a16z: Decentralized design reference guide from the bottom to the realization of Web3

This article describes specific patterns and principles of decentralization, and guides Web3 builders in addressing the practical implications of decentralization in several use cases.

The prospect of decentralization is much discussed and debated, from why it matters to the larger question of who will control the software that powers the internet. These questions are crucial because, as we have seen, when control is in the hands of a very small number of people, violations of individual freedom, choice, and privacy are inevitable. When the CEO decides one direction or the other, “don’t be evil” is very different from “can’t be evil.”

But the decentralization of the Internet has always been difficult to achieve. When contrasted with the improved efficiency and stability of centralized systems, decentralized systems have struggled to keep pace. Now, however, the emerging technologies of cryptocurrencies and Web3—especially programmable blockchains, composable smart contracts, and digital assets—enable decentralized systems to achieve unprecedented coordination and operational capabilities. This evolution has fostered new forms of governance and organization, community-owned and operated networks and services, robust economies, and countless other innovations.

We have seen specific categories such as Decentralized Finance (DeFi) and core infrastructure projects take off and will soon see decentralized versions of existing Web2 categories such as social media, video games, music and marketplaces . The success of these systems will depend on their ability to deliver the practical benefits of decentralization, including fairer ownership among stakeholders, reduced censorship and greater diversity. However, the more familiar decentralized models for DeFi are not necessarily applicable to these more complex systems (i.e. those with more user interface capabilities, richer customer experience, centralized products or services, or authorized IP) .

Therefore, I thought it would be useful to share specific patterns and principles of decentralization gleaned from working closely with cryptocurrency founders over the past few years to guide Web3 builders in addressing the practical implications of decentralization in several use cases help. Depending on where you are in your Web3 journey, I welcome you to read the full article below; or the more comprehensive document on which this article is based (including additional background and details);

(1) Design challenges of Web3 decentralization

Decentralization can be thought of as a single design challenge that spans three distinct but interrelated elements: technology, economics, and law . Understanding the differences between these elements is key to designing a Web3 system, because design decisions on one element affect other elements.

technology decentralization

The technical decentralization is mainly related to the security and structural mechanisms of the Web3 system . The core innovation behind programmable blockchains is that they can support technological decentralization by providing a permissionless, trustless and verifiable ecosystem where value can be transferred and more importantly The thing is, Web3 products and services can be built on top of it.

This means that products and services can be deployed and run without the need for trusted, centralized intermediaries to operate (or pull the rug from under them), opening up a vast world of possibilities. For these reasons, technical decentralization is the basis for the other two types, economic and legal.

Economic decentralization

Economic decentralization is related to the economy of the Web3 system . The advent of programmable blockchains (such as Ethereum, Solana, and Avalanche) and digital assets (such as ETH, SOL, and AVAX) unlocked the possibility of open source and decentralized systems eventually having their own decentralized economy (i.e. autonomous free market economy) Ability.

This is a critical breakthrough. Open-source and decentralized protocols of previous generations of technology, such as Web1 (eg http, smtp, ftp, etc.), stagnated because they lacked the ability to incentivize continued development and/or further investment in critical resources back into their systems. This leaves fertile ground for the emergence and success of Web2’s centralized companies, as they are able to leverage their efficiencies and resources to build products and services beyond Web1. However, this centralization has also led to countless examples of user rights abuses, lack of freedom of speech, and aggressive fees.

Now, the technologies underpinning Web3 make it possible to create more complex open source and decentralized systems, and to form decentralized economies around them, which will allow Web3 products and services to compete with and eventually surpass Web2 products and services they.

Builders of Web3 systems can facilitate the formation of a decentralized economy by making careful design decisions, so that their systems derive “value” from a wide range of sources – whether it be information, economic value, voting rights, or other forms, and distribute these values ​​fairly among the stakeholders of the system according to their contributions. To achieve this, the Web3 system needs to give meaningful power, control, and ownership to the stakeholders of the system (via airdrops, other token distributions, decentralized governance, etc.). This in turn encourages stakeholders to contribute meaningful value because they have a say in how their contributions are treated and rewarded.

