Summary 

As of 2022, the global number of holders or users of digital assets is around 300 million. If we compare this to the advent of the internet, we are somewhere in the mid to late nineties, with the bulk of innovation and sticky user growth yet to come. Therefore, as we head into what we feel is the third quartile of an S curve in the growth of digital assets and expansion of Web 3.0, we at Woodstock have decided to re-publish our thesis. Even though the consensus seems to indicate that we are in a bear market and approaching recession, we are as committed to DLT (Distributed Ledger Technology, or Blockchain) and Digital Assets as we have always been. We strongly believe that this asset class continues to present an opportunity of a lifetime.

We have focused our thesis on seeking answers to fundamental questions: 

1. Why will new users come to Web 3.0? While privacy and control are important aspects, ultimately, the users will need fundamental utilities – cheaper and/or better experience. This can be brought about with increased transparency and technological shifts using blockchain.
2. What type of sticky users will initially move into Web 3.0? Those who are underserved and those who are looking for newer or better experiences. The primary target segments are the gig economy, SMBs, and Gen Z.
3. Where will new sticky capital come from? While we have been mostly reliant on crypto-natives and retail, it is difficult to sustain or scale with just these sources. A substantial amount of capital (retail and institutional) has still not touched digital assets as they need better risk management, regulatory clarity, and sustainable business models.
4. What technological shifts are necessary to enable 1 to 3? Does everything need to be decentralised, or can we find a credible path towards decentralising what is absolutely necessary?

To that end, we believe that three megatrends will dominate the next cycle: 

1. Convergence – we anticipate further melting of physical borders facilitated by Web 3.0-based technological growth that will allow for greater convergence of cultures, communities, economies, and governance globally. 
2. Financialisation – we believe that DeFi has proven that financial architecture can be recreated without intermediaries. We anticipate an increased permeation of this promise into traditional use cases, under greater regulatory oversight, towards solving real-world problems.
3. Virtualisation – we expect the chasm between real and virtual worlds to blur further and progress to shift from tokenomics to better experiences in such virtual worlds.

Before we begin diving deeper into the thesis, we have illustrated the thesis in the graphic below.

We will endeavour to write more detailed articles for specific topics within each theme over the course of the year.

Convergence

Throughout the history of humankind, inflexion points have occurred in the convergence of society, technology, economics, and ecology. Various factions of the society intermingling with each other have created an amalgam of ideas, knowledge sharing, value creation, and more.

The convergence of Society has shaped our social behaviours, expressions, beliefs, arts, media, and traditions. The convergence of Technology has spread accumulated knowledge and application of skills, methods, and processes. The convergence of Economics has boosted growth and shared knowledge of production, distribution, and consumption of goods and services. The convergence of Ecology has changed how we use energy and transform it for global growth.

Web 3.0’s core principles of borderless and collaborative communities with distributed control (social), consumer-centric incentive structures (economic), and conscious sustainability (ecology), all on the bedrock of blockchain (technology), will be the next inflexion point in the evolution of humankind. 

Social

The generation gaps are reducing drastically, and Gen Z has increasingly gained more power (creators shaping up opinions) and purchasing capacity (earning propensity through technology and related investments at an early age), thereby defining narratives. This is also subliminally pushing Gen X and Gen Y to step up and match the rhythm of Gen Z.

The Covid-19 lockdowns have contributed significantly to the breakdown of geographical boundaries and have led to massive scaling of online and offline infrastructure to support the future gig economy. It has become easier for people from different cultures to converge and work together.

• We see an increasing number of purpose-driven agile teams working across continents and shipping out tier-1 products and services for a global audience.
• A new world of opportunities is redefining the gig economy, providing local merchants exposure to a global stage, and setting new standards of customer service and consumer protection.

Remote teams are ubiquitous in Web 3.0 and intend to stay that way. This unlocks access to global talent, panoramic views, and vivid ideologies from various jurisdictions and locations, converging to create better products and experiences.

Thus, social convergence leads to accelerated development and improved quality of life, as resource-sharing and collective efforts tackle the world’s most important problems.

Economics

Blockchain and digital assets have enabled the creation of community-centric economic incentives. This is a significant shift from previous technological advancements as developers and consumers, the creators and users of the products, are now able to partake in the growth of these products and benefit from its economic growth. This also allows such stakeholders to participate in the governance of the underlying products and networks.

Such convergence can also be extended into traditional sectors where the use of blockchain technology can enable fractional ownership of previously illiquid assets. Much more equitable participation in economic growth is essential in bringing together a fractured and multi-tiered society. 

It is important to improve knowledge and user experience so that the sections of the society (in people and businesses) that benefit the most from such equitability are, in fact, brought into the ecosystem.

