This is part of a series of posts on trying to understand the basics of Web 3.0.

Last week, I covered the topic of decentralization. This week, I’ll cover how it impacts the design of networks.

Much of this article is a summary an paraphrased version of the articles on this topic by Chris Dixon and Albert Wenger. This Tweetstorm by Naval also helped clarify my thinking on this topic.

The Internet is a demonstration of the power of networks. The Internet is a network of networks itself, and also an platform for the development of networked applications.

From Crypto Tokens: A Breakthrough in Open Network Design: 

Networks - computing networks, developer platforms, marketplaces, social networks, etc — have always been a powerful part of the promise of the internet. Tens of thousands of networks have been incubated by developers and entrepreneurs, yet only a very small percentage of those have survived, and most of those were owned and controlled by private companies. Networks become more powerful as new participants join, a phenomenon known as network effects.

The best way to grow a network today is to build an application and scale it’s adoption to as many people as possible. Those that have invested in growing the network, whether its a social network, marketplace, or developer platforms, are most often the equity holders of corporations (employers, investors). They are the ones that reap the financial benefits of network control.

There are a few issues with this.

First, related to the core trust issue, is the financial benefit is not always distributed with the participants of the network. When it is shared, it is controlled by that same central party - often in the form of arbitrary revenue share. The second issue is the nature of the benefit itself which is in the form of a in a fiat currency. A more ideal benefit would be more native to the network - something where investing in the network allows you to extract some benefit from the network itself.

This is where tokens come in. Tokens are a kind of virtual currency, akin to what is used in games. We can create new tokens specific to a protocol and have all transactions of the token written to the blockchain for that protocol. What this does is prevent a sender from “double spending” a token, so when an asset is sent it cannot be used again by the sender.

A digital asset can be transferred like money moving between accounts - without a central authority like a bank.

This is a powerful capability, because every protocol can have a currency associated with it. Put another way, the ability to program money can now be built into a protocol. Also, every protocol can now have an associated marketplace that can serve multiple purposes to benefit the protocol.

This marketplace can be used to fund development of the protocol itself. The developer of the network (i.e. the protocol developer) can issue a fixed number of tokens and put them on sale and raise funds through an ICO (initial coin offering). Note this is only one way to fund development - an ICO is not necessary to develop a blockchain powered protocol.

This token marketplace also behaves as a tool of governance. Continued investment in the market through buying tokens is a way to signal to the protocol developers that they are “doing the right thing”.

This is a great summary of the flywheel effect of how protocol tokens appreciate in value (from Fat Protocols):

When a token appreciates in value, it draws the attention of early speculators, developers and entrepreneurs. They become stakeholders in the protocol itself and are financially invested in its success. Then some of these early adopters, perhaps financed in part by the profits of getting in at the start, build products and services around the protocol, recognizing that its success would further increase the value of their tokens. Then some of these become successful and bring in new users to the network and perhaps VCs and other kinds of investors. This further increases the value of the tokens, which draws more attention from more entrepreneurs, which leads to more applications, and so on.

With the blockchain and tokens, protocols themselves can now be encoded with shared logic, data and a native currency.

This quote really sums the promise and potential of tokens (from Crypto Tokens: A Breakthrough in Open Network Design):

If present trends continue, they will soon be seen as a breakthrough in the design and development of open networks, combining the societal benefits of open protocols with the financial and architectural benefits of proprietary networks. They are also an extremely promising development for those hoping to keep the internet accessible to entrepreneurs, developers, and other independent creators.