A balance of incentives between stakeholders—developers, contributors, and consumers—can drive further value contributions to the overall system, benefiting all. In other words: Web3 systems have all the benefits of modern network effects, but without the drawbacks of centralized control and captive economies.

Legal decentralization

Legal decentralization has to do with the legitimacy of the Web3 system. In this article, I focus primarily on US securities laws, which determine how and whether Web3 systems can leverage their own native digital assets. While there is no codified standard for “legal decentralization,” a first-principles analysis of U.S. securities law, case law, and SEC guidance (including the SEC’s April 2019 final guidance) can help us develop a practical standard.

First, U.S. securities laws are generally designed to create a “level playing field” for securities trading, limiting the ability of those with more information to take advantage of others with less information. This is the principle of information asymmetry, and U.S. securities laws often eliminate asymmetry in certain securities transactions by applying disclosure requirements. This principle comes into play in the Howey test, a subjective test that determines whether U.S. securities laws should apply to digital asset transactions where (1) funds are invested (2) in a common enterprise (3) there is a reasonable expectation of profit ( 4) Primarily based on the management efforts of others. The fourth principle is intended to address information asymmetry because we believe that if there is a reliance on “managerial effort,” the risk of information asymmetry (managers vs. outsiders) may be high and securities law may need to apply.

Based on the above and the SEC guidance, we can speculate that if a Web3 system can (a) eliminate the possibility of significant information asymmetries, and (b) eliminate the fundamental management efforts of others to drive the success or failure of the enterprise , then the system is likely to be “sufficiently decentralized” and, therefore, the application of U.S. securities laws to its digital assets should be unnecessary. In this article, I refer to these systems as legally decentralized . Granted, the legal threshold of decentralization will not be met by most businesses, but as I outline below, the novel components of the Web3 system give it a unique advantage in meeting such a threshold.

Collectively, these three separate aspects of decentralization— technical, economic, legal —must be viewed holistically as a single design challenge, as design decisions about one can affect the other. Generally speaking, the interplay between technology, economics and law is mostly additive rather than subtractive – developments in one create more possibilities for the others. For example. A decentralized economy helps drive the system toward legal decentralization by prioritizing decentralized ownership among stakeholders, value appreciation from decentralized sources, and decentralized value distribution among stakeholders. All of this reduces the risk of information asymmetry and reliance on individual management efforts.

For more background on legal and economic decentralization, and how these aspects fit together, see the full article.

(2) How to use the components of the Web3 system to achieve decentralization 

When a Web3 system is well designed, decentralization becomes a virtuous cycle, not a vicious one. Now that we have a framework for the design challenges of decentralization, let’s quickly review how builders can drive decentralization in practice using the following novel components of Web3 systems:

a16z: Decentralized design reference guide from the bottom to the realization of Web3

Blockchain Network and Smart Contract Protocol

At a fundamental level, blockchain networks and smart contract protocols enable technological decentralization. But they can also be designed to promote both economic and legal decentralization, including:

  • By enabling transparency – for example, anyone can currently see where the most digital assets are being held in Ethereum’s DeFi ecosystem, and which DeFi apps earn the most fees;
  • By being an open source public product – anyone can freely use and test features to ensure security, promote a decentralized economy, etc.;
  • By allowing data portability, mobility and interoperability – users retain control over data, purchases and content of Web3 products and services;
  • By prioritizing composability – elements can be programmed to interact, making these programs like building blocks that anyone can use.

Collectively, these features reduce the risk of information asymmetry, reduce the importance of any Web3 system’s proprietary technology, and increase the importance of the system’s network of contributors and consumers relative to its developers.

In other words: these characteristics transfer the value of the system from its technology stack to its network. Since the web is more open and decentralized than proprietary systems, this shift highlights why Web3 systems are better positioned to achieve decentralization than Web2 systems.

digital assets

The decentralized economy of the Web3 system is driven by two types of incentives:

  • Intrinsic incentives , based on the basic characteristics of the system, such as user groups, network effects, technology, etc., trigger the innate willingness of third parties to participate in such systems.
  • External incentives , such as digital asset distribution, income sharing, etc.