Ecology

Most of the past technological developments have carried an unintended consequence of adverse environmental impact. It is therefore important that Web 3.0 growth is conscious and sustainable. While we have all seen the energy-intensive nature of the Proof-of-Work consensus mechanism, we have to collectively work towards less energy-intensive mechanisms and/or the usage of renewable energy sources. 

Most existing technology streams (climate, health, urban tech, etc.) are layered solutions that lack an efficient, transparent, and incentive-driven structure which can benefit from blockchain integration. That’s where blockchain can step in.

Technology

The evolution and development of open-source technologies have led to a massive boom in software development. Instead of repeatedly writing redundant code, developers can now focus on building and adding functionality to pre-built packages, thus saving a lot of time and increasing the community’s productivity. Market leaders, such as Ethereum and Bitcoin, leverage a system of Improvement Proposals that any community member can propose.

Even though emerging technologies and platforms are solving major global issues, they are associated with a steep learning curve that is off-putting for many end-users. We believe in the convergence of emerging and traditional technologies to make the transition for users as smooth as possible. With emerging technologies, including blockchain, artificial intelligence, augmented and virtual reality, quantum computing, and IoT taking centre stage in this decade, the aforementioned building blocks will help reduce the time, effort, and energy required to bring about radical paradigm shifts for existing spaces. Blockchains will increasingly become embedded as a bedrock technology in all our digital experiences as the industry matures and builds consumer-grade distributed networks with low fees and interoperable networks.

While multiple teams are building different layers of the foundational technology underpinning Web 3.0, the convergence of these technologies is necessary to offer consumers an efficient and seamless experience.

Opportunities in Convergence

Convergence of technology is primarily about making the infrastructure and middleware layers of the Web 3.0 stack more homogeneous, secure, and fast (vertical). It will enable smoother rails to be built between the Web 3.0 stack, the traditional stack (horizontal and vertical), and the emerging technologies stack (newer or incremental paradigms) to create the best user-centric solutions. 

The more standardised and integrated the endpoints, the more homogeneous the stack. This leads to greater composability of the data and value across technologies. The smoother the rails, the easier it is to onboard newer users and capital from existing paradigms. The better we adopt and integrate other emerging technologies (AI, ML, AR/VR, etc.), the more transformative the experience. 

Protocol layer:

The last 12-24 months have seen new innovations in the layer-1 ecosystem, with an incredible amount of research and effort put into designing technical architectures and consensus algorithms that enable scalable, secure, decentralised, and interoperable layer-1 platforms. Ethereum accounted for ~95% of the Total Value Locked (TVL) and volumes until 2021. Since then, Ethereum’s dominance has decreased, with an all-time low of ~50% TVL compared to other chains. The multi-chain future seems inevitable now, and we can expect to see many diverse ecosystems emerge on multiple layer-1s (and corresponding layer-2s), which will be highly interoperable and composable with each other.

On the protocol layer, the two main areas of growth will be modular blockchains that deal with separate layers for execution, settlement, and data availability and sharded blockchains like Elrond and NEAR that maintain a high level of decentralisation with the constant reshuffling of nodes without compromising the security of the protocol. 

A lot of the research effort still remains in these domains as cross-shard transactions on most sharded blockchains are not atomic, EVM support is lacking, and interoperability and trustless communication need to be enabled in the modular blockchain stack. As these problems are dealt with, we will see bigger ecosystems driving more value in the multi-chain world.

Another approach that we anticipate will grow over the next few years is the use of application-specific chains. To separate their scalability and performance from the limited block space of a larger network, app-specific chains focusing on composability and interoperability of various assets will attract users, offering a clean user experience. For scalability, we are keen to see more ZK solutions at the infrastructure level and data availability protocols for maintaining off-chain data. 

Infrastructure layer:

As seen above, the computation layer consisting of various blockchain solutions paves the way for a “decentralized network of everything”, as envisioned in the broader goal of Web 3.0. In conjunction, the infrastructure layer provides additional functionalities that make various applications on the blockchain a reality for millions, and soon, billions of users. To support the influx of the next billion users, Web 3.0 requires scalable infrastructure which does not compromise the security of consumers and decentralization of the network.

To further enable growth in the protocol layer, the core themes for infrastructure in the next decade need to be focused on composability, interoperability, and consolidation of existing technology for Web 3.0.

For a truly multi-chain future, composability is a must. To improve the communication between various siloed ecosystems, and to enable the free flow of liquidity, we see the cross-chain space growing significantly. Cross-chain services like Biconomy (Hyphen) and Router Protocol focusing on state-sharing (such as relayer networks) between and amongst layer-1s and layer-2s are crucial for network interoperability.

