3 Ways To Invest in the Web3 Ecosystem of DeFi, Metaverse, & Smart-Contracts
By: Gavriel Shaw
Tags: Web3, Investing, Startup, Dealflow, Venture Capital

Investors are piling into the emerging web3 economy.

…which itself will disrupt how investing and profit-making gets done.

Through web3 we achieve 2 fundamental innovations:

1. Distributed Incentives — Economic incentives become more broadly distributed to ‘stakeholders’ (including end-users and creators) rather than just ‘shareholders’ (Founders, Investors, VC Funds).

2. Distributed Governance — Innovation and operational management will increasingly be guided by the broad base of stakeholders via distributed ownership using such things as tokenized, and stake-weighted voting.

Both of which greatly impact investors — and it’s not without controversy.

Recent Tweets from the likes of Jack Dorsey (Founder of Twitter) and Elon Musk (Founder of Tesla and SpaceX) reveal concerns over web3.

Venture Capital firms, Jack argues, can have a centralizing influence on the profitability of web3 products:

To which @mdudas replied and Jack redirected:

While Elon apparently argues for the practical non-existence of web3 products to date :)

Jack retorts with a crack at VC firm a16z…

So let’s explore…

The Profit Motive of web2 vs web3

Some web3 advocates argue that external venture capital goes against the spirit of decentralization — because they assume the bulk of profits or control end up in the hands of ‘venture capitalists’.

The nature of venture capital is to follow trends to follow the money, and as web3 develops, VC’s will accommodate. The purpose of VC funding is to enable rapid growth of a venture in exchange for a share of the profit potential, not inherently to ‘centralize control’ — no more than if 51% of tokens are bought up in a pre-sale by early token investors and thus lock-up the governance of a web3 platform.

In fact, VC’s tend to end up with far less than a ‘controlling stake’. More like 5% to 20%. What’s more, VC’s only tend to profit from a small minority of ventures they ‘invest’ in (gamble on).

Today via the innovation of web3, ‘tokenomics’ are improving the chances for everyone to profit: from pre-listing token buyers, to secondary market token traders, to VCs, to project founders, to end-users, AND experience creators.

The Tokenomic Distribution of Ownership

Tokenomics allows a wide range of participants to contribute value on open platforms for broadly distributed economic incentives (profit share).

How?

Because tokens assign and protect ownership of digital property while allowing a highly liquid management of incentive distributions (investors might think of it as ‘dividends’).

Make no mistake, ownership rights are fundamental to web3; protected by the power of encryption. On-chain claims on ownership enable profit incentives that serve all stakeholders via the distribution of productive output amongst participants. Whether that contribution is content creation, coding, marketing, liquidity staking, or growth capital.

The problem of web2 systems was allowing shareholding governors to restrict stakeholder contribution, governance and economic reward while maximizing centralization of power and profit for a small number of owners (shareholders, founders, and core staff). In the face of web3, that old web2 model will be seen as narrow minded.

Investors are now juggling the integration of two worlds: the tried and true systems of traditional capital management, and the new opportunities made possible via token incentives.

Web3 economies-of-scale (the efficiencies of going big) and potential network effects (the synergy of more participants) are astronomical. Web3 VC’s like Helios or a16z see the vast profit potential of distributed systems, distributed governance, and distributed rewards.

The most forward looking investors (accredited investors, token buyers, and VC’s) are leaping head first into the realm of distributed incentives. Web3 will quickly become competition against those stuck in web2, providing more economic incentive for creators and users to abandon web2 platforms in favor of web3.

The Web2 / Web3 Flippening

To be clear: web2 didn’t share enough economic incentive with users, and so will be outcompeted by distributed systems that share both profit incentive and governance — better for all stakeholders including shareholders, token holders, and end users.

Whereas Facebook, Twitter, Google, etc take 50% of profits for themselves, web3 will see a reduction down to just a few percentage points of margin (‘take’ or ‘profit’) for the platform builders.

Why would stakeholders such as whale token holders, VC’s or Founders be happy with such a reduction in their % take of profits? Because of the volume… because of the plethora of new app opportunities made possible via web3 systems, and because it’s simply the direction that tokenomics will push us all through free-market competition.

The creator community as a whole can earn multiple times more than platform builders — and yet the builders will still earn a satisfying and well deserved take based on huge economies-of-scale and network effects.

In a web3 world, all stakeholders do exceedingly well providing the exponential growth in the network is faster than the exponential decline in % profit margin.

Eventually: we see a world where all shareholdings will be entirely tokenized, instantly liquid, attached to clear governance rights, with direct link to dividend yield (profit share).

The Role of VC’s

VCs need to deliver more than just capital investment. Funding for startups brings more than just ‘external ownership’ — it means an accelerated path towards profitability. In today’s age, time is of the essence. Otherwise Founders wouldn’t sell a stake in their project.

Solana, for example, took a leap ahead in market traction through VC partnership. (Yes Solana has its faults, which blockchain doesn’t?)

Investment also brings advisory, mentoring, and connections. Entrepreneurs understand this to be vital for a fledgling startup to achieve success. FOMO degen token traders rarely grasp the challenge of bringing a startup idea to life. Developers sometimes think ‘build a better mousetrap and they [customers] will come”. A sea of abandoned github projects reveals how false that belief is.

All that being said, there are broadly speaking…

3 ways to invest in web3

a) Really early. b) Early. Or c) Late.

Really early includes what angel investors or VC’s do in traditional finance, to give an idea a fighting chance at becoming a business. Bravo for their bravery given the statistic that 85% of startups fail. Really early investors (Founders, Angels, VC’s) deserve the wins.

Really early investment into web3 can also include private token sales or pre-sales. Startups approach various types of investor for a significant enough size backing of the token sale.

This helps seed the project with operating capital… and gives the project some level of credibility in the run up to a public sale or main sale…. and also helps them gain advisors, or refine their pitch before making the project public.

This essentially means that investors with better connections, or more money than a typical public sale investor, will typically ‘get in’ at a lower price than future token buyers will pay.

Private token sales often have a $50k+ minimum and often a long vesting period, perhaps 6 months or more, until those early investors receive their tokens and thus can exit if they choose or continue to hodl.

b) Early

Instead of being really early via pre-seed or seed equity investment or private token sale, ‘early’ is akin to a public token sale or Series A venture capital. Not a bad way to go if you want more assurance that a project has some legs.

c) Late

As my Grandpa used to advise me, “If you’re always early, you’re never late”.

Anyway…

Jack Dorsey is wrong, although he may be playing 4D chess. He can criticize VC’s because as a billionaire founder, he doesn’t need VC funding to kick-start his entry into the web3 industry via his FinTech company Block (formerly Square).

Bottom line: VC investment does not in any way prevent web3 from being ‘decentralized’. Web3 means distributing governance and the profit motive to end-users (play-to-earn, learn-to-earn) and experience builders (create-to-earn).

A Word On Governance

Above we focused on web3 economic incentives, but what about the means of governance? Since governance is tied to tokenomics, there is no way to exclude large token holders from having an unfair say in the governance of a DAO (decentralized autonomous organization)… or is there.

Let’s dig into those details in a follow up soon.

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