Among them, digital assets are the most critical tool for Web3 builders to facilitate the formation and continuous operation of their decentralized economy, because they can balance the incentives between developers, contributors and consumers.

So, if properly designed, digital asset allocation has the potential to drive a “flywheel” of network effects, where the entire system becomes more valuable to more users as more people participate in the network. But unlike Web2’s locked-in network effects, Web3’s digital assets enable users to shape their own experiences and benefit from their contributions.

Successful user acquisition and retention can greatly improve the Web3 system’s intrinsic incentives for developers and contributors, driving these aspects to produce greater value to the system, ultimately attracting more users, and so on. Ethereum’s growth over the past two years is a prime example. From early 2020 to early 2022, the amount of digital assets deposited in Ethereum DeFi protocols has grown from just over $600 million to over $150 billion. But this is not a narrative of the amount and its monetary value – rather, it shows how developer activity produces products and services that attract users, which then attract more developers and additional products and services, which in turn This in turn led to further growth in users.

In addition to potentially creating such flywheels, the network effects of Web3 systems could provide builders with a moat to prevent competitors from replicating and redeploying their infrastructure, which is open source. how to say? Because for systems with strong network effects, replication alone is unlikely to incentivize users to switch to new systems.

This again emphasizes that the real value of a Web3 system will be in the network of its stakeholders — not in its technology stack, closed or proprietary systems, or other typical moats.

Decentralized Governance

The vast majority of blockchain networks and smart contract-based protocols have decentralized governance, governed by a Decentralized Autonomous Organization (DAO). Decentralized governance and DAOs provide many benefits along the three decentralization standards already discussed, including:

  • Web3 systems are made more secure by allocating technical control over such systems to decentralized parties — thereby limiting the ability of any unilateral party to control the governance of the system.
  • Provide meaningful representation to stakeholders in decision-making and ensure long-term incentive alignment among stakeholders. This feature, coupled with enhanced security, helps make decentralized governance more efficient — making it a contribution to the overall health and sustainability of the Web3 system’s decentralized economy.
  • Supports legal decentralization by reducing stakeholders’ reliance on the governance efforts of any individual or group – thereby reducing the risk of potential information asymmetry.

When designing decentralized governance for any Web3 system, we can draw some insights from several different models that have been developed and implemented across the DeFi sector. E.g:

Sub-DAOs : To streamline decision-making, some DAOs authorize sub-DAOs to have specialized powers in certain categories of actions, such as legal, financial, development, etc.

Minimization of governance : To increase the reliability of DeFi protocols and overcome challenges in DAO participation rates, some have called for minimizing the number of final decisions a DAO needs to make, or creating a hierarchy where more important decisions require more high voter turnout.

Incentives for Participation : To ensure effective DAO governance, some DAOs incentivize active participation, including remuneration of delegates. Note that while grant programs do not play well here, retrospective award programs can be very effective because they defer the evaluation and award of contributions until after the value has been delivered. If designed well, they can also help stimulate competition and open up markets.

Progressive Decentralization : To prevent malicious attacks, many DAOs use “Progressive Decentralization”, where greater control is handed over from developer companies to the community as protocol/network security improves.

Ultimately, Web3 builders should be careful not to put too much power in the hands of insiders. Instead, significant control should be handed over to the community. Where there is an imbalance of power, Web3 builders should look to delegation procedures to help decentralize power.

In striking this balance, Web3 builders should also seek to instill safeguards against malicious attacks, including the potential manipulation of decentralized governance for profit. While the use of off-chain governance mechanisms and Multisigs (control requires multiple multi-signers, each with their own key, to authorize an action) have been common safeguards for this purpose, they have recently come under significant criticism, Including them could break decentralization.

For more examples of how all of the above components can be designed to enhance decentralization, as well as a discussion of further best practices, see the full article.