A credibly decentralised, battle-tested, and a well-integrated bridge will likely emerge as the preferred choice for maximum liquidity, low fees, and minimal slippage. We will see explosive growth in sectors like wallet-to-wallet and cross-chain communication, Web 3.0 notification services like EPNS, and development tools focused on modular frameworks. 

An interoperable Decentralised Identity (DID) layer is important to create identity, reputation and credibility, while upholding privacy. Once meaningfully solved it can provide applications and institutions the means to develop DID based cohorts to better target their ideal customer segments. For instance, credit scorecards can be developed on top of DID layer to identify users with an ability and willingness to repay credit, enabling un/undercollaterlised lending. Vendible, ENS and Polygon ID are working within the Identity layer.

Oracle protocols, decentralised storage and computing solutions, decentralised wireless protocols, and decentralised hosting protocols will undergo incremental changes and research to solve the problems (centralisation of power, revenues, and status) currently created by the technology incumbents. For instance, there is still a requirement for decentralised storage solutions with better reliability and lower costs, analytics dashboards for better representation of data and trends, and data indexing solutions for efficiently reading blockchain data. 

Middleware layer:

Middleware solutions are pieces of computer software that provide services to other software applications beyond those available from the underlying blockchain protocol. Middleware services are the glue holding together the blockchain protocol layer with the applications, making rapid development and deployment possible.

Developer tooling enables faster development and deployment of applications on a blockchain network. It provides programmers with the right tools to build their applications from the best templates and the most reliable data.  The emergence of new development tools plays a crucial role in bringing more developers into the ecosystem. As Web 3.0 services become mainstream, there will be a need for simplified APIs for interacting with core functions of different protocols, such as staking, lending and borrowing, data, etc., in a novel interface. Our key focus is on integrated systems and solutions like Covalent and Moralis –

• No/low code tools – to onboard non-technical creators, designers, and enterprises to build products and solutions.
• Open APIs (application programming interface) – to build on top of existing products and shorten the development lifecycle.
• SDKs (software development kits) – to make systems more composable across the Web 3.0 space by standardising development tools. 

In addition, better security and auditing firms for smart contracts, more seamless on and off ramps, compliant payment gateways, tax and compliance solutions, and customer service layers are all sectors that can develop around a decentralised economy to integrate large pools of developers, users and capital from the traditional world (such as gig economy, SMB economy). 

Convergence in Economic and Social layers is associated with the distribution of incentives and control across stakeholders. Web 3.0 is the only paradigm that enables such convergence across all stakeholders – users, contributors, investors – and this is enabled through DAOs where the unit of convergence is tokens.

DAO treasuries have increased their AUM significantly from a few millions in early 2020 to over $10 billion in Q3 2022. DAOs are at the core of enabling decentralization by providing a voice to all stakeholders towards managing treasury assets, building protocols, voting on community matters, and supporting projects via grants and investments, etc. 

Blockchains like Bitcoin & Ethereum have been able to achieve relatively deeper decentralization due to a very clear set of responsibilities and a clear sense of right and wrong. However, while DAOs have been excellent at gathering individuals around ideas, events such as the Tribe DAO situation and the Merit Circle decision making have proven that DAOs are not the panacea yet. DAOs may decentralise economic decisions with an ‘ask for forgiveness rather than permission’ model for most functions and include an element of “centralisation” to make business functions more efficient through subject matter experts.

DAO tools today are trying to build decentralised versions of Jira, Notion, and Discord. However, there is no real need for such tools just yet, and DAOs are comfortable using the existing Web 2.0 tools. We believe that teams focused on DAO tooling should start with a niche, achieve product-market fit, and then scale. Not too dissimilar to how traditional Web 2.0 tooling has been built. The niche could be either vertical or horizontal:

• The vertical focus would be to focus on a specific type of DAO (e.g., protocol DAO, social DAO, NFT collector DAO, etc.)
• The horizontal focus would be a specific tool for different types of DAOs (e.g., governance, treasury management, payroll, contributor onboarding, etc.)

Tokens are the units that enable distributed control and governance. Currently, most tokens either increase the friction of using the product OR are irrelevant to the product. We encourage and assist founders in working towards easy-to-understand token models that even common users can understand and utilise appropriately.

We are firm believers that unless the protocol requires a token from the beginning (for instance, a layer-1 blockchain), launching a token before achieving an initial product-market fit and a sticky community is counterproductive. Thereafter, the token design should be able to accommodate for equilibrium or slow growth phases as well.

We believe that tokenomics mostly benefits early adopters, which disincentivises later adoption, and this can potentially be solved by including dilution mechanics similar to traditional equity. Even staking of tokens for high APYs is mercenary, and the mentality needs to move from a ‘buy now, sell later’ mechanism toward giving the token holders real value accrual and governance.

