Web3 and the future of the Internet: opportunities and challenges for the financial world (Part II)
Where in the first part we looked at blockchain technology as the foundation of Web3, we will now look at other important elements and practical implications of the Web 3 concept.
An important component of Web3 is the token economy. According to the concept, physical or digital values are represented on the blockchain in the form of tokens. These tokens can fulfill various functions: They can serve as a means of payment (such as Bitcoin), represent property rights (such as NFTs) or provide access to certain services [5].
Fungible and non-fungible tokens (NFTs)
This new type of tokenization makes it possible to trade real and digital assets in a way that was not possible before. Users can own tokens with a wallet and participate directly in blockchain-based platforms without having to rely on intermediaries. There are various forms of “token” on the web3, so that today a large number of variants of tokens have emerged depending on their characteristics and terminology. One of the best-known classifications of tokens is the distinction between fungible and non-fungible tokens based on their uniformity and interchangeability [5].
Fungible tokens: These tokens are interchangeable, such as Bitcoin or Ether. Each token has the same value as another token of the same type [5].
Non-Fungible Tokens (NFTs): NFTs, on the other hand, are unique tokens that are not exchangeable. They are often used to represent ownership rights to digital artworks, collectibles or other digital assets. A famous example is the NFT artwork Everydays: The First 5000 Days by the artist Beeple, which was auctioned for over 69 million US dollars in 2021 [5].
Decentralized applications (DApps): The future of the Internet
Decentralized applications (DApps) play a central role in Web3. In contrast to traditional apps, where the backend and data are stored on central servers, DApps run on the blockchain. This not only decentralizes control, but also creates new possibilities for interaction and transfer of ownership [6].
A well-known example of a successful DApp is CryptoKitties, a blockchain-based game in which users can collect, breed and trade digital cats. Each of these cats is a unique NFT and cannot be replicated. This game illustrates the concept of “digital scarcity” on the web3: digital goods can be just as unique and valuable as physical items [7].
Decentralized Finance (DeFi): A paradigm shift in the world of finance
Another core concept of Web3 is Decentralized Finance (DeFi). DeFi aims to decentralize and democratize traditional financial systems. By using smart contracts, financial services such as loans, insurance or investments can be processed directly between users without the involvement of banks or other central institutions. A typical DeFi example is lending and borrowing. Here, users can contribute their crypto assets to a lending pool and receive interest in the form of tokens. Borrowers, in turn, deposit collateral and can borrow tokens without the need for a traditional lender (https://cc-bei.news/was-steckt-hinter-dem-begriff-decentralized-finance).
The advantages of DeFi are obvious:
- Increased access: Anyone with a wallet can participate in DeFi, which is especially beneficial for unbanked or underbanked populations.
- Lower costs: Since no central intermediaries are required, transaction costs are reduced.
- Speed: Transactions are executed almost in real time, without the waiting times associated with traditional financial systems.
Self-Sovereign Identity (SSI): control over digital identities
One of the biggest innovations in Web3 is the concept of Self-Sovereign Identity (SSI), which gives users complete control over their digital identity. In contrast to centralized identity systems, where large companies or governments store and manage users’ personal data, SSI allows identities to be stored decentrally and securely on the blockchain [8].
Many countries are already working on developing national e-ID systems that allow users to identify themselves digitally. By linking with SSI and blockchain, e-IDs can not only become more secure and trustworthy, but also better protect users’ privacy. The integration of e-ID with SSI on the web3 could create new ways for users to identify themselves online without giving up their privacy [9].
Potential benefits of digital Web 3 identities for the financial sector
- Data protection and control: Users decide for themselves who they provide which information to, which can strengthen trust in digital interactions.
- Efficiency in identity verification: Banks and financial service providers can verify identities faster and more cost-efficiently, which reduces dependence on centralized identity databases.
- Security and trustworthiness: Blockchain technology protects identity data from manipulation and misuse, as data is cryptographically secured and stored unalterably.
- Minimized risks of data theft: Users do not disclose confidential data every time they log in online, which reduces the risk of data theft.
Opportunities and challenges for the financial services sector
Web3 represents a new phase of Internet development that gives users more autonomy and sovereignty over their data and digital identities. The financial sector could benefit considerably from this decentralization, but also faces challenges.
Web3 gives users back control over their data. In contrast to centralized storage, for example in large Big Tech platforms that manage data, Web3 enables self-determined management. This could increase customers’ trust in digital financial services, as they know that their personal data remains secure and in their possession. For banks, this means that they need to redefine their role – no longer as sole custodians of customer data, but as partners in a transparent network.
The decentralized structure offers the opportunity to optimize existing business models and develop innovative services. Banks and financial service providers could reduce transaction costs and make processes more efficient by using smart contracts and decentralized platforms. At the same time, they must adapt to an environment in which traditional structures are being replaced by decentralized networks. This could attract new competitors that already rely on these technologies.
Despite the potential benefits, Web3 also brings uncertainties. Many technical and regulatory issues remain unresolved. The scalability and user-friendliness of Web3 technologies must be improved in order to achieve broad acceptance. Regulatory uncertainty is also a major challenge, as there are still no uniform standards for dealing with decentralized systems.
The introduction of Web3 is not just a question of technology, but also a business case. Banks and financial service providers need to carefully consider how they want to position themselves in a decentralized ecosystem. They could play a pioneering role in developing innovative and user-friendly financial services based on Web3. A well-thought-out Web3 strategy can help them to compete in a changing market environment and tap into new target groups. At the same time, they must maintain their role as trusted institutions and ensure that the new technologies meet the industry’s high security standards.
Web3 offers both opportunities and challenges for banks and financial service providers:
Opportunities:
- New business models: Through DeFi and the token economy, financial service providers can develop innovative services, such as tokenized securities or decentralized credit systems.
- Increased efficiency: Smart contracts and blockchain enable the automation and increased efficiency of many traditional processes, such as the settlement of securities transactions or international payments.
- Data sovereignty: Web3 enables users to regain control over their data, which could be an advantage for banks, especially in times of increasing data protection requirements.
Challenges:
- Regulation: As many Web3 applications operate outside the traditional financial infrastructure, many legal and regulatory issues still need to be clarified.
- Scalability: Web3 technologies still face the challenge of keeping pace with the growing number of users and data volumes.
- Security risks: Although the blockchain is considered secure, there have already been hacks and security incidents in DeFi protocols that could shake user confidence.
Sources:
[1] https://burstiq.com/web3-the-future-is-here-and-now/
[2] Shoshana Zuboff: The Age of Surveillance Capitalism (2019)
[3] https://elevatex.de/de/blog/web3-de/unterschied-zwischen-web1-web2-und-web3/
[5] Roger Heines: The Tokenization of Everything: Towards a Framework for Understanding the Potentials of Tokenized Assets (2021)
[6] https://www.redappletech.com/what-is-web-3-0-use-cases-and-examples/
[7] https://medium.com/@Matzago/why-the-net-giants-are-worried-about-the-web-3-0-44b2d3620da5
[8] https://www.fit.fraunhofer.de/content/dam/fit/de/documents/Fraunhofer%20FIT_SSI_Whitepaper.pdf
[9] https://www.bsi.bund.de/SharedDocs/Downloads/DE/BSI/Krypto/Eckpunkte_SSI_DLT.html