(3) Decentralized model in practice 

Now let’s look at how the techno-economic-legal framework I shared earlier applies to several different decentralization models in practice. These models range from “full” decentralization (every component of the system is decentralized) to “open” decentralization (a decentralized system where independent third parties all participate in a shared decentralized system). I also include models for specific applications of open decentralization, such as NFT projects and tokenized protocols.

Totally Decentralized: How to Decentralize DeFi and Other Simple Applications

Complete decentralization is currently the most common decentralization model in the DeFi field. As reflected in the image below, the transition from a centralized model (like Web2) to a decentralized model (like Web3) involves:

  • Deploy open source smart contract protocols on a decentralized and programmable blockchain network to form the core infrastructure layer of the Web3 system — smart contract protocols are all back-end components that can be deployed on the chain (i.e. payments, messaging etc.) provides an execution layer;
  • Run the “client” layer in a decentralized way – the client represents all the software running outside the chain of the system, and acts as the gateway of the smart contract protocol (the client can be a simple front-end website or a complex application program);
  • Increase the distribution of digital assets – this can be an airdrop to contributors and consumers; distribution to insiders (employees, advisors and shareholders of the developer company); distribution of digital assets to clear incentive programs (such as in DeFi) liquidity mining); and the formation of a DAO-controlled treasury for use in relation to any future incentives:
  • Initiate DAO governance of smart contract protocols and DAO treasury ;
  • Make sure users own and keep their own data (there’s a huge debate in Web2 systems right now).

a16z: Decentralized design reference guide from the bottom to the realization of Web3

This fully decentralized model assumes that the Web3 system is a novel smart contract protocol deployed within an existing programmable blockchain network. “User” here refers to consumers and contributors.

For the Web3 system using this model, the decentralization of the blockchain network and smart contract protocols is mainly achieved through the technical decentralization of these layers , and by starting the decentralized governance in the form of DAO , from the creation of The developer company of the system gains control over the smart contract protocol. Deploying a smart contract protocol onto a public blockchain and launching its DAO gives the system transparency as well as greater security, it means no individual or group controls the system.

The decentralization of the client layer then happens in several different ways. Inside DeFi, most clients are just simple front-end websites that provide a gateway to the underlying smart contract protocol (that is, they allow users to interact with the protocol), and most developer companies make their clients/websites open source , and host it on a decentralized file system (like IPFS). As clients/websites become open source, third parties independent of the developer company often end up hosting their own clients/websites, providing access to the same underlying protocol. Additionally, independent third parties often build protocol gateways in their own aggregators and dashboards. This means that the protocol’s gateway is always available whether or not the developer company’s client/website is maintained.

The above steps mostly eliminate the possibility of information asymmetry – the bulk of the driving force of US securities laws – because (1) information about the protocol and its operation is transparent on a public blockchain ledger, (2) the protocol is launched The management efforts of the developer companies are no longer critical to the success or failure of such a protocol.

Also, since the blockchain and smart contract layers are operational and not controlled by any group or entity, the system is fully redundant and no longer depends on the developer company. DeFi primitives are a good example, as they continue to provide utility to users with little need for ongoing development. Therefore, protocols implementing this decentralized model can be considered legitimately decentralized, even without a fully functioning decentralized economy.

Limitations of complete decentralization

Although the fully decentralized model has been successfully applied to DeFi, its simplicity may make it unsuitable for more complex Web3 systems. Builders should be aware and plan for these factors that introduce complexity:

Sophisticated clients: Given its relative simplicity, decentralization of clients within DeFi is somewhat straightforward – there is little incentive required for third parties to build independent and simple gateways (mostly in the form of websites) to this protocol . However, as Web3 products and services become more complex, with computationally expensive/resource-intensive client-side layers built on top of the underlying smart contract protocols, decentralization of the client-side becomes more complex. For example, consider that a client/website providing access to Uniswap and Compound protocols is not as complex as a hypothetical Web3 social media client, which requires the full functionality of Web2 applications like Twitter and Instagram. This complexity may reduce the willingness of third parties to establish and/or host alternative clients, or to integrate access to the protocol layer into their own systems without explicit incentives.