Financialisation

Introduction

DeFi has been one of the shining lights of digital asset expansion in the last 24 months. The technology proved its worth as the TVL/AUM of DeFi went from virtually 0 at the end of 2019 to over US$ 250bn in Q1 2022. However, this TVL has now come down to below US$ 60bn due to retracing of capital and a fall in token prices. This is due to no real utility outside of speculation, fragmented liquidity, and most importantly, a lack of fiat rails from lack of regulations which has prevented broad basing of the DeFi ecosystem. It is, therefore, not surprising that a lot of the capital making up the TVL was speculative and crypto-native – from VCs, protocols, whales, degens, etc.

As we stand here in Q3 2022, how can we summarise these last 2 years in DeFi? A much more efficient technology than TradFi that can enable a faster and cheaper borderless flow of capital and liquidity, yet, an ecosystem that needs to evolve to attract sticky capital and demand and is almost certainly under a lot more regulatory scrutiny. 

To define more objectively – How will the wallets interacting with DeFi protocols go up from 4.8 million to 200 million? How can TVL go from around US$ 55bn to US$ 10tn? We call this next phase of evolution in DeFi the ‘Financialisation of borderless economies.’ 

From a technology perspective, the latency limitations of underlying blockchains constrain certain products’ creation or scaling, such as HFT solutions or continuous re-margining of options. Until the chains get more robust, these can probably be solved with off-chain hybrids.

The Financialisation Trilemma

We define the Financialisation Trilemma as the overlap between Technology (Blockchain), Regulations, and Liquidity.

Liquidity x Regulation (TradFi/Fintech) has ample liquidity and is heavily regulated, but operates on archaic technology and inefficiencies that prevent capital from flowing to the sections of the society that need it the most.

Liquidity x Blockchain (DeFi) is prospering on “regulatory arbitrage”.  Its key advantages are – borderless liquidity and access, transparency, token incentives, censorship-resistant. We anticipate this intersection will innovate rapidly but struggle to scale sustainably. As the digital assets economy expands again, DeFi TVL will increase again. However, if the base is narrow, then it will always be prone to sharp pullbacks.

Regulation x Blockchain (Tokenisation) has been trying to bridge DeFi to real-world assets but is hampered by inertia, missing rails, and lack of regulatory clarity. This intersection promises sticky demand and real-world utility.

The DeFi we know today has proliferated due to regulatory arbitrage allowing censorship-resistant products to access liquidity globally without the regulatory burden such as KYC/AML. This can only extend to individuals and unregulated institutions and is therefore not scalable in the long term. The larger capital is held within real-world assets and regulated institutions. For instance, the global Real Estate market is US$ 320tn, and globally, Pension Funds hold over US$ 56tn of assets.

We have the technology to unlock this liquidity more efficiently. However, we are impeded from accessing them due to the very aspect whose absence has proliferated activity in DeFi – regulations. 

The end state of the DeFi trilemma is ReDeFi or Regulated DeFi, an intersection of Blockchain, Liquidity, and Regulation, which will most likely require giving up a component critical to the ethos of DeFi – censorship resistance. We are already noticing traction in ReDeFi through entities such as Propine, and JP Morgan’s Onyx which has already processed over US$ 300bn of assets. Undoubtedly, DeFi will innovate much faster than ReDeFi and will provide the architecture that ReDeFi can adopt. 

While we are mainly focused on Web 3.0 and open-source DeFi, we are also keeping tabs on ReDeFi.

Next Wave of DeFi Adoption?

The open-source nature of DeFi has allowed for a massive scale of “experimentation” to re-create financial markets without intermediaries. From decentralised exchanges to lending protocols to asset management to insurance products, and from stablecoins to protocol native assets to real-world assets, all mostly within the last couple of years. 

It is however important that DeFi aspires to build end-to-end functionality (earn, borrow, transact, insure, invest, pay – all in digital assets) with a neat user experience for the sectors that are most in need of such access.

There are about 1.1 billion workers in the gig economy worldwide, 34% of the US workforce is part of the gig economy, and 90 million non-farm jobs are expected to be within the gig economy in India. They are typically underbanked and at the mercy of intermediaries for earnings and credit. 

The direst need for capital globally is within the SME sector, which houses 90% of global businesses and 50% of the global workforce. It has an unmet financing need of up to US$ 5.2tn per year even though their default rates are lower than large corporates. 

Opportunities in Financialisation

Creating Rails for Real-World Access

With respect to the gig economy, on-chain payroll, credit, and investment solutions can bring large volumes of the gig economy into DeFi. The rails for this end-to-end solution will most likely be on stablecoins.

