Web3 is all the rage these days. It’s being talked about by the news, local politicians, and business leaders. Everyone seems to be talking about it. You may have come across terms like “DAOs,” “NFTs,” and more while learning about web3.

In this article, I will introduce the concepts of Web3 projects and how to choose one to invest in. I will also discuss how to ensure that the project is worth your time and money.

Please note that the following text does not constitute financial advice. Any decision made regarding your personal finances is your responsibility. Be sure to always do your own research and only invest as much money as you can afford to lose. With that being said, let’s explore the world of Web3!

Terminologies: Trust me, they’re easy!

Web3 is the third generation of the World Wide Web. It is characterized by increased user control over data, greater transparency, and the ability to interact with smart contracts. In order to understand Web3, it is important to first understand the previous two generations of the World Wide Web – Web1 and Web2. Web1 was the first generation of the World Wide Web and was characterized by static websites that could be accessed by anyone. Web2 was the second generation of the World Wide Web and was characterized by dynamic websites that allowed for two-way communication and collaboration.

In other words, Web1 was the internet when it was mostly used for reading purposes, as opposed to writing or posting purposes. The content available on static webpages was mostly in the form of blogs or articles.

0 Web2.0 is a more developed version of the World Wide Web in which content is available in a “read-write” format. This means that users not only consume information but can also interact with it and produce their own content. All social media, dynamic webpages, API interactions, etc are part of Web2.0.

Web3 is a newer and improved version of the internet that uses blockchain technology and cryptocurrencies to allow users to completely own their data. It’s essentially the “read-write-own” version of the internet!

Value investing framework for web3 projects

” This article assumes you have a basic understanding of the web3 space. If you’re unfamiliar with the term web3, it refers to the decentralized web. The decentralized web is a network of interconnected decentralized applications (dApps) that run on a decentralized network. In other words, it’s the infrastructure that allows for a more open, transparent, and censorship-resistant internet. Some of the terms used in this article about web3 include decentralized applications (dApps), decentralized network, and blockchain.

• Smart contracts: Code that lives and runs on a blockchain-based smart contract platform like Ethereum and Solana. Bitcoin can not run smart contracts.
• Protocols: One or more smart contracts that do a specific task. A protocol could be comprised of other protocols. L1s like Ethereum, Solana, etc., L2s/sidechains like Optimism, Arbitrum, etc., and programs built on top of the L1s like Aave, Fractional, Serum, etc. are all referred to as protocols.
• dApp: Decentralized apps. Frontend to protocols. Will ask you to connect your wallet. dApps are how end-users interact with protocols. A single app may run on multiple protocols. Examples include Matcha, Mirror, Partybid, etc.
• Rug pulls: Blanket term for scams. Getting rugged = getting scammed.
• PMF: Product Market Fit. Point where the product becomes something that the market wants.

. Refer to this list for a more comprehensive understanding of any confusing terms. To get started, lets begin by searching google for any other terms you may find confusing.

General checks

There are certain checks that you should perform when evaluating any project that you are considering investing in.

Founder and founding team

The ability for a founder to guide their project through tough times is an important quality to consider when evaluating them and their team. This is especially true for projects that are in the early stages and haven’t yet found their groove.

Crypto’s culture is one of anonymity. Many prominent projects in the space have founders who are anonymous or use pseudonyms. This works well when the person has built up credibility over a long period of doing good work. For example, Samczun is a legendary white-hat who works with Paradigm. He has been anonymous from the start and is one of the most reputed security researchers in crypto. Other reputed anonymous people include Punk 6529 and Hasu.

— Pseudonymous identities can be beneficial in some cases, but often times things go wrong when people rely on them. For example, 0xSifu, one of the founders of the Wonderland protocol, was recently revealed to be a convicted felon who had served time in prison for fraud. In another case, 0xMaki, the founder of sushiswap, drained most of the protocol’s funds (however sushiswap survived and 0xMaki eventually returned the funds). Having doxxed founders definitely adds to the project’s credibility. There have been countless NFT and shitcoin rugs by anon founders. The exception to this might be if the pseudonym has a stellar on-chain reputation.

Pseudo-anon arrangements allow VCs to know a founder’s identity for due diligence purposes, but the founder’s identity is never revealed to the public. However, this is difficult to accomplish. The founders of BAYC (Bored Ape Yacht Club), a very successful NFT project on Ethereum, were completely anonymous until their recent raise. However, soon after the raise, Buzzfeed got access to their real identities and leaked them to the public. This made many people on crypto Twitter quite angry.

Vision

You should be able to see the most optimistic version of the product, especially in the early stages. This means seeing what the world would look like in 10 years if everything went perfectly according to the plan. For example, what new behaviours would users have, what problems would no longer exist, etc. However, you should not allow founders to build castles in the sky. The project’s vision needs to be at least somewhat realistic. The company’s ability to execute on the vision should be evaluated using other factors.

Almost every 10k non-fungible token project coming out these days has a metaverse play in its roadmap. However, very few will make any progress.

Market- Timing and TAM

You need to understand why the product you are creating is needed now. It can be difficult to accurately predict whether or not a product will be successful, but you can look at factors such as technological advances, current cultural trends, and changes in society to get an idea of whether or not there is a demand for your product.

If you enter a market too early, it may be difficult to stick to your intuition and keep pushing forward when the market does not seem to respond. However, if you can stay alive until the market realizes the need for your product, you can emerge as a dominant player. If you enter a market too late, you may be able to get some market share, but it is unlikely that you will emerge as a dominant player.