Significant Improvements Needed : Likewise, systems that require significant improvements after the launch of digital assets may find it difficult to make these improvements in a decentralized manner. In DeFi, for example, many protocols are struggling to successfully use explicit token incentives to drive continued meaningful development of their smart contract protocols.

Ongoing Operations : Developer companies may intend to perform extensive operations to increase the value of their Web3 systems after their digital assets are launched. If the additional value contribution is not from an independent third party, this could weaken the decentralization of the system. Furthermore, since governance tokens themselves generally do not confer any rights over the products and services that the developer company may produce in the future, the developer company should be careful not to make the token holder feel that any such relationship exists.

Retention of exclusive rights : If the original developer company (or others) retains exclusive rights to any intellectual property used in the system, it may weaken the complete decentralization of the system. For example, if developers of complex clients for Web3 social media want to retain ownership of such clients, complete decentralization may not be possible.

These limitations can be overcome by Web3 systems that stimulate significant economic decentralization, creating an efficient decentralized economy . If a decentralized group of developers, contributors, and consumers builds and acquires significant value — thereby downplaying the importance of the original developers to the system as a whole — it moves the system from a fully decentralized model Shift to an open decentralized model .

Open Decentralization: How to Decentralize Complex Web3 Applications 

Like the fully decentralized model, the open decentralized model includes a decentralized blockchain and smart contract protocol layers, digital assets and DAOs.

But unlike a fully decentralized model, an open decentralized model would also have independent developers building and operating several clients (possibly centralized) on top of a shared smart contract protocol layer. Consider, for example, a potentially rich and complex client for Web3 social media that functions similarly to Web2 applications such as Twitter and Instagram, but both use shared smart contract protocols rather than separate proprietary backend systems.

a16z: Decentralized design reference guide from the bottom to the realization of Web3

This model assumes that the Web3 system is a novel smart contract protocol deployed in an existing programmable blockchain network. “User” here refers to consumers and contributors.

In this open and decentralized model, all customers will utilize the digital assets of the underlying smart contract protocol, and their creation and operation will be incentivized as follows:

  • Initial Incentives : Initial development can be incentivized through explicit and implicit incentives, including rewards for digital assets from the DAO-controlled coffers of the smart contract protocol; the protocol’s network effects; and the ability for these developers to retain their respective clients’ intellectual property fact.
  • Ongoing Incentives : Similar incentives are available for ongoing maintenance and ongoing development, and digital asset-based incentives can be automatically awarded based on performance metrics set by the DAO. An example in DeFi is the Liquity protocol, which rewards hosts of independent front-end websites that provide access to the protocol, with rewards tied to the economic activity of those front-end websites on the protocol. In more complex Web3 systems, we expect to see a substantial increase in the prevalence of this reward. For example, in a decentralized social media ecosystem, customer user engagement can be measured and rewarded with tokens. Finally, in addition to the incentives from the protocol, the operators of clients will be incentivized by any economic returns they can generate through their own proprietary clients.

Builders seeking to decentralize their Web3 systems through an open decentralization model will need to design their incentives and decentralized governance model to be “customer agnostic” to encourage participation by many participants. In addition, they need to ensure that a single customer does not have a clear power imbalance that would dominate the entire ecosystem. If this imbalance were prone to occur, the builders of these clients would have a bad view of the Web3 system and would be reluctant to invest time and resources in it. In some respects, such systems would have similar centralization and control issues as Web2 systems.

Builders using an open decentralized model should also prioritize transparency, open source technologies, data portability, and composability to further reduce the risk of the concentration of power in their systems in the hands of developers. These features eliminate information asymmetry, lower barriers to entry for competing developers, and allow users to switch between clients — all of which promote a more open and decentralized ecosystem where users will not Limited or burdened by any one client. (This is a huge hurdle in current Web2 systems, where user data is enclosed in every closed Web2 system).

