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WEB 3.0

Web 1.0: static webpages, minimal interactivity, users are mere consumers

Roughly from the dawn of the internet to 2004

Web 2.0: interactive webpages, social media, users as content generators

Growth of and market domination by large platforms (Facebook, YouTube, etc)
Proliferation of Javascript
Roughly from 2004 until the present

Web 3.0: ???

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WEB 3.0: DEFINITIONS

Immutability (permanence of data)

Anonymity

Collective decision-making

AI, Big Data, Machine-learning

Bottom-up design

Decentralization

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Investopedia

Wikipedia

CoinMarketCap

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DECENTRALIZATION

In this class, we have discussed one of two solutions for the problems of Web 2.0: regulating large tech companies

The Web 3.0 solution is to move to a decentralized system where these problems don’t exist

The internet would be dominated by democratic organizations rather than corporations

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HOW DOES THIS ACTUALLY WORK?

Blockchains are “distributed ledgers”

Instead of having a central authority (a bank) controlling a single authoritative list of transactions and balances, a blockchain’s balances and transactions are all stored collectively, out in public view
It is virtually impossible for anyone to create a false version of the blockchain—any false entry in the chain is trivial to identify
It is virtually impossible to falsify a previous transaction
And when I say “virtually impossible,” I mean your odds are better to win the lottery 20 times in the next year*

*with one caveat, which I’ll come back to later

No one can lie about how much money they have, and no one can steal

(in theory)

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HOW DOES THIS ACTUALLY WORK?

Anyone can interact with the blockchain
Anyone can make apps that interact with the blockchain
Total anonymity if desired
No certifications are necessary: everyone is equally trusted

“trustless”

What Bitcoin has done for finance can be extrapolated to other sectors

Imagine a blockchain for social media: no one can be de-platformed, no one can pretend to be someone they aren’t

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IS DECENTRALIZATION A GOOD THING?

In theory, yes.

In practice? Maybe not so much.

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DECENTRALIZATION AND REGULATION

Decentralized systems are inherently difficult to regulate
Blockchains essentially exist as just a protocol–a set of deterministic rules governing transactions.
Put together a program that functions according to this protocol, and you’re now part of the collective that is managing the blockchain
A licensing scheme would be impossible, by design: it is fundamental to the system that anyone can participate, without any credentials required
There is no one in charge, no head office, no jurisdiction of origin

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DO WE WANT TO REGULATE?

The absence or at least the difficulty of regulation is part of the appeal of decentralization

Web 3.0 is all about anti-authoritarianism and resilience to corporate or governmental surveillance and coercion

But let’s look a bit closer at the realities of a decentralized system…

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NOVEMBER 2021…

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2 MONTHS LATER

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REGULATION TODAY

You may notice that several of the scams above have resulted in criminal and civil action
All of the interaction (that I have found) between cryptocurrencies and the legal system has been through money–laundering regulation and traditional fraud actions

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MONEY LAUNDERING REGULATION

“Know Your Customer” (KYC)
Most money laundering regulations revolve around demanding that financial institutes takes measures to confirm the identity of the customers
Crypto exchanges are included in the lists of institutes covered by these laws both in Canada and the US
Proceeds of Crime (Money Laundering) and Terrorist Financing Act:

s. 5(h) persons and entities that have a place of business in Canada and that are engaged in the business of providing at least one of the following services:

(iv) dealing in virtual currencies

s. 5(h.1) persons and entities that do not have a place of business in Canada, that are engaged in the business of providing at least one of the following services that is directed at persons or entities in Canada, and that provide those services to their clients in Canada:

(iv) dealing in virtual currencies

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HOW DOES THIS AFFECT CRYPTO?

The “off-ramp”: its easy enough to buy Bitcoin, but how do you turn your bitcoin back into CAD?
All major crypto exchanges comply with Canadian KYC regulations when dealing with Canadian investors
You are required to prove your identity using multiple forms of ID
Your transaction will be denied if your crypto has been through a “tumbler” or has triggered one of many money laundering red flags

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WHAT ARE THE IMPACTS OF KYC REGULATION?