SMEs are being catered to by protocols like Centrifuge and Goldfinch, however the demand from such counters is extremely underserved. Scaling of such protocols is complicated due to limited on-off ramps, off-chain dependency on default recourse, and lack of knowledge and visibility within the sector.

The lack of fiat rails limits the real-world utilisation of DeFi capital. Integrating stablecoins into payrolls and payments can go a very long way in increasing the utilisation, which will have a knock-on effect on increasing the demand for DeFi. This is difficult in developing economies where there are strict forex and capital convertibility regulations and where the regulators perceive the risk of “dollarisation”. Solving for the forex convertibility and enabling last-mile convertibility in a compliant manner will unlock tremendous value – including within the gig economy and SME sector.

User experience is still not upto the mark in DeFi – while it is not a “sexy” business, there is enough room for customer service solutions in DeFi to help newer users on-board and transact. 75% of consumers prefer human interactions to automated interactions, and full-service brokers are increasing their market share. Interesting incentive structures can be created to encourage standardising educational and research modules and onboarding new users to DeFi.

Even if we have the users, sticky capital, and fiat rails, there is an inherent risk of DeFi protocols that must be meaningfully solved. Solving for technology risk (insurance products, escrows), credit risk (credit scoring, collateralisation, CDS, risk assessors), and regulatory risk (blacklists, KYC/AML) are imperative to provide sufficient comfort to participants. Some of this will require off-chain participation as on-chain data is extremely limited. Solutions like Formidium will also be important to bring appropriate management and reporting standards to institutions.

Building Financial Blocks within DeFi

Flash loans, squeeths, AMMs, etc., are DeFi primitives that have no TradFi analogues. We’re interested in out-of-the-box ideas for developing an open financial infrastructure without intermediaries.

Exchanges:

The DEX landscape appears fairly robust. A few incumbents have developed sufficient network effects and are also at the forefront of innovation – such as Uniswap, Serum, and 0x. The key problem includes optimising for gas, optimising for impermanent loss, preventing front running, etc. It is our view that the CLOB model, along with sophisticated market makers coming in through RFQs off-chain, will be the end state for high volume pairs, while the AMM model will thrive for the (long) tail and high-correlation assets. The latter may also be an interesting model to construct liquidity in illiquid real-world assets such as (tokenised) real estate, (tokenised) pre-IPO stocks, etc.

Money Markets:

The lending and borrowing landscape took off with Compound’s liquidity mining program. Most of the borrowing in DeFi is over-collateralised and for speculative purposes, which partly explains the drastic depletion of TVLs in the last couple of months. However, this is one of the largest TAM sub-sector for DeFi. 

Stickiness can be enabled with 2 significant changes – a) markets for under-collateralized and uncollateralised lending, b) real-world use cases.

Projects like Centrifuge, Maple Finance, Goldfinch, etc are all working on solving for these changes, and Maker has been playing a pivotal role through DAI, PSM, and integrations with traditional banks. However, it is difficult to scale such projects as the associated ecosystem is not yet fully developed, especially – a) risk assessment of borrowers, b) liquid market for lenders to manage their credit risk.

• Risk assessment of borrowers: Calculating default risk of a borrower based on their credit history. This includes identifying the borrower (Bright), understanding their source of funds (Chainalysis), and analysing their economic activities (Spectral, Teller). With very little on-chain data, the ideal solution here appears to be an aggregation of on-chain and off-chain data toward building sophisticated scoring models that can be used on-chain.
• A liquid market for lenders: Lenders should be able to hedge their credit risk through insurance markets (Nayms). This will allow them to reduce their risk exposure and, in turn, increase their lending limits.

The capital markets equivalent will build an entirely permissioned market for global borrowers (retail and institutional) that enables them to borrow seamlessly from lenders across the world who are able to access the credit risk profiles on-chain, pseudonymously.

Derivatives: 

Derivatives are another area where a lot of innovation has been happening for the last couple of years, however, volumes have not picked up except for Perpetual Futures Contracts (dYdX, Perpetual Protocol). This is in complete contrast to traditional markets where derivatives volumes are multiples more than the spot volumes. 

Futures are relatively easier to create and price, and retail users find them fairly intuitive. However, options are not that intuitive. A full on-chain options stack requires an option creation engine (Opyn), a marketplace for buying and selling options (Arrow, Opyn v2), and a “go-to-market” that can create structured products for the masses (Ribbon). Creating options on-chain and a marketplace is not straightforward due to latency issues that impact dynamic pricing of options, fragmentation of liquidity across similar products and strikes and expiry dates, and capital inefficiency for option sellers who have to collateralise their entire downside. 

