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Strategy insights June 21, 2023 | 10 min read
There is likely no sector more debated and polarizing with investors right now than cryptocurrency. But what is Web 3.0? What is it not? And why should private markets investors care?
Cryptocurrency, and the roller coaster ride its investors have endured, has been dominating headlines for the last several years. Beginning in August 2020, the digital token market saw a meteoric rise that lasted through much of 2021. Then, in 2022, the crypto market lost nearly two thirds of its market value, contracting by $2 trillion.1 Late last year, the FTX debacle materialized and investor confidence in the digital asset market was severely shaken. Despite what some have called another crypto winter, the digital token market is recalibrating and has rebounded back over $1 trillion in the first few months of 2023.2
Principal
Elliott is a member of the direct co-investment team specializing in disruptive digital technologies.
A transaction is requested
The transaction is broadcast to every party in the network
Those in the network approve the transaction as valid
The transaction is unified with other transactions as a block of data
The new block is added to the blockchain in a transparent and unalterable way
The transaction is completed
While cryptocurrencies have captured the limelight, Web 3.0 is an umbrella term often used to describe the growing number of companies making up the dynamic and diverse network of users and developers building products and services utilizing blockchain technology and digital tokens. While the rise in tokens over the last several years is a proxy for the broader innovation in the ecosystem and the exponential growth in users of Web 3.0, the token simply serves as a medium of exchange or representation of digital ownership in the blockchain protocol.
The fundamental innovation of Web 3.0 revolves around blockchain technology, which provides an instrumental upgrade to existing centralized digital ledger technology. Public blockchains leverage cryptography, distributed systems, and digitally native tokens to enable the exchange of goods and services without the need to place trust in a third-party or centralized intermediary. Blockchain systems can seem complex, but they are simply networks of digital tokens and underlying users. The network is powered by a decentralized group of computers running shared software that is programmed with algorithmic rules that govern the ecosystem. In short, mathematics and computer code replace humans as the arbiter of governance for a community of individuals, assets, or products and services. Advantages potentially include the lowering of costs to operate via the removal of third parties and better protection of user data via cryptography.
As the asset class matures, blockchain technology applications are extending their reach and disrupting current delivery structures in areas ranging from healthcare and supply chain logistics to banking and capital markets, or gaming, sports, and art. Traditional companies like IBM, Apple, or JP Morgan, along with technology innovators like Coinbase, Open Sea, or Anchorage Digital, are exploring applications of blockchain technology across a variety of different industries. Despite the pronounced volatility during 2022, institutional adoption remained strong with several large players continuing to launch blockchain initiatives.
April 2022: Allows clients to invest in Bitcoin through their 401(k) accounts
November 2022: Launches retail crypto accounts, enabling trading and custody of Ethereum and Bitcoin.
BlackRock
June 2022: BlackRock’s Aladdin partnered with Coinbase to provide institutional clients with direct access to crypto, an access point that could potentially help usher trillions into the asset class in the coming years.
J.P. Morgan
September 2022: Executes first decentralized finance trade using public blockchain and launches Coin Systems, a new payment rail to support domestic and cross-border payments enabling clients to make programmable real-time, multi-currency payments using multi-bank shared ledgers.
BNY Mellon
October 2022: Launched crypto custody platform to safeguard assets for institutional investors. Touching more than 20% of the world’s investable assets, BNY Mellon could use Bitcoin to scale financial services cost-effectively.
MSCI
Goldman Sachs
November 2022: MSCI, Goldman Sachs, and CoinMetrics are jointly launching a new digital assets data system to provide institutional investors a standardized overview of digital asset performance based on their use cases.
Meta
November 2022: Meta and Instagram announce a partnership with Arweave to use the protocol to permanently store digital collectable data on the blockchain. Meta also announced the reveal and development of an end-to-end toolkit allowing Instagram users to mint non-fungible tokens on the Polygon (MATIC) blockchain and sell them on social media.
Source: HarbourVest, based on 2022 public company press releases.
A reference to a specific company does not constitute a recommendation to invest nor an indication that HarbourVest funds or accounts hold any specific company.
Web 3.0 and blockchain technology may seem a bit complex and esoteric, even speculative from an investment perspective, however, the technology driving the innovation simply represents the continuation of several decades of secular technological trends, including faster and cheaper computing power, the digitization of information, and network economies.