Finally, for the system’s decentralized economy to be truly resilient, the success or failure of the entire Web3 system should not depend on any individual or group, including any single client. If this condition, as well as the aforementioned conditions of economic decentralization, are met in a Web3 system, the risk of major information asymmetry in such a system is greatly reduced, making it legally decentralised.

It may be counterintuitive at first to suggest that builders should prioritize the above design decisions because they effectively incentivize their own competition. But doing so will help form a functional decentralized economy built on shared infrastructure, which in turn will lead to a broader and richer ecosystem than any single company could build alone.

In other words: these actions grow the entire pie, rather than prioritizing one piece.

Web3 version of Web2

To see how these principles work in practice, let’s apply the open decentralization model to create simplified Web3 versions of familiar Web2 applications. The promise of Web3 goes beyond mediating known functions and applications, as it enables completely new things; but to illustrate, I’ll focus on some simple examples.

Web3 games may require a system of multiple games that implement a shared smart contract protocol and governance token; have separate in-game currencies and NFTs; and enable both players and contributors to earn digital assets. These assets can also be carried across the ecosystem. The games with the most usage receive the largest percentage of governance tokens allocated by the system’s DAO, allowing game creators in turn to fund additional development of their games.

Web3 social media may require a system with multiple iterations of social media services and messaging services, each an independent client built on the same open source smart contract protocol. Since the protocol will share a native governance token: consumers will earn tokens based on usage, contributors will earn tokens based on the content they create, and clients will earn tokens based on various metrics established by the DAO.

The Web3 marketplace may require a system where a collection of smart contracts and clients coordinate service providers, as well as facilitate their interactions and scheduling with clients. Developers can then build white-label versions of these customers, enabling suppliers to offer many different levels of customized services or products. Both clients and service providers will receive the same governance token based on their contributions to the system. There are a growing number of examples that Web3 businesses are already using tokenomics to create and capture long-term value.

Ultimately, an open infrastructure—comprised of blockchain networks and smart contract protocols in this model—provides a rich environment for building various specialized products and services on top of its layers. By leveraging this shared infrastructure, builders can build Web3 products and services at a fraction of the cost of building centralized Web2 applications from scratch.

progressive open decentralization

One challenge resulting from the interplay between economic and legal decentralization in an open decentralization model is that it often leads to a chicken-or-egg paradox: true economic decentralization may require the use of digital assets ( That is, legal decentralization), but the use of digital assets requires economic decentralization and thus legal decentralization. This problem is particularly acute in the open decentralization model, which requires a fully functioning decentralized economy (by contrast, DeFi protocols using a fully decentralized model do not necessarily require economic decentralization).

While there are many ways to solve this problem from a technical and practical point of view, Web3 systems can take advantage of the process of progressive decentralization and take precautionary measures for the distribution of digital assets before achieving full decentralization. These precautions include restricting transferability and restricting issuance and listing in the U.S. until the system is fully decentralized.

Open Decentralization: How to Use IP (and Third-Party Resources) to Decentralize a Project

An iteration of the open decentralization model that deserves further exploration is where third parties contribute resources to the Web3 system with the goal of allowing system customers to use it for products and services.

This can take the form of licensed intellectual property (video game engines, data assets, marketplaces, etc.), and a range of services (including regulatory compliance, marketing, and business development) that anyone in the ecosystem can use or include for their own clients end. The following model reflects the intellectual property being contributed to the Web3 system:

a16z: Decentralized design reference guide from the bottom to the realization of Web3

The introduction of proprietary intellectual property may bring some of the decentralized economy of the system back to the owner-controlled Web2 economy, especially if the client’s developers/operators are reluctant to make their products and services subject to the intellectual property owner of whimsy and control.

However, this risk can be mitigated by the contractual terms of the license (through irrevocable/perpetual term, rights to amend/improvement, etc.). An important consideration in this regard is what services and ongoing maintenance of intellectual property are required, and whether such services and maintenance, if any, can be provided by independent third parties – as there is more reliance on a single third party Three-way intellectual property owners can weaken the overall economic decentralization of the system.