It is important to note that traditional options markets (except probably the options on blue-chip stocks and stock indices) are mostly institutional products and are used both for directional trading and hedging by and for financial institutions. As such, it may be imprudent to expect too much liquidity in options on-chain until we have on-boarded the relevant institutions to make markets and hedge against digital asset exposures. 

Insurance: 

Robust insurance markets are essential to provide capital and liquidity providers with products to hedge their downside risk against credit events such as smart contract exploits, rug pulls, debtor defaults, etc. Within a homogenous pool of capital, US$ 1 of capital should be able to protect against >> US$ 1 of risk capital. 

While insurance in DeFi seems like a no-brainer considering the risks involved, under 2% of the TVL is insured, mostly within Nexus Mutual. The evolution of insurance comes down to 3 key observations: a) capital providers are mostly “degens” and crypto-VCs who aren’t particularly interested in insurance; b) insurance products cover limited events, even that being disputed, and c) due to capital inefficiency and lack of re-investments, insurance writers can get better risk-reward through the underlying rather than the premiums.

Insurance in DeFi today is highly inefficient. For instance, one can earn 0.7-1.5% on ETH, USDT, and USDC on Aave, however, one has to pay 2.60% for a 90-day insurance contract on Nexus Mutual to protect against Aave’s smart contract risk.

Insurance products are traditionally institutional where a lot of data is analysed by subject matter experts towards coming up with efficient pricing models and appropriately defined claim events. While it may feel against the ethos of DeFi, the ideal insurance solution may need off-chain dependencies on pricing and claims validation by experts that can be combined with claim definition and processing on-chain.

Liquid Staking:

Liquid staking protocols have had impressive success in the last few years, especially around the popularity of PoS chains and a booming application layer ecosystem. Liquid staking has become a US$ 9.88bn and is bound to be larger.

In the future, we expect staking returns to be the defacto IRR for digital assets investments and liquid staking derivatives to be a crucial part of the DeFi ecosystem. While decentralised liquid staking like Lido and Rocketpool will continue to remain popular, it will also offer an alternative revenue stream to centralised, regulated players like Coinbase. The much anticipated Ethereum Merge will boost the PoS ecosystem while staking will increasingly make blockchain-based tokens an attractive asset class.

Maximal Extractable Value (MEV):

MEV draws parallels from dark pools, and high-frequency trading in TradFi. But with blockchains, the opportunity to generate this value is widely available. MEV has allowed sophisticated searchers and miners to earn an additional US$ 675mn. 

In the future, we are expecting the following:

• DeFi protocols will be built with an MEV-aware design to provide better execution for their users. E.g. Cowswap, Rook
• Services can help existing protocols recapture the MEV value and pass it to token holders and users. E.g. Manifold Finance
• Addition infrastructure around MEV developed by organisations like Flashbots will be required to democratise access to such opportunities in the entire ecosystem . 

India and other emerging economies:

DeFi’s promise is to provide censorship-resistant liquidity and capital to the sections of the retail and institutional society that need it the most. To that end, India is a country that can significantly benefit from integrating DeFi technology within its ecosystems. Some use cases highlighted below can give rise to interesting business models.

• Bring down the cost of capital for small businesses by accessing global pools of liquidity within DeFi
• Provide borrowing access to the underprivileged (potentially scalable only after on-chain credit scoring is robust)
• Improve capital markets infrastructure by building it on permissioned blockchain networks

Virtualisation

Introduction

Virtualisation for us is about creating virtual immersive worlds and assets that seamlessly integrate with and extend today’s physical world.

The journey towards virtualisation started once humans figured out the concept of remote communication. Humanity stepped its feet into the virtual world at the time when Alexander Graham Bell invented the telephone. The phenomenon that started with telephone lines and evolved into instant messaging initially through pagers and eventually to voice and video over the internet, is now making its way to become increasingly immersive with every iteration of its evolution. 

The pandemic has forced rapid and irreversible digital formats and assets adoption. The convergence of this accelerated adoption with emerging technologies (blockchain, AR, VR, AI, etc.) is leading us to a tipping point, a melting pot of the convergence of these technologies. 

The 2 billion strong Gen Z population is already spending at least 8 hours per day online. They are  used to spending time in reality-like experiences through games, music and virtual worlds. Hence they are primed to be early adopters of this new economy we will describe below. This is also a segment that is digitally native and understands virtual worlds, and values diversity, equality, optionality, and social issues. It is our view that Gen Z, the future of the world, will eventually embrace virtual worlds built on public blockchains.

Existing virtual worlds such as Roblox, Fortnite and Minecraft have around 400 million MAUs combined with an average user age of 12-13 (Gen Z). Around US$ 54bn was spent on virtual goods, skins, and lives in 2020, even without buyers having any true ownership or transferability of these goods. With NFTs, users can now truly own and trade virtual goods, which should lead to a higher willingness to spend.