Web 3.0 represents the third iteration and the monetization of internet-based protocols. Web 1.0 (roughly 1990 to 2005) focused on open protocols that were decentralized and community governed. Web 1.0 has often been referred to as “read only” with users consuming analog content through a digital medium. Web 1.0 was revolutionary in that it provided an electronic platform that removed the geographical restrictions associated with brick-and-mortar businesses.
Web 2.0 (roughly 2005 to 2020) introduced the ability for users to create and share content, and the proliferation of mobile devices further expanded access to the internet. Web 2.0 was about siloed, centralized services run by corporations—largely on mobile devices—where the lion’s share of the value accrued to a handful of companies like YouTube, Apple, Twitter, and Facebook. The monetization model of Web 2.0 is based on selling advertisements and capitalizing on the large volume of users that leading platforms attract. Due to the network effect, Web 2.0 companies generally centralize overtime, with the economic value accruing to a handful of players that hold the majority of user data. Revenues often come at the expense of user privacy in the Web 2.0 environment.
In stark opposition to the Web 2.0 model, Web 3.0 reinvents the centralized business model using blockchain technology to better align network incentives and share the value more broadly among the users and the contributors to the platform. Web 3.0 is leveraging technological advancements to create a next generation structure where the builders and users can capture the majority, if not all, of the value that is created.
the dematerialization (replacement of physical records or certificates with a paperless computerized system) of physical stores of value via bitcoin and the Bitcoin blockchain
the dematerialization of traditional financial services via decentralized finance and smart contracts being built on blockchains like Ethereum
the dematerialization of centralized, corporate-owned platforms via interoperable, user-owned decentralized platforms, known as Web 3.0
As blockchain technology matures, and digitization by companies drives innovation, blockchain applications are extending their reach into a myriad of industries and sectors, including:
In addition to finding companies with strong business models and healthy cash flows, capital allocators today are faced with the difficult decision of determining how to participate in the potential outsized return opportunity of investing in disruptive digital technology. In particular, the track records of Web 3.0 firms are nascent, the industry itself is growing exponentially but still relatively immature, and the proliferation of firms and innovation remains immense.
As the history of innovation demonstrates, identifying investment opportunities that materialize from nascent and emerging technologies can be incredibly difficult — and blockchain technology is no different. The real challenge for potential Web 3.0 investors is deciphering where the opportunities and risks reside in today’s tighter economic conditions and positioning a portfolio to take advantage of these opportunities in a risk-adjusted manner.
While risk tolerance and portfolio construction are at the core of an investor’s underlying objectives, we think the distinct characteristics of investing in Web 3.0 via a diversified venture capital portfolio can potentially help drive more robust overall portfolio outcomes. Chart 1 below demonstrates that historically US venture funds investing in digital disruption, like Web 2.0 and Web 3.0, have generated returns similar to, or in excess of, the venture asset class overall. Chart 2 shows private equity portfolios that combine buyout and venture have regularly outperformed 100% buyout portfolios and the MSCI World index.
Source: Burgiss, data as of 12/31/2022. US Venture – IT Funds includes only funds that invested 50%+ of capital in portfolio companies classified as in the Information Technology sector using GIC classification standards. All performance in USD.
Sources: Burgiss, MSCI, data as of 12/31/2022. All performance in USD.
For illustrative purposes only. Past performance is not a reliable indicator of future results.
Economic growth occurs whenever people take resources and rearrange them in ways that make them more valuable. Web 3.0 is reimagining the delivery of goods and services and harnessing monetary energy to more efficiently generate, store, and transmit value.
Given the early state of Web 3.0, the winners have yet to be definitively determined, and that presents an opportunity for investors to drive meaningful outperformance and alpha generation. While lower than the torrid pace of the last several years, the Web 3.0 ecosystem remains active logging an estimated $20 to $30 billion in new private capital during 2022.3 Aggregate deal value of emerging technologies (including Web 3.0) accounted for 11.6% of all seed- and early-stage venture capital investment in 2022 — a notch higher than the historical average of 10%.4 Consumer adoption and developer activity have also continued to show progress with active developers across the Web 3.0 environment increasing more than 60% in the last three years, and active addresses doubling over the last two years to hit an all-time high of 15 million in March 2023.5 Total Web 3.0 AUM is now estimated at $94 billion, with the bulk amassed in the last 3 years.6 Bottom line: we think Web 3.0 is here to stay.
