Fun With Data – Web 3.0
If you don’t know what Web 3.0 is, you should not feel left out, as the term has a variety of meanings, depending on who you ask, although the basic premise is a system based on blockchain, a decentralized form of data storage that breaks data into ‘blocks’ containing a ‘header’ that identifies the block, the data itself, and a number of ‘identifiers’ that includes descriptive information about the parameters of the block, including some that are used to validate the block before it is processed and others that describe the data. The blocks, when verified, are added sequentially to the blockchain network, with the links to the previous block creating a chain that cannot be broken, which, in theory, makes the data (transactions, etc.) unalterable.
After a block is validated it is added to the network, which means every computer on the network has a record of the block and the particular characteristics of the data, whether it is a transaction or or other data. Only certain nodes do the actual pre-add validation process, but the key to blockchain is the data is ‘copied’ (not actually copied but ‘known to’ all of the computers on the blockchain network, which means if someone tries to change a block on a particular computer, other computers will recognize that the ‘identifiers’ (hash) has changed, as the link to all subsequent blocks will change and the blocks will fail the ‘challenges’ (basically a check to see if the hash is correct) and the data will be ‘unconfirmed’.
Depending on the network, the number of confirmations needed varies, but without the required number of confirmations the data is not valid, so the more confirmations blocks have the more ‘secure’ the data is considered. Given the complexity of the algorithms[1] used to confirm a block, confirmation time can vary and this is where ‘miners’ come in. As transactions are uploaded to the network they enter a ‘pool’ before they are added to the blockchain. Miners can select these unprocessed transactions, on which they run the complex validation algorithms to confirm the transaction blocks at which point they are added to the blockchain. Since the mining process is expensive in that it requires high-speed processing which consumes considerable power, each transaction in the pool carries a transaction fee determined by the originator of the transaction. Miners will take those transactions with the highest fees from the pool first, which means that those transactions that offer lower fees to miners will take longer to get added to the blockchain.
In Bitcoin, mining a block takes about 10 minutes (equal to one ‘confirmation’) so it can take considerable time for those transactions that want more security than the typical three confirmations needed for bitcoin transactions. In order to speed up the process other networks like Ethereum use a system called POS (Proof of Stake) as opposed to the POW (Proof of Work) system described above, which is a simpler system that allocates block publishing through a lottery using the amount of each ‘stakers’ (equivalent of ‘miner’) holdings across the network. The POS system reduces the hardware and energy requirements needed to publish blocks to the blockchain network, although it is said to give large stakers more control over the network as the more funds a staker has on the network, the more chance they will be picked to post the next block.
So what does this have to do with our fondness for data? Web 3.0’s decentralized approach to the internet, as opposed to Web 1.0 (static content) and Web 2.0 (user-generated content), Web 3.0 gives the promise of increased transparency and the security that transparency should provide, and consequently move power away from some of the companies that exert significant control over the internet (Facebook (FB), Amazon (AMZN), etc.). Of course, this is still up for debate, and our suspicious/cynical nature leaves no doubt that such an idealistic goal will find was in which to be corrupted by ‘other’ power/money hungry companies/institutions as Web 3.0 develops, but in the interim, there seem to be plenty of investors willing to pump billions into private companies that they believe will be the ones that will benefit from Web 3.0.
VCs pumped ~$4.3b and $4.9 into Web 3.0 companies in 2019 and 2020, but really caught the bug in 2021, where that spending increased by 571.5% y/y to almost $33b, and while 2022 has seen a considerable slowdown in VC funding activity, based on the spending in the 1st half of this year and the seasonality of 1H/2H Web 3.0 VC investments, one might assume that the 2022 estimate derived from 1H VC spend for Web 3.0 this year, would only decline by ~3.1% to $31.78b, as shown in Figure 1. That said, the detail shown in Figure 2 gives a different outlook on VC Web 3.0 spending for the year given that 3Q spending fell by 89.1% q/q/ and 89.9% y/y to $0.72b, and while we would hesitate to make a stab at a realistic 4Q estimate given the almost inconceivable volatility this year, we would guess that given the current macro environment, it would lead to a lower 2022 spend than the statistical estimate in Figure 1 shows.
Perhaps funding to VCs with a penchant for Web 3.0 investments has slowed and private valuations are reflecting a bit of the lower valuations the market is placing on public companies, however investor optimism on a long-term basis, despite the weak 3Q, seems to have remained high, so as long as VCs are able to exit investments profitably over the remaining few months of this year and the 1st half of next, we expect funding will improve a bit from 3Q’s $0.72b, but while crypto companies are still a relatively small part of overall VC Web 3.0 investments, the rather poor performance of crypto this year casts a negative light on the space to some degree. Blockchain is certainly a valid data storage and valid technology, especially for financial transactions but the massive spike in early stage investments seen last year and earlier this year might moderate a bit as VCs become a bit more selective toward potential investments.