There is already a clear product-market fit between virtual worlds and Gen Z. However, DAUs and MAUs on blockchain-based virtual worlds are minuscule. The key questions now are: a) How do we increase the user base of virtual worlds built on blockchains, b) What technological and product advancements are needed to enable such an increase? 

Virtualisation and Blockchain

We believe that “virtual = real” will be the paradigm that will define virtualisation.

Blockchain brings immutable ownership, transferability, composability, and programmability to virtual worlds – properties that are impossible in existing (walled) virtual worlds. Immutable ownership brings authenticity and prevents duplication, enforcing copyright laws at scale. Transferability enables commerce across virtual worlds. Programmability enables the receipt of perpetual benefits without dependence on expensive legal contracts and enforcements, and composability accelerates innovation.  

The asset that represents these benefits in a “tangible” manner in virtual worlds is an NFT.

Some examples of blockchain-enabled virtualisation are:

• Virtualisation of ownership of real-world assets: Bringing real-world assets on-chain as NFTs to enable use cases like authenticating high-value but easy-to-forge goods (concert tickets), verification of ownership through on-chain registries (land and home titles), transfer of ownership (cars, homes), and fractionalisation of assets, especially illiquid ones like real estate.
• Virtualisation of contracts: Today, contracts exist mainly for high-value and one-to-one relationships. The overheads of execution and enforcement make it difficult for low-value and one-to-many contracts to exist in the traditional world. Blockchain and NFTs enable this, thereby creating financial relationships between creators and fans through royalty tokens, crowd-funding with income-sharing, revenue sharing from secondary sales, etc.
• Gaming: Web 3.0 gaming can be an evolution over existing Web 2.0 gaming. We can have ownable and tradeable in-game assets as NFTs, a verifiable source of truth for game data, open and collaborative ecosystems, and monetization of gaming skills/time of gamers.
• Metaverse: Metaverse is an integrated world with immersive experiences that blurs the distinction between the real and virtual, and the physical and digital, through a user interface made up of both software and hardware. A metaverse could allow users to work, learn, create, shop, etc., thereby recreating real-life experiences in virtual worlds.

The Metaverse Stack

We are seeing early signs of technologies like IoT, VR/AR, and AI beginning to interplay with each other towards creating centralised and walled metaverses such as Horizon Worlds being built by Meta. We, however, believe that such individual worlds will suffer from the same limitations as social media today around data, privacy, and economics. It is, therefore, imperative that the future of social media and interaction is created on open technologies such as blockchains that provide ownership, transferability, and interoperability. 

Drawing on the metaverse stack described by Jon Radoff, we have the following 8 layers, slightly modified to better reflect how we have been dissecting the stack internally.

The bottom 4 layers (enablers, infrastructure, human interface and spatial computing) have to technologically converge to enable platforms and rich experiences to be built on top of them.

Interoperability & Decentralisation layer enabled by blockchains and digital assets (especially NFTs) will lead to the creation of open worlds instead of the walled ones of today. Open worlds are empty right now, especially compared to the established closed versions, as infrastructure and applications are lacking. However, this has not stopped establishments like J.P Morgan, Samsung, Walmart, Nike, PwC, Warner Music Group, Adidas, etc. from entering such open worlds.

From Epic Games integrating other brand experiences and experimenting with cross-game asset portability to Web 2.0 gaming executives creating blockchain-based gaming entities like Gala Games and Mythical Games, it is clear that the thesis of an open metaverse will eventually pan out. 

Opportunities in Virtualisation

We believe that NFTs will be the data and asset standard for virtualisation. We wrote a blog post wherein we covered the evolution of these tokens, explained the technology behind them, discussed the ecosystem, and spoke about the foundations of the NFT sector. 

Verticalization of Marketplaces: We expect marketplaces to start fragmenting into niches, similar to what happened in Web 2.0. We are already noticing this through Sloika and Cheeze (photography), Royal (music), Mirror (publishing) etc. and expect these to expand further with customised functionality for creators and fans. It would be interesting to build index solutions on top of such platforms to allow regular people (and not just aficionados) to participate. We are also bullish on plug-and-play solutions for enterprises to utilise NFTs for marketing and loyalty programmes, as being done by Gig Labs.

Virtualisation of Contracts: The entire music, media, and entertainment industries are ripe for disruption. Enabling many-to-one contracts and programmability of revenue has allowed artists to crowd-fund and share revenues directly with their fans. This can be extended to OTT and movie scripts, sharing the bulk of the revenues with IP creators and their consumers, globally and regionally. Similar to gaming we are noticing Web 2.0 executives stepping out to create Web 3.0 equivalents for the entertainment industry. Considering the challenges in scaling business models that go up against large incumbents, we are interested in looking at infrastructure layers which work closely on distribution. Virtual event organisation features such as ticketing, event management, and merchandise sales are also interesting in this context.