Similar to the “S” shaped path of earlier technology innovations, there is sure to be a continuing shake out of winners and losers. And a stronger regulatory framework will help support more measured growth. But innovative applications of blockchain technology continue expanding across a wide variety of market verticals and it is reinventing how goods and services are purchased and delivered. As long-term technology investors, HarbourVest believes that diversification across leading Web 3.0 managers has the potential to mitigate concentration risks during bouts of market volatility while preserving the upside of investing in the earliest stages of technology innovation.
Would you like to discuss Web 3.0 opportunities?
1 Source: https://coinmarketcap.com/charts/
2 Source: https://coinmarketcap.com data as of 3/2/2023.
3 Bain & Company, Web3 Remains Highly Relevant for Private Equity, 2/27/2023.
4 PitchBook, Q4 Emerging Tech Indicator, 3/1/2023.
5 https://a16zcrypto.com/content/article/state-of-crypto-report-2023/
6 Bain & Company, Web3 Remains Highly Relevant for Private Equity, 2/27/2023.
Diversification does not ensure a profit or protect against a loss.
This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or adopt any investment strategy. The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication, are not definitive investment advice, and should not be relied upon as such. This material has been developed internally and/or obtained from sources believed to be reliable; however, HarbourVest does not guarantee the accuracy, adequacy or completeness of such information. There is no assurance that any events or projections will occur, and outcomes may be significantly different than the opinions shown here. This information, including any projections concerning financial market performance, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.
The MSCI AC World Index (ACWI) is designed to measure the performance of publicly-traded large and mid-capitalization equity securities in global developed and emerging markets. The MSCI ACWI Index is maintained by Morgan Stanley Capital International (“MSCI”) and has historically captured approximately 85% coverage of the free float-adjusted market capitalization of its publicly-traded global equity opportunity set.
Private Equity Index Data: Unless otherwise indicated, all private equity fund benchmark data reflects the fees, carried interest, and other expenses of the funds included in the benchmark. Burgiss (unless otherwise noted) is the source and owner of any private equity index data contained or reflected in this material and all trademarks and copyrights related thereto.
Strike is a global mobile payments network that operates on the Bitcoin protocols’ Lightning Network, one of the first multiparty micropayment systems providing real time, high volume clearing capabilities. Strike is a mobile payment application much like Cash App, but Strike operates on the Lightning Network which reduces the time required for the clearing and settlement of transactions. Legacy mobile payment apps like Cash App operate in their own closed network (i.e. you cannot send money from your PayPal account to your Cash App account). Strike operates on an open payment network, Lightning, and you can send and receive to any bank account.
Strike app users can send money to anyone in the world for a fraction of a cent with transactions that can settle instantly. Traditional remittance service providers charge as much as 6% of the transaction value to send money globally and settlement takes on average three days.
Dynamic is a developer of Web 3.0 digital wallet-based authentication and authorization tools. The Company’s software makes it easy for companies to create digital asset wallet-based login, onboarding, and authentication flows. Dynamic’s tools build on existing identity standards, but allow developers to operate more efficiently, providing the ability to launch support for multiple wallets in a single click versus creating custom code for each chain or wallet.
The most common authentication tool today is email-based authentication, which allows users to prove their identity via email and password when logging into an application. Dynamic will instead provide wallet-based authentication infrastructure as Web 2.0 moves toward Web 3.0. Digital wallets leverage cryptography technology to provide a more secure and higher consumer privacy authentication solution.
Decentralized ecosystem of users and developers building products and services utilizing blockchain technology and digital tokens
A decentralized, anonymous, censorship resistant digitally native medium of exchange used to facilitate the transfer of value (not simply copied) between two parties over the internet without requiring the consent of another party. Also referred to as digital tokens or digital assets, cryptocurrency serves as the unit of account for each participants’ ownership in the blockchain eco-system.
