What is Web3?

A breakdown of Web3, Cryptocurrency, & Decentralized Finance. We’ll discuss what these terms all mean, how they impact your business.

Amber Welch, Senior Manager at Graphite

Updated 2022

What is Cryptocurrency?

A popular buzzword today…you may have heard it referred to as “Crypto”, “Cryptocurrency”, or even heard others mention types of “Coins” (i.e Bitcoin) when referring to modern cryptography-related topics. 

But what is Cryptocurrency to the layperson? The simplest answer is that Cryptocurrency is a type of virtual currency secured entirely by cryptography, meaning it is nearly impossible to counterfeit, or, as of this writing, hack. 

Traditional currency (a.k.a. Fiat currency) and Cryptocurrency are both a medium of exchange, a store of value, or a unit of account, but that is where the similarities end. Fiat is legal tender tied to government-issued securities, while Crypto derives its value from the blockchain on which it exists (more on that shortly). Historically, Fiat is controlled by governments and financial institutions that share little if any of the details, and access is limited to only those who meet the standards of those institutions. Cryptocurrency lives on blockchain, which is  open-source, meaning anyone has the ability to view and even copy and use the computer code that creates the blockchain and the end product(s) on it. Fiat’s value exists only because a government declares it has value, but Cryptocurrency has intrinsic value, similar to precious metals, or salt, or even shells in ancient populations.  

Think of it in this way…if having your ceiling fan run 24/7 produced the solution to a crossword puzzle that you could then use to trade for food, you just wrapped your brain around Blockchain, Cryptocurrency, and smart contracts! In that example the ceiling fan is Blockchain, the solved crossword is how the Cryptocurrency are ‘found’, and the food you buy is the smart contract with which you use your Cryptocurrency. 

 

What is Decentralized Finance?

Decentralized Finance, known more commonly as DeFi, is similar in many ways to traditional finance; like Crypto, it performs outside of the normal bounds of government oversight on a multi-server network vs a single server. So, what does that mean in terms of day-to-day use? DeFi uses the same secured ledger-system via the blockchain that cryptography does but expands its offerings beyond virtual currency to include more robust financial services found in banks, lending firms, and other contract-driven financial institutions. One goal of both Crypto and DeFi (as well as Web3 as a whole) is to remove the boundaries and fees associated with the centralized experience we have come to expect, and provide the ability for peer-to-peer functions without the required middleman traditional methods have always required.

 

What is Web3?

If DeFi is the system and Crypto is the currency, what does that make Web3? Web3 is the ecosystem in which all Decentralized Finance and the Cryptography of virtual currencies are built-upon. Yes, blockchain (which we’ll discuss next) is still the foundation below all these things, but Web3 is the next generation of the internet, helping to create a network of users and platforms all built on the same technology without previous constraints and pitfalls of the world wide web.

 

What is Blockchain and how is it different from traditional thinking?

Imagine you have a huge glass bank vault. In that big glass vault are a bunch of glass boxes all stacked one upon the other. You can see the contents of each of those glass boxes, but you can’t open them, change them, or remove them from that bigger vault. However, if you are assigned a key to one of those boxes, you can access its contents while everyone else can only view what is in that box, along with all the others. THIS is the basic idea behind blockchain. The cryptography that is built on blockchain is viewable by everyone, along with all transactions, and all smart contracts, but only the individual who has the key to that specific glass box can use the contents in the box. Foundationally, all sorts of contracts, transactions, and other methods of business can be stored and used; limitless amounts of opportunity to form contracts and conduct business. They’re all viewable, all unable to be hacked or changed, and all open-source, meaning that if the building-out of a specific application on the blockchain isn’t viewed as positive it can be copied easily and a fresh version can be started elsewhere, allowing for ever-improving use for the end users rather than the few making decisions for the many. At its simplest is the idea that it provides access to everyone and is held to a standard by everyone.

What guidance currently exists surrounding Web3?

The current guidance on Web3, Cryptocurrency, and DeFi is very limited as of the writing of this article. In fact, the only guidance currently is from the Internal Revenue on how cryptocurrency should be treated from a tax perspective and one very recent release from the SEC for publicly traded companies that are operating as Web3 ‘wallets’ for other holdings. Like stock assets, the IRS has stated that Crypto should be treated as an intangible asset with both unrealized and realized gains and losses. The overall treatment differs from stocks in that cryptocurrency is easily liquid and Web3 overall can be and is a major part of many companies’ structures, which leaves the door open on future guidance beyond the FIFO methods currently being applied as these additional applications and uses with Web3 become available.

 

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How does this impact start-ups?

You may be asking yourself as a start-up or company how this may impact you? The answer is completely dependent on what you’re currently doing with this knowledge, and what you might consider doing with this knowledge in the future. 

Smaller end-users of Web3 may only be holding Crypto assets related to investment into a specific currency or even investment from shareholders into the company. For those end-users, the most important thing to note is the impact of correct reporting of these assets on your financial statements. For the simple asset-holder, this is ensuring the currency-based assets are being properly assessed monthly for gains and losses (both unrealized and realized), and that they are seated as an intangible asset on your balance sheet. Many institutions overlook these assets as they are so unfamiliar with not only what to look for when onboarding clients, but what to do with them if they do recognize them at all.

For more heavily immersed companies in Web3, actions will build upon the previous asset-based treatment to more in-depth functions such that the team handling company financials also must have some level of understanding of Web3 functions as well. Companies who are immersed in the Web3 world require an immersion between finance and computer science much as other industries require inside knowledge of function in order to understand beyond the numbers. This impacts everything from the general ledger classifications of expenses to the long-term cash forecasting and modeling to grow a start-up into a household name.

 

Final thoughts

Much like all frontiers, there is much to discover and learn in the world of Web3, Cryptocurrency, and Decentralized Finance, and now is the time to consider this knowledge and these impacts on your business. Current guidance is limited, and those with knowledge of the industry and finance will help mold and form those standards as they progress. Graphite is a leader in the world of finance for start-ups, including those in the Web3 space. Let us know how we can help!

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