Does nothing to address the proliferation of scams

Greatly reduces many of the benefits of switching to crypto in the first place

Less centralized – you have to enter through one of a small set of major, government approved exchanges
Anonymity becomes impossible

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CRIMINAL FRAUD

You may have noticed charges being laid against crypto scammers in the scam section earlier
NFT “rug pulls” (when someone publicizes a new NFT project with lots of benefits to participants, “mints” the NFTs, then disappears with all of the money before any of the benefits materialize) are now being prosecuted in the US:�

"Rather than providing the benefits advertised to Frosties NFT purchasers, Nguyen and Llacuna transferred the cryptocurrency proceeds of the scheme to various cryptocurrency wallets under their control… the same rules apply to an investment in an NFT or a real estate development. You can’t solicit funds for a business opportunity, abandon that business and abscond with money investors provided you.”

-US Dept. of Justice

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CRIMINAL FRAUD

While I have not seen regulation specifically aimed at fraud in the crypto space, this is conceivably not far away

How would this work? Most likely, by demanding that people initiating new projects be accountable to some central authority

The decentralized community has proven itself completely incapable of handling the problem so far

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ARE DECENTRALIZATION AND REGULATION INHERENTLY INCOMPATIBLE?

As the NFT community has sought to prevent rug-pulls and other scams, the only solutions available to them end up looking very centralized
OpenSea is the primary marketplace for NFTs, controlling 95% of NFT trading
When you get scammed out of your NFT, what do you do?

Complain to OpenSea, who will delist your NFT so no one can trade it

When you’re an artist and your work is used in an NFT without your permission, what do you do?

Complain to OpenSea, who will delist your NFT so no one can trade it

When someone is outed as a scammer, how do you stop them from scamming others?

Complain to OpenSea and the big crypto exchanges to get them blacklisted

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ARE DECENTRALIZATION AND REGULATION INHERENTLY INCOMPATIBLE?

Another major goal of blockchain-based systems is immutability—unalterable transaction data

When a scam is so big that it threatens your community’s survival, what do you do?

Previous transactions on the blockchain cannot be altered. However, the chain can split off in two directions—some people say block B is the block that should follow block A, and others say that block C is the right next block

Ordinarily, the community quickly and automatically decides which is correct

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THE “HARD FORK”

However, there is nothing preventing the community from simply going back to a earlier block, when they feel that later blocks should be ignored
This is called a “hard fork” – the blockchain splits in two and one side of the split is retroactively discarded
How/why does this happen? When a major scam upsets the community, everyone can simply agree to pretend every transaction after a certain point didn’t happen, and “hard fork” back to a state before the scam, and start from there

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THE “HARD FORK”

Admittedly, this happens fairly rarely. And in a very widely used blockchain like Bitcoin, it probably never will.

However, it means blockchains are from from immutable—they’re only immutable so long as the community remains in agreement on which transactions are legitimate

Furthermore, the decision to “hard fork” is a collective, de-centralized decision in name only

Even if it is done by vote, it is often effectively controlled by the people in charge of the project

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HARD FORKS

The DAO (July 2016)

Ethereum blockchain splits in two to undo a hacker stealing 1/3 of a large project’s funds
Democratic decision, but very low voter turnout (5.5%)
Some purists still use the older, scammed blockchain today, “Ethereum Classic”

Polygon (December 2021)

Almost the entirety of the currency in circulation is stolen, effectively ruining the project
Project leaders choose to hard fork to save the project with no community input

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ETHERIUM’S HARD FORK

“The people who continued with Ethereum Classic advocate for blockchain immutability, and the concept that "code is law"^[17] against the pro-fork side (Ethereum) which largely argued for extra-protocol intentionality, decentralized decision-making, and conflict resolution.^[18]^”

https://en.wikipedia.org/wiki/Ethereum_Classic#Code_is_law

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CONCLUSIONS

Crypto and NFTs are not as decentralized as their proponents claim them to be, and if they want to become adopted widely they never will be

This is due to a fundamental tension between scam-prevention and de-centralization: if you want to prevent scams and punish bad actors, you inevitably need to implement centralized regulatory systems

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