A blockchain is a digital ledger that records the transaction history of a community of users. A blockchain expresses digital ownership via digital tokens that are created and exchanged via network participants
“Professional Investor” under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) (the “SFO”) and its subsidiary legislation) means:
(a) any recognised exchange company, recognised clearing house, recognised exchange controller or recognised investor compensation company, or any person authorised to provide automated trading services under section 95(2) of the SFO;
(b) any intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong;
(c) any authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong;
(d) any insurer authorized under the Insurance Ordinance (Cap. 41 of the Laws of Hong Kong), or any other person carrying on insurance business and regulated under the law of any place outside Hong Kong;
(e) any scheme which-
(i) is a collective investment scheme authorised under section 104 of the SFO; or
(ii) is similarly constituted under the law of any place outside Hong Kong and, if it is regulated under the law of such place, is permitted to be operated under the law of such place,
or any person by whom any such scheme is operated;
(f) any registered scheme as defined in section 2(1) of the Mandatory Provident Fund Schemes Ordinance (Cap. 485 of the Laws of Hong Kong), or its constituent fund as defined in section 2 of the Mandatory Provident Fund Schemes (General) Regulation (Cap. 485A of the Laws of Hong Kong), or any person who, in relation to any such registered scheme, is an approved trustee or service provider as defined in section 2(1) of that Ordinance or who is an investment manager of any such registered scheme or constituent fund;
(g) any scheme which-
(i) is a registered scheme as defined in section 2(1) of the Occupational Retirement Schemes Ordinance (Cap. 426 of the Laws of Hong Kong); or
(ii) is an offshore scheme as defined in section 2(1) of that Ordinance and, if it is regulated under the law of the place in which it is domiciled, is permitted to be operated under the law of such place,
or any person who, in relation to any such scheme, is an administrator as defined in section 2(1) of that Ordinance;
(h) any government (other than a municipal government authority), any institution which performs the functions of a central bank, or any multilateral agency;
(i) except for the purposes of Schedule 5 to the SFO, any corporation which is-
(i) a wholly owned subsidiary of-
(A) an intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong; or
(B) an authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong;
(ii) a holding company which holds all the issued share capital of-
(A) an intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong; or
(B) an authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong; or
(iii) any other wholly owned subsidiary of a holding company referred to in subparagraph (ii); or
(j) any person of a class which is prescribed by rules made under section 397 of the SFO for the purposes of this paragraph as within the meaning of this definition for the purposes of the provisions of the SFO, or to the extent that it is prescribed by rules so made as within the meaning of this definition for the purposes of any provision of the SFO.
The first of such classes of additional “professional investor”, under the Securities and Futures (Professional Investor) Rules (Cap. 571D of the Laws of Hong Kong), are:
(k) any trust corporation (registered under Part VIII of the Trustee Ordinance (Cap. 29 of the Laws of Hong Kong) or the equivalent overseas) having been entrusted under the trust or trusts of which it acts as a trustee with total assets of not less than HK$40 million or its equivalent in any foreign currency at the relevant date (see below) or-
(i) as stated in the most recent audited financial statement prepared-
(A) in respect of the trust corporation; and
(B) within 16 months before the relevant date;
(ii) as ascertained by referring to one or more audited financial statements, each being the most recent audited financial statement, prepared-
(A) in respect of the trust or any of the trust; and
(B) within 16 months before the relevant date; or
(iii) as ascertained by referring to one or more custodian (see below) statements issued to the trust corporation-
(A) in respect of the trust or any of the trusts; and
(B) within 12 months before the relevant date;
(l) any individual, either alone or with any of his associates (the spouse or any child) on a joint account, having a portfolio (see below) of not less than HK$8 million or its equivalent in any foreign currency at the relevant date or-
(i) as stated in a certificate issued by an auditor or a certified public accountant of the individual within 12 months before the relevant date; or
(ii) as ascertained by referring to one or more custodian statements issued to the individual (either alone or with the associate) within 12 months before the relevant date;
(m) any corporation or partnership having-
(i) a portfolio of not less than HK$8 million or its equivalent in any foreign currency; or
(ii) total assets of not less than HK$40 million or its equivalent in any foreign currency, at the relevant date, or as ascertained by referring to-
(iii) the most recent audited financial statement prepared-
(A) in respect of the corporation or partnership (as the case may be); and
(B) within 16 months before the relevant date; or
(iv) one or more custodian statements issued to the corporation or partnership (as the case may be) within 12 months before the relevant date; and
(n) any corporation the sole business of which is to hold investments and which at the relevant date is wholly owned by any one or more of the following persons-
(i) a trust corporation that falls within the description in paragraph (k);
(ii) an individual who, either alone or with any of his or her associates on a joint account, falls within the description in paragraph (k);
(iii) a corporation that falls within the description in paragraph (m);
(iv) a partnership that falls within the description in paragraph (m).
