Builders of Web3 systems currently face numerous challenges in initiating, managing and scaling decentralization. That’s a problem if Web3 is to emerge fitter, faster, and stronger than the well-established efficiency and stability of centralized Web2 systems.
But framing decentralization as a single design challenge with three aspects — technical, economic and legal — should provide a strong reference guide to help builders overcome these challenges.
Miles Jennings, general counsel at the Web3 VC fund a16z, has provided a set of principles of decentralization gleaned from his experience working with crypto founders to guide Web3 builders tackling what decentralization means in practice.
Anyone interested in how current centralized arrangements for monetizing and distributing content will be upended by Web3 technologies should take note.
Decentralized versions of existing Web2 categories like social media, video games, music and marketplaces are coming. The success of these systems will depend on their ability to deliver the actual benefits of decentralization, including more equitable ownership among stakeholders, reduced censorship, and greater diversity.
Jennings bases his article on a comprehensive paper on the subject, which he also authored.
Fair warning: both the article and paper require existing knowledge of the jargon surrounding Web3 and Web2, and are not easy reading. Many of the concepts the paper addresses have been simplified here, but those who are interested in Jennings’ detailed advice for Web3 builders should head straight to source.
The Framework for Decentralization
Decentralization, explains Jennings, can be thought of as a single design challenge that spans three different but interrelated elements: technical, economic and legal. Understanding the differences in these elements is key to designing Web3 systems because design decisions with respect to one affects the others.
Technical decentralization relates primarily to the security and structural mechanisms of Web3 systems.
“The core innovation behind programmable blockchains is that they can support technical decentralization by providing a permissionless, trustless, and verifiable ecosystem in which value can be transferred — and, more importantly, upon which Web3 products and services can be built,” Jennings writes.
This means that products and services can be deployed and run without requiring trusted, centralized intermediaries to operate (or pull the rug out from under) them, opening a vast world of possibilities. For these reasons, technical decentralization acts as the foundation on which the other two types of decentralization can occur: economic and legal.
“Economic decentralization” relates to the economies of Web3 systems. The advent of programmable blockchains (such as Ethereum, Solana, and Avalanche) and digital assets (such as ETH, SOL, and AVAX) unlocked the ability of open source and decentralized systems to finally have their own decentralized economies (i.e., autonomous free-market economies).
“This is a critical breakthrough,” says Jennings. “The open source and decentralized protocols of previous generations of technology like Web1 (such as http, smtp, ftp, etc.) stagnated because they lacked the ability to incentivize ongoing development and/or further investment of critical resources back into their systems.”
This, says Jennings, left fertile ground for the centralized companies of Web2 to emerge and succeed as they were able to leverage their efficiency and resources to build products and services that surpassed those of web1. But this centralization also led to countless examples of user rights abuses, de-platforming, and aggressive take-rates.
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“Now, the technology underpinning Web3 makes it possible for far more sophisticated open source and decentralized systems to be created — and enables decentralized economies to form around them — which will enable the products and services of Web3 to compete with and eventually surpass those of Web2.”
Jennings continues his point noting that builders of Web3 systems can facilitate the formation of decentralized economies. They can do so through careful design decisions that lead to their systems accruing “value” — whether information, economic value, voting power, or other form — and distributing that value equitably among system stakeholders according to their contributions.
This in turn encourages stakeholders to contribute meaningful value because they have agency over how their contributions are treated and rewarded.
“The ongoing balancing of incentives among the stakeholders — developers, contributors, and consumers — can then drive further contributions of value to the overall system, to the benefit of all. In other words: all the benefits of modern network effects, but without the pitfalls of centralized control and captive economies.”
“Legal decentralization” relates to the legality of Web3 systems. In Jennings’ piece, he focusses primarily on U.S. securities laws, which dictate how and whether Web3 systems may make use of their own native digital assets. It’s heavy stuff.
The important point is that together these three separate aspects of decentralization — technical, economic, legal — “must be viewed holistically, as a single design challenge, because design decisions with respect to one will affect another.”
In general, the interplay between technical, economic, and legal is primarily additive, not subtractive. Developments in one create more possibilities in the others.