Virtualisation and Fractionalisation of Real World Assets: Liquidity and commerce can be generated in real-world assets (RWA) by creating NFTs of the assets and making them transferable. There is a $78 Trillion market for non-bankable assets that can access credit (NFTs) or liquidity (fractionalisation) through the blockchain. Centrifuge creates NFTs of assets that are financed on its platform and Enjin allows for creating NFTs of any real-world assets. Vesta Equity, one of our portfolio companies, provides investors access to fractionalised residential real estate. We anticipate significant growth in this sector where steady yields (albeit not 1000% APY!) can be generated through previously illiquid assets. This is an area where NFTs and DeFi can overlap and generate ample synergies. This intersection will need more regulatory oversight as the look-through is typically into real world and/or regulated assets.

Gaming: One can read our detailed view on Web 3.0 gaming here. While gaming on blockchain was made famous by the play-to-earn mechanics of Axie Infinity we have generally been bearish on such purely financial models as they primarily bring speculators and not true gamers. We need more teams that bring experience in both game design and game economy design (we can definitely help on the latter). We are interested in hyper-casual gaming studios that can adapt quickly to new gaming trends. We are not expecting entire games to be Web 3.0 as gaming infrastructure and toolkit for Web 3.0 is still in its nascence. Products like low code/no code plugins to develop UGC, white label guild solutions for in-game lending and borrowing of assets would play a key role in creating large in-game economies. 

Metaverse: For the open metaverse the entire stack should ideally be decentralised. Before immersive content and commerce can become commonplace, the infrastructure and computation needs to sufficiently scale. 

On the latter, outside of structural gaps identified in the Convergence section; Metaverse as a service (including Web 3.0 social media), data analytics around metaverses (such as footfalls), tools that promote search and discovery of experiences within the metaverse, immersive retail, solutions for creation and management of 3D assets interoperable within virtual worlds, ad exchanges for metaverses, plugins for communication within and notifications from metaverses, are certain tools that once developed can increase involvement and commerce within open metaverses.

We anticipate regional metaverse plays becoming more prominent, considering that niche target segments are interested in entertainment, mythology, and other “cults” within every region or country. We expect aggregation of IPs (existing and new) that can be meaningfully positioned towards long-term community engagement and utilities as opposed to simple NFT drops. 

Discovery platforms for both creators and consumers are needed to help navigate through the fragmented marketplaces. Metaverse-as-a-Service (MaaS) to non-Web 3.0 native brands could be interesting, where the MaaS platform provides a wallet, identity, asset management, and payment solutions and connects the brands to creators.

Gaming and Metaverse CAN provide the experiences that attract Gen Z. However, these cannot just be based on tokenomics, i.e. financial incentives. The below illustration captures our thoughts on how we anticipate this flywheel to build out.

Other: Financialisation of NFTs has been difficult due to opaque pricing, illiquidity, and low volumes. However, NFTs are the building blocks of virtual worlds and will therefore need financial solutions to enable commerce at scale. We are, therefore, always looking for interesting solutions around swapping, lending/borrowing, and fractionalising NFTs. Similar to the DeFi explosion, a Uniswap v2/v3 equivalent may trigger the growth in NFT volumes. We are interested in watching how the newer token standards like ERC 4907 evolve as they enable the separation of an asset and its cash flows, which could be structured to bring interesting financial use cases into NFTs.

Conclusion

Web 3.0 is open-source, borderless, and extremely fast-paced, and therefore we hope our thesis is helpful to founders, investors, enterprises, and other stakeholders. We will be hosting sessions on diving deeper into certain topics in our thesis, and you can receive an invitation for such sessions by subscribing to our webinars and newsletters here. 

Disclaimer

This publication is not investment advice and may not be used or relied upon in evaluating the merits of any investment. Woodstock has made investments in some of the entities and projects discussed herein. The information contained herein is current only as of the date of publication. This publication does not constitute an offer to sell or a solicitation to purchase any security or interest in any entity organised, controlled, or managed by Woodstock, or any of its affiliates. Every financial product, asset class, or investment has risk. A cryptocurrency (also known as digital assets, digital coins, or crypto(s)) is no different. That is why it is important for users to be aware of the potential risks present in cryptocurrency and blockchain projects. You should not invest funds in the cryptocurrency market that you are not prepared to completely lose; i.e., only allocate risk capital to digital tokens. Furthermore, we will not accept liability for any loss or damage that may arise directly or indirectly from any such investments.