[1] SHA-256 – A cryptographic function that always produces the same output (hash) for a given input. There is no known way to figure out what the input should be to get a specific output, so miners must try millions of input combinations before they can match a block’s hash identifier which is 256 bits.
After a block is validated it is added to the network, which means every computer on the network has a record of the block and the particular characteristics of the data, whether it is a transaction or or other data. Only certain nodes do the actual pre-add validation process, but the key to blockchain is the data is ‘copied’ (not actually copied but ‘known to’ all of the computers on the blockchain network, which means if someone tries to change a block on a particular computer, other computers will recognize that the ‘identifiers’ (hash) has changed, as the link to all subsequent blocks will change and the blocks will fail the ‘challenges’ (basically a check to see if the hash is correct) and the data will be ‘unconfirmed’.
Depending on the network, the number of confirmations needed varies, but without the required number of confirmations the data is not valid, so the more confirmations blocks have the more ‘secure’ the data is considered. Given the complexity of the algorithms[1] used to confirm a block, confirmation time can vary and this is where ‘miners’ come in. As transactions are uploaded to the network they enter a ‘pool’ before they are added to the blockchain. Miners can select these unprocessed transactions, on which they run the complex validation algorithms to confirm the transaction blocks at which point they are added to the blockchain. Since the mining process is expensive in that it requires high-speed processing which consumes considerable power, each transaction in the pool carries a transaction fee determined by the originator of the transaction. Miners will take those transactions with the highest fees from the pool first, which means that those transactions that offer lower fees to miners will take longer to get added to the blockchain.
In Bitcoin, mining a block takes about 10 minutes (equal to one ‘confirmation’) so it can take considerable time for those transactions that want more security than the typical three confirmations needed for bitcoin transactions. In order to speed up the process other networks like Ethereum use a system called POS (Proof of Stake) as opposed to the POW (Proof of Work) system described above, which is a simpler system that allocates block publishing through a lottery using the amount of each ‘stakers’ (equivalent of ‘miner’) holdings across the network. The POS system reduces the hardware and energy requirements needed to publish blocks to the blockchain network, although it is said to give large stakers more control over the network as the more funds a staker has on the network, the more chance they will be picked to post the next block.
So what does this have to do with our fondness for data? Web 3.0’s decentralized approach to the internet, as opposed to Web 1.0 (static content) and Web 2.0 (user-generated content), Web 3.0 gives the promise of increased transparency and the security that transparency should provide, and consequently move power away from some of the companies that exert significant control over the internet (Facebook (FB), Amazon (AMZN), etc.). Of course, this is still up for debate, and our suspicious/cynical nature leaves no doubt that such an idealistic goal will find was in which to be corrupted by ‘other’ power/money hungry companies/institutions as Web 3.0 develops, but in the interim, there seem to be plenty of investors willing to pump billions into private companies that they believe will be the ones that will benefit from Web 3.0.
VCs pumped ~$4.3b and $4.9 into Web 3.0 companies in 2019 and 2020, but really caught the bug in 2021, where that spending increased by 571.5% y/y to almost $33b, and while 2022 has seen a considerable slowdown in VC funding activity, based on the spending in the 1st half of this year and the seasonality of 1H/2H Web 3.0 VC investments, one might assume that the 2022 estimate derived from 1H VC spend for Web 3.0 this year, would only decline by ~3.1% to $31.78b, as shown in Figure 1. That said, the detail shown in Figure 2 gives a different outlook on VC Web 3.0 spending for the year given that 3Q spending fell by 89.1% q/q/ and 89.9% y/y to $0.72b, and while we would hesitate to make a stab at a realistic 4Q estimate given the almost inconceivable volatility this year, we would guess that given the current macro environment, it would lead to a lower 2022 spend than the statistical estimate in Figure 1 shows.
Perhaps funding to VCs with a penchant for Web 3.0 investments has slowed and private valuations are reflecting a bit of the lower valuations the market is placing on public companies, however investor optimism on a long-term basis, despite the weak 3Q, seems to have remained high, so as long as VCs are able to exit investments profitably over the remaining few months of this year and the 1st half of next, we expect funding will improve a bit from 3Q’s $0.72b, but while crypto companies are still a relatively small part of overall VC Web 3.0 investments, the rather poor performance of crypto this year casts a negative light on the space to some degree. Blockchain is certainly a valid data storage and valid technology, especially for financial transactions but the massive spike in early stage investments seen last year and earlier this year might moderate a bit as VCs become a bit more selective toward potential investments.
[1] SHA-256 – A cryptographic function that always produces the same output (hash) for a given input. There is no known way to figure out what the input should be to get a specific output, so miners must try millions of input combinations before they can match a block’s hash identifier which is 256 bits.
Yearly VC Spending on Web 3.0 - Source: SCMR LLC, Crungchbase.com
Quarterly VC Spending on Web 3.0 - Source: SCMR LLC, Crunchbase.com
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