Ultimately, if the terms of the Web3 system are properly structured, its decentralized economy will remain intact. For example, the Web3 system’s use of extensive APIs (application programming interfaces) among its clients will not weaken the overall decentralization of the Web3 system, but may strengthen it.

From a legal decentralization perspective, the key issues to consider are. Should the basic management efforts of IP providers be necessary to drive the success or failure of Web3 systems? Will there be serious information asymmetry? Even if intellectual property is critical to the success of the system, if the owner of the intellectual property cannot revoke it at any time, the answer to both questions is likely to be no — thereby supporting the legal decentralization of the system. This would also be the case if the IP owner had to seek approval from the DAO before making any critical changes to the IP.

This concept can be extended beyond intellectual property to other resources that may be contributed or licensed to the Web3 system. For example, if a third-party regulatory compliance service enables DeFi protocols to confirm that their users are verified Americans, such a service should not undermine the decentralization of the Web3 system. Likewise, one could imagine third parties providing marketing and business development-related services to the agreement — independent of the activities of individual client businesses.

While there are many ways in which the introduction of third-party resources can compromise the decentralization of the system, this risk (as above) can generally be mitigated through structural and contractual mechanisms.

Open Decentralization: How to Decentralize NFT Projects 

Non-Fungible Token (NFT) projects and their communities are an emerging and increasingly popular type of Web3 system that provides a good opportunity to discuss some additional concepts of open decentralization.

First, it is important to understand the legal basis why most artistic NFTs can be excluded from US securities law, which is that they fail Title IV of the Howey test. The value of the National Trust is primarily intrinsic rather than derived from the management efforts of others. However, as NFT projects have grown in complexity, Howey’s analysis has become less straightforward. Today’s NFT projects often involve additional content creation/additional NFT placement, implementation of NFTs in video games, community-driven product development, and other activities – all of which can increase NFT holders’ reliance on others’ curation efforts .

Therefore, NFT projects should consider incorporating the principles of decentralization into their Web3 systems, especially if they intend to combine the project with fungible tokens. What would this decentralized model of NFT projects look like? The image below is an example. It reflects:

(1) A collection of NFTs minted on the blockchain, held by different users;

(2) The intellectual property contributed to the NFT community is likely to be related to the NFT itself (which can be “staken” by the holder to the community), as well as any legends created by the community;

(3) Digital asset allocation and incentive mechanism;

(4) Initiate DAO governance in relation to community intellectual property and the DAO treasury;

(5) Start derivative projects;

(6) Host social gatherings and events.

a16z: Decentralized design reference guide from the bottom to the realization of Web3

In this model, the economic decentralization of NFT projects can be achieved in several steps:

  1. First, DAOs can use their initial resources for community engagement (like Twitter, Discord, etc.) and fund social meetups and other events — thereby boosting the community’s implicit incentives (i.e., its popularity).
  2. Second, these implicit incentives —along with explicit incentives (such as fungible token rewards, access to NFT sales, etc.)—can then be used to incentivize the creation of derivative projects that leverage community intellectual property . Developers will be rewarded for developing such projects, and consumers will be rewarded for using them. For example, a DAO could hire third-party developers to use the community’s characters to create a game with token economics featuring the community’s native digital assets. In this regard, the role of derivative projects is similar to the client described in the previous open decentralization model, making the entire system less dependent on any single source to drive the value of NFT holders, which helps limit the occurrence of major information asymmetries. risks of.
  3. Finally, another important tool that NFT projects have is that royalties from secondary sales of NFTs should be credited to the DAO, which can power their decentralized economy. These royalties will provide the DAO with a decentralized revenue stream during times when derivative projects may not generate sufficient returns for the system.

Ultimately, the combination of value that spinoff projects and secondary sales bring to the ecosystem can drive NFT projects to build a healthy decentralized economy.

From the perspective of legal decentralization, the key issue remains. Are any basic management efforts by third parties necessary to drive the success or failure of the Web3 system? Is there a possibility of serious information asymmetry? The answers to these two questions will depend on many of the same considerations discussed above.