The success of web3 is dependent on the success of major web3 primitives such as DeFI, DAOs, and NFTs. It is difficult to predict when each sector will gain a significant market, but it is certain that if web3 succeeds, some version of these primitives will as well. When investing in this space, it is crucial to identify projects that can survive until they reach PMF.

Total Addressable Market (TAM) is a quantification of the project’s vision. It is a measure of the size of the industry that the project operates in. projects with bigger TAMs tend to be more valuable, as even a small percentage of the market can be very lucrative. The size of a TAM grows as the industry grows.

Web3 specific checks

Products vs Protocols

In web3, tokens provide protocols with an intrinsic economic value, reversing the current state where protocols like HTTPS, FTP, and SMTP have no value. With tokens, value flowing through a protocol actually results in the accrual of value for the protocol. This has trillion-dollar implications for companies built on top of these protocols.

Composability

A key factor to consider when investing in protocols is how composable the protocol is. Composability refers to the ability to stack together smart contracts permissionlessly. The more stuff that gets built on top of your protocol, the more valuable it becomes.

DeFi has some great examples of protocols that can be combined to form more complex protocols. For example, Uniswap, Aave, and Compound can be combined to form more complex protocols like Alchemix and Instadapp.

Tokenomics

Tokenomics refers to the study of the economic characteristics of a digital asset, typically a cryptocurrency or token. The main idea to understand with tokenomics is that it is similar to supply and demand in traditional economics. If the demand for a digital asset is more than the available supply, the price will increase.

• Factors that increase demand:
  • Making the token deflationary: This could be because the total number of tokens is fixed or because more tokens are being burnt than issued. Bitcoin is deflationary, it’s total supply is capped at 21 million.
  • Making the token disinflationary: Disinflation refers to reducing the inflation of a token over time. This lowers expected future supply. This can be done by reducing issuance or by burning more tokens. Eth has burn-introduced disinflation thanks to EIP 1559.
  • Incentivizing staking: Staked tokens are locked up and can not contribute to liquidity.
• Factors that increase demand:
  • Utility: Tokens might be required to perform an action in the corresponding protocol(eg GRT).
  • Governance privileges: Token holders may get to propose and vote on protocol changes.
  • Speculation driven demand

Types of tokens:

• Fungible tokens: Divisible and non-unique tokens. Analogous to currency in the real world. Commonly known as coins. Follows the ERC20 standard on Ethereum and the SPL standard on Solana. Some way that fungible tokens can be used are as:
  • Equity tokens: Function similarly to shares in a company. This is rare today as most jurisdictions outlawed it after the ICO boom of 2017.
  • Utility tokens: Tokens that are needed to perform some action within a protocol. L1 tokens like ETH and SOL are examples of utility tokens, they are needed to pay gas costs in their corresponding chain.
  • Governance tokens: Tokens that give holders the right to propose and vote o protocol changes. The weight of your vote is often proportional to the amount of tokens you hold.
• Non Fungible Tokens (NFTs): Unique tokens. Each is a unique representation of an asset on the blockchain. Some way that NFTs can be used are as:
  • Art: NFTs allow for people to truly own digital art.
  • Utility: NFTs can be used in several ways, the most common of which is to gate access. Most PFP(profile picture) NFT communities like BAYC give holders access to a gated online space(usually a Discord server). NFTs can also be used for in-game assets. Axie infinity, a popular play-to-earn game, uses breedable NFTs to represent their in-game characters.
  • Governance: NFTs can be used in addition to fungible tokens to reduce the effects of plutocracy in protocol governance. For example, the Optimism protocol issues soulbound NFTs(non transferrable NFTs) for the core team. This prevents the protocol from being taken over by someone who can buy up power in the form of tokens.

Why Web3?

Web3 enables decentralization, which is important because centralized platforms follow a predictable path where they start by recruiting users and forming partnerships with developers, businesses, and organizations. However, as these platforms gain more power, they begin to take control over their users, third parties, and everything else. After reaching a certain point, the only way these platforms can grow is by competing against their cooperators and compromising user data. Some examples of this scenario are Google vs Yelp, Facebook vs Zynga.

The users’ personal data and privacy are at risk because they are unwillingly giving it up, making them more susceptible to security breaches.

The reason decentralization is important is because it allows for a fairer distribution of power. Web3 is built on blockchain technology, which also allows for a consensus mechanism that enables decentralization on a scale that we have not seen before.

NFTs and why they are important

NFTs… what are they? Well, the simplest way to put it is this:

These tokens can be used to represent anything from digital art to in-game items, and they are often created using the Ethereum blockchain. A non-fungible token is a digital asset that is stored on a blockchain. These tokens can represent anything from digital art to in-game items, and they often use the Ethereum blockchain.

Yes, NFTs can be used for more than just pictures in JPG format! Art/pictures in the form of JPGs is just one of the easier ways to implement NFTs, which is why there are so many of them! If you want a better, more in-depth understanding of NFTs, check out my previous article on the topic or watch this episode of my podcast.

a16z General Partner and co-lead of the firm’s crypto fund, The air of misconception around Web3 in general and NFTs in particular is due to the hyper financialization around us. However, when we look at broader narratives, we realize that NFTs are the way forward.

NFTs allow for digital ownership, which adds a new layer of value that didn’t exist before.