For the purposes of paragraphs (k) to (n) above:
An institutional investor as defined in Section 4A of the SFA and Securities and Futures (Classes of Investors) Regulations 2018 is:
(a) the Singapore Government;
(b) a statutory board as may be prescribed by regulations made under section 341 of the SFA, as prescribed in the Second Schedule of the Securities and Futures (Classes of Investors) Regulations 2018;
(c) an entity that is wholly and beneficially owned, whether directly or indirectly, by a central government of a country and whose principal activity is —
(i) to manage its own funds;
(ii) to manage the funds of the central government of that country (which may include the reserves of that central government and any pension or provident fund of that country); or
(iii) to manage the funds (which may include the reserves of that central government and any pension or provident fund of that country) of another entity that is wholly and beneficially owned, whether directly or indirectly, by the central government of that country;
(d) any entity —
(i) that is wholly and beneficially owned, whether directly or indirectly, by the central government of a country; and
(ii) whose funds are managed by an entity mentioned in sub‑paragraph (c);
(e) a bank that is licensed under the Banking Act 1970;
(f) a merchant bank that is licensed under the Banking Act 1970;
(g) a finance company that is licensed under the Finance Companies Act 1967;
(h) a company or co‑operative society that is licensed under the Insurance Act 1966 to carry on insurance business in Singapore;
(i) a company licensed under the Trust Companies Act 2005;
(j) a holder of a capital markets services licence;
(k) an approved exchange;
(l) a recognised market operator;
(m) an approved clearing house;
(n) a recognised clearing house;
(o) a licensed trade repository;
(p) a licensed foreign trade repository;
(q) an approved holding company;
(r) a Depository as defined in section 81SF of the SFA;
(s) a pension fund, or collective investment scheme, whether constituted in Singapore or elsewhere;
(t) a person (other than an individual) who carries on the business of dealing in bonds with accredited investors or expert investors;
(u) a designated market‑maker as defined in paragraph 1 of the Second Schedule to the Securities and Futures (Licensing and Conduct of Business) Regulations;
(v) a headquarters company or Finance and Treasury Centre which carries on a class of business involving fund management, where such business has been approved as a qualifying service in relation to that headquarters company or Finance and Treasury Centre under section 43D(2)(a) or 43E(2)(a) of the Income Tax Act 1947;
(w) a person who undertakes fund management activity (whether in Singapore or elsewhere) on behalf of not more than 30 qualified investors;
(x) a Service Company (as defined in regulation 2 of the Insurance (Lloyd’s Asia Scheme) Regulations) which carries on business as an agent of a member of Lloyd’s;
(y) a corporation the entire share capital of which is owned by an institutional investor or by persons all of whom are institutional investors;
(z) a partnership (other than a limited liability partnership within the meaning of the Limited Liability Partnerships Act 2005) in which each partner is an institutional investor.
An accredited investor as defined in Section 4A of the SFA and Securities and Futures (Classes of Investors) Regulations 2018 is:
(i) an individual —
(A) whose net personal assets exceed in value $2 million (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount;
(B) whose financial assets (net of any related liabilities) exceed in value $1 million (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount, where “financial asset” means —
(BA) a deposit as defined in section 4B of the Banking Act 1970;
(BB) an investment product as defined in section 2(1) of the Financial Advisers Act 2001; or
(BC) any other asset as may be prescribed by regulations made under section 341; or
(C) whose income in the preceding 12 months is not less than $300,000 (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount;
(ii) a corporation with net assets exceeding $10 million in value (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe, in place of the first amount, as determined by —
(A) the most recent audited balance sheet of the corporation; or
(B) where the corporation is not required to prepare audited accounts regularly, a balance sheet of the corporation certified by the corporation as giving a true and fair view of the state of affairs of the corporation as of the date of the balance sheet, which date must be within the preceding 12 months;
(iii) A trustee of a trust which all the beneficiaries are accredited investors; or
(iv) A trustee of a trust which the subject matter exceeds S$10 million; or
(v) An entity (other than a corporation) with net assets exceeding S$10 million (or its equivalent in a foreign currency) in value. “Entity” includes an unincorporated association, a partnership and the government of any state, but does not include a trust; or
(vi) A partnership (other than a limited liability partnership) in which every partner is an accredited investor; or
(vii) A corporation which the entire share capital is owned by one or more persons, all of whom are accredited investors.
Continuation solutions encompass a host of transaction types in which a GP secures interim liquidity and/or additional primary capital for their LPs in a strongly performing asset, or set of assets, that the GP will continue to own and control. Specifically, they include continuation funds, new funds created by GPs for the purpose of acquiring the asset(s) that continue to be managed by the same GP and capitalized by one or several secondary buyers, or equity recapitalizations involving a direct equity or structured equity investment into a portfolio company. These transactions can also include a parallel investment from the GP’s latest fund into that same pool of assets (a “cross-fund trade”).