For example: Decentralized economies help drive systems towards legal decentralization by prioritizing decentralized ownership among stakeholders, value accretion from decentralized sources, and value distribution to decentralized stakeholders. All of these decrease the risk of information asymmetries and the need to rely on managerial efforts of individuals.
Web3 Components and Decentralization
That’s the framework for the design challenge of decentralization. It follows a review of how key components of Web3 systems slot in.
They include blockchain networks and smart contract protocols. These enable technical decentralization but can also be designed in a manner that promotes both economic and legal decentralization as well.
For example, by enabling transparency — anyone can currently view where the most digital assets have been deposited, and where the most fees are being earned in a DeFi ecosystem. Blockchain contracts also allow data portability, mobility, and interoperability in which users retain control of their data, purchases, and content across Web3 products and services.
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In addition, elements can be programmed to interact with each other, making these programs like building blocks that anyone can use. This is called composability.
Digital assets are the most critical tool Web3 builders have to facilitate the formation and ongoing functioning of their decentralized economies, according to Jennings, “because they enable the balancing of incentives among developers, contributors, and consumers.
“When properly designed, digital asset distributions therefore have the potential to drive a ‘flywheel’ of network effects where the overall system becomes more valuable to more users as more people participate in the network,” he says.
But unlike the locked-in network effects of Web2, Jennings notes, Web3 digital assets empower users to shape their own experience and benefit from their contributions.
The vast majority of blockchain networks and smart contract-based protocols have decentralized governance administered by a decentralized autonomous organization (DAO). Benefits of DAOs include:
- Make Web3 systems more secure, by distributing technical control over such systems to decentralized groups — thereby limiting the ability of any single party to take control of the system’s governance.
- Provide stakeholders with meaningful representation in decisions and ensure long-term incentive alignment among stakeholders. This feature, along with the enhanced security, helps make decentralized governance more effective — allowing it to contribute to the overall health and sustainability of the decentralized economies of Web3 systems.
- Support legal decentralization by reducing stakeholder reliance on the managerial efforts of any individual or group — thereby reducing the risk of potential information asymmetries.
“Ultimately, Web3 builders should be careful not to vest too much power in the hands of insiders,” warns Jennings. “Instead, significant control should be given to the community. Where there are imbalances in power, Web3 builders should look to delegate programs to help diffuse it.”
In striking this balance, Web3 builders should also look to instill safeguards against malicious attacks, including potential manipulation of decentralized governance for profit.
How Might a Web3 Version of Web2 Look?
Jennings has some simple examples.
Web3 gaming could entail a system with multiple games implementing a shared smart contract protocol and governance token; having separate in-game currencies and NFTs; and enabling both players and contributors to earn digital assets. These assets would also be portable across the ecosystem. The games driving the most use could then earn the greatest percentage of the governance tokens distributed by the system’s DAO, leading game creators to in turn fund additional development of their games.
Web3 social media could entail a system with multiple iterations of social media services and messaging services, each built as a separate client upon the same open-source smart contract protocol. Since the protocol would share a native governance token: consumers would earn tokens based on use, contributors would earn tokens based on the content they create, and clients would earn tokens based on various metrics established by the DAO.
Web3 marketplaces could entail a system where a collection of smart contracts and clients to coordinate service providers, as well as facilitate their interactions and scheduling with customers. Developers could then build white-label versions of those clients, enabling providers to offer many different levels of customized services or products. Clients and service providers would all earn the same governance token based on their contributions to the system.
Nail the Framework, Nail Web3
If implemented correctly, an open infrastructure comprising the blockchain network and smart contract protocols provides a rich environment for a variety of specialized products and services to be built on top of its layers, Jennings says.
He also notes that, by utilizing this shared infrastructure, “builders can build Web3 products and services at a fraction of the cost” of building centralized Web2 applications from scratch.
However, there’s a warning.
Failure to account for all technical, economic, and legal elements will lead to a Web3 that falls short of the future that blockchain technology and cryptocurrencies make possible.
“No one wants a Web3 that’s built on new tech, but that is otherwise indistinguishable from Web2. Instead, by building systems that carefully and deliberately design for decentralization, builders can create digital infrastructure, and give life to decentralized economies, which will form the foundation of the internet for decades to come. It’s time to build that internet, and that future.”