However, in this case, the intellectual property in the NFT scheme may help rather than hinder the overall decentralization of the community. Why? Because intellectual property is contributed to the DAO from a decentralized source (NFT holders). Furthermore, if DAOs were able to control the distribution of tokens, additional minting of NFTs and decentralized intellectual property — as well as decentralized revenue streams (from royalties or derivative projects) — the system would be less likely to develop significant information asymmetry.

Most NFT projects are still in their infancy, so we haven’t seen many examples of NFT projects deploying decentralized token economics, but we expect to see various mechanisms. At the same time, many experiences can also be incorporated into NFT projects from other Web3 systems. 

Open Decentralization: How to Decentralize Tokenized Protocols 

Tokenized protocols are another type of emerging Web3 system. In these systems, assets are piggybacked onto the blockchain, tokenized through smart contract agreements, and then sold or used for other purposes. Types of tokenization protocols include serial NFT minting projects, digital asset markets, and protocols that tokenize real-world assets.

The following open decentralization model reflects:

  • Bring assets on-chain from multiple suppliers through a shared smart contract agreement ;
  • Smart contract protocols that tokenize these assets ;
  • Sell ​​or use these tokenized assets through multiple clients ;
  • Allocation and incentive mechanism of native digital assets;
  • Initiate DAO governance in terms of community intellectual property and DAO treasury .

a16z: Decentralized design reference guide from the bottom to the realization of Web3

In this model, economic decentralization is achieved through sufficient diversity of inputs (asset providers) and outputs (asset acquirers), and the layers through which tokenized assets flow (blockchain, smart contracts, and clients) of decentralization.

The protocol’s DAOs can also come with explicit incentives (fungible token rewards, no commissions/fees, etc.).

  • Incentivize asset providers to provide assets to the system;
  • Incentivize clients to trade in tokenized assets;
  • Acquirers are incentivized to acquire or consume these assets.

While the original developer company may have played an important role in any of these roles (asset provider, customer operator, asset acquirer), once the system is decentralized, developer companies will ultimately be only in any given role one of many actors. This would limit the risk of any significant information asymmetry and reduce reliance on its management efforts. Additionally, many roles can be assumed by DAOs and/or subordinate DAOs.

Over time, explicit incentives can also be adjusted to take into account potential shortfalls on the supply or demand side. For example, in a decentralized marketplace, token incentives for sellers (supply side) can be increased to bring more goods into the platform for sale; token incentives for buyers (demand side) can be increased to encourage more purchases.

From the perspective of legal decentralization, the key issue remains. Are any basic management efforts by third parties necessary to drive the success or failure of the Web3 system? Is there a possibility of serious information asymmetry? The answer to both questions depends on whether the DAO can manage its incentives as effectively as the example above to balance supply and demand — but more broadly, it’s really about preventing any one asset provider, asset acquirer, or client has become so important that the success of the entire system depends on the efforts of any one entity.

Builders of Web3 systems currently face numerous challenges in launching, managing, and scaling decentralization. But even though regulatory requirements may change, addressing decentralization as a single design challenge encompassing three dimensions — technical, economic, and legal — should provide a strong reference guide to help builders use the new features of Web3 systems. components to overcome these challenges.

If these three factors are not considered, our Web3 will not be able to realize the future brought by blockchain technology and cryptocurrencies. No one wants a “Web3” built on new technology but otherwise indistinguishable from Web2. Instead, by building well-designed decentralized systems, builders can create digital infrastructure and breathe life into the decentralized economy that will form the foundation of the Internet for decades to come. Now is the time to build such an internet and future.

Special thanks to Chris Dixon, Sriram Krishnan, Sonal Chokshi, Eddy Lazzarin, David Kerr, and Adam Zuckerman for their contributions and insights, as well as the authors of all the works I cite in the more comprehensive version of this post.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/a16z-decentralized-design-reference-guide-from-the-bottom-to-the-realization-of-web3/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

Like (0)
Donate Buy me a coffee Buy me a coffee
Previous 2022-04-08 11:12
Next 2022-04-08 11:13

Related articles