosystem.”