Tomasz Tunguz
Web3 startups are facing a mammoth decline in funding: Earlier last year, I estimated that web3 funding would drop by 73%. In reality, second-quarter funding in 2023 looked even worse — a full 76% decline from the previous year’s figures, according to Crunchbase. In the first half of 2023, web3 companies raised about $4 billion (miniscule in comparison to the nearly $16 billion invested in the first half of 2022), and investments continued to decline through the end of the year.
Most startups have been challenged by the tepid fundraising market, with AI being the sole bright spot. It’s clear that investors are hesitant to fund crypto and blockchain-inflected businesses right now.
Why? The last couple of years have been a grizzly bear of a market for web3. The FTX fiasco cast a long Bahamian shadow over the trustworthiness of counterparties. Just a few months before, the ecosystem suffered through the Three Arrows and Luna debacles, which destroyed billions in value overnight.
A slew of regulatory actions against some of the biggest names in the category have underscored regulatory risk. Active developers in web3 have fallen, lagging a decline in both users and overall transaction volume on exchanges.
But there’s more to web3 than this boom-and-bust cycle, and these dark skies mask the considerable potential of decentralized databases. Web3 introduced a novel way of building software, an architecture that will become increasingly important with governments enacting new data regulatory regimes.
U.S. states, European countries, and Asian states each have their own rules about managing data. With additional regulation and complexity inevitable, web3’s databases enable technical judo. Rather than companies managing data for users, users will manage their own data and software products will use it only with users’ permission.
We won’t see Web 2.0 companies evolving into web3 companies. Instead, web3 companies will become Web 2.0 companies, selling their novel infrastructure to classic software buyers.
Common roots to bridge the GTM divide
In the mid-2010s, essentially every company evolved from Web 1.0 to Web 2.0. Web 2.0 companies aren’t really going to transform into decentralized platforms. But to survive, web3 startups need to learn to market and sell like their centralized brothers. The web3 software market is just too small today — fewer than 60 companies generated more than $5 million in revenues on chain in 2022.
It’s helpful to remember that the core technology underlying web3 is not so different from existing distributed systems. One example is the raft consensus algorithm that was pioneered in Stanford in 2014 and is used by many distributed databases today. Raft keeps databases in different regions in synchronicity. Raft is an evolution of another consensus algorithm that has been used in crypto currency.
Multiparty computation, a technology at the core of blockchain, also is an important ingredient in Web 2.0 distributed systems. It’s an essential ingredient in data clean rooms, technologies that allowed two companies to share datasets while maintaining the privacy of the underlying users’ data.
The nuances of each particular technology are not important. The broader point is that distributed Web 2.0 and decentralized web3 infrastructure technologies have common roots — and therefore more than we might think to bridge the go-to-market (GTM) divide.
How web3 startups can start fresh
To survive, web3 startups must expand their buyer base to brand-new markets that showcase a greater willingness to spend, invest and innovate. Web3 startups will find opportunity vying in the cloud software and infrastructure market, which constitutes 40% of the $1.5 trillion in global IT spend.
But how can they do so?
- Use recognizable language. A key component of this evolution simply involves returning to language that buyers understand — for example, transitioning “wallets, blockchains and tokens” to “accounts, databases and credits.” Some investors have been turned off by the apparent complexity of web3, feeding into the notion that its use cases aren’t clear. Simple language is a first step.
- Promote the value prop and focus on the best of both worlds. Web3 startups must sell to Web 2.0 buyers promoting classic value propositions that appeal to buyers: greater revenue growth at lower cost. As an investor, I look for evidence that companies can deliver on these most basic needs for buyers, especially in today’s market.
- Lean on the unique advantages of decentralization to bring about the best of both worlds. Decentralized software can improve performance, provide greater guarantees for security and compliance, and provide superior user experience, all while better respecting data privacy regulation.
For example, more than 15 states and 71% of countries have enacted or drafted data privacy laws. As the morass of regulation grows, compliance costs will increase. At the same time, Google will deprecate the third-party cookie just as Apple decommissioned its identifier for advertisers (IDFA), making personalization more difficult.
Blockchain technologies have the power to combine the benefits of personalization with the privacy of crypto — enabling users to custody and manage their own data and letting publishers customize their sites to users while maintaining their privacy — a promise that can be proven to any regulator.
Encrypting preferences on the public blockchain, and enabling publishers to selectively unlock them with user consent, replicates cookie functionality in a way that satisfies international regulation.
There are numerous other use cases that utilize the power of combining Web 2.0 and web3 to satisfy modern demands for privacy and personalization. For web3 to cross the chasm, these are the areas to focus on.
Turning theory into action
When I founded Theory, which invests up to $25 million in early-stage software companies that leverage technology discontinuities into GTM advantages, we aimed to focus in part on the power of web3’s decentralized databases.
Our enthusiasm hasn’t waned — because of the convergence of Web 2.0 and web3 software we see on the horizon today. Already we’re seeing web3 companies meet the moment, looking to the past to ensure their future.
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