Web3's Biggest Challenges
... and why this isn't the end.
At its core, web3 technologies such as blockchains and decentralised networks enable the creation of applications that are not controlled by any single entity, but rather operate on a distributed and open platform.
This approach has the potential to address many of the issues with the current web, such as the centralisation of power and data, and the lack of transparency and accountability. However, web3 is not without its own challenges and limitations.
In this article I will attempt to address three common points of concern for web3 (in no particular order) and briefly explain why these do not mean the end of web3. Like any new paradigm-shifting technology, it is bound to face many challenges before becoming mainstream.
Regulation:
The decentralised nature of cryptocurrency and web3 technology makes it difficult for governments and regulatory bodies to control and monitor. This lack of regulation has made it a target for malicious actors, who use it for illegal activities such as money laundering and fraud. To combat this, governments around the world have begun taking a closer look into cryptocurrencies, with many already implementing regulations to try and mitigate these risks.
Many countries have implemented Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations for cryptocurrency exchanges and other businesses dealing with cryptocurrency. These regulations require businesses to collect and verify the identity of their customers, and to report any suspicious activity to the appropriate authorities. While this may be a good idea in practice to combat illegal activity, it goes against some of the underlying principles of crypto—privacy and anonymity.
Tight regulation on crypto makes it much harder for new businesses to enter into the field as they must now comply with a host of new regulations. The rate of innovation would also suffer at the hands of regulation as businesses must devote more resources into ensuring their compliance with region-specific regulations.
However, not all regulation is bad for crypto. Users need some kinds of standards and legal protection against fraud, and some people might be hesitant to participate in the space until such measure exist. Regulation can be favourable for adoption if done correctly.
Scalability:
One of the main issues is scalability, which refers to the ability of a system to handle a growing number of users and transactions without sacrificing performance. Many current web3 applications, such as decentralised exchanges and gaming platforms, struggle to achieve the same level of scalability as their centralised counterparts.
For example, the Ethereum blockchain, has faced scalability issues since its launch in 2015. The network has had congestion during peak times, leading to slower transaction processing and higher fees for users. This has made it difficult for some web3 applications, such as decentralised finance platforms, to compete with their centralised counterparts in terms of speed and cost.
Adoption:
The value of decentralisation significantly is significantly reduced if there are a small amount of users. This poses a problem for web3 as many people are still unfamiliar with the technology and hesitant to use it, despite its potential benefits. Fewer users and developers leads to fewer applications and services being built, which is less attractive to users and developers.
These challenges have a significant impact on the potential applications of web3. Decentralised finance, for example, which aims to enable financial transactions without the need for intermediaries such as banks, is limited by the scalability and adoption of web3. Many decentralised finance platforms have struggled to achieve the same level of user experience and functionality as similar centralised platforms, leading to slower growth in the sector.
Similarly, decentralised marketplaces are also affected by these challenges. Without enough people participating in markets as either buyers or sellers, it will be much harder sales to occur between the two parties.
There’s still hope…
The issue of scalability on Ethereum has been actively researched since 2015, and the first major upgrade on the path towards scalability was implemented in September this year. The Merge provided the base for many more of Ethereum’s scalability upgrades to come in the future—one of those being Sharding, which is expected to increase Ethereum’s transaction throughput to 100,000 transactions per second. Sharding works by dividing the data on a blockchain into smaller pieces and spreading the load across more nodes, allowing more transactions to be processed simultaneously without compromising security or decentralisation.
Additionally, the development of Layer 2 solutions on top of existing blockchain infrastructure has provided more options for companies to take advantage of the benefits of blockchains without experiencing the drawbacks of slow and costly transactions.
Layer 2 protocols offer an additional layer of functionality on top of the underlying blockchain, allowing for increased scalability and faster transaction speeds. A recent example of this is Starbucks Odyssey—their new rewards system built on a carbon-negative Layer 2 protocol called Polygon. Starbucks’ current rewards system has nearly 29 million active users in the US alone, with all of these being exposed to their new system on Polygon. That’s a lot of exposure—a huge win for web3 adoption.
More good news for adoption—according to data from Glassnode, the number of ETH addresses holding more than 100 ether has hit a 20-month high of 47,459, meaning that more users are stacking ETH since the FTX crash, and will hopefully bring more liquidity to markets in the near future.
In terms of regulation, The White House recently published an information sheet outlining a “Framework for Responsible Development of Digital Assets.” Many important points are covered, such as:
Protecting consumers, investors, and businesses against “unlawful practices in the digital assets space.”
Promoting access to safe, affordable financial services.
Fostering financial stability—for example by making stable coins safer to prevent another collapse like TerraUSD, which wiped out nearly $600 billion in consumer and investor wealth.
Advancing responsible innovation by providing “regulatory guidance, best-practices sharing, and technical assistance,” to companies developing new financial technologies.
There is a lot more to take in from this sheet, along with some potentially controversial proposals. However, it is an important step in the right direction for digital currencies and decentralised systems to be recognised as worthy of regulation in the first place. Let’s hope whatever regulations come out of this and similar inquiries by other countries are used to enhance the strengths of web3, whilst also minimising its weaknesses.
Cryptocurrencies and, more generally, web3, have come a long way since the introduction of the first digital currency—Bitcoin—in 2008. The rate of innovation in this space is increasing exponentially, naturally bringing in new challenges that possibly haven’t even been considered yet. This is expected. The new age of the internet is here to stay.
Thank you for reading.
~ Thomas.