Is Web3 devolving back into Web2?

Joel Monegro’s Fat Protocols thesis has had a long-lasting impact on crypto. While it’s been heavily debated, the overall vision stands true 10 years later - but for how long?

The thesis is fairly simple: blockchain protocols generate exponential value for end users as more applications (DApps) are built on top of them. Think how yield optimizers built on top of Dexes help users get more out of the same basis product. Everything is open source and interconnected, creating a virtuous growth cycle. This stands in stark contrast to Web2, where value is concentrated in monolithic applications.

This take stands true to this day, despite being 10-years old.

But as Web3 grows and welcomes newbies, it can feel like it’s dropping more and more of its initial identity. To provide smoother experiences, it becomes more centralised, sacrificing self-custody for the convenience of intermediaries.

In short, back to the old ways.

The growth of centralized applications raises a critical question: is crypto devolving into Web2, back to thin protocols and fat applications?

What’s thin, what’s fat?

Self-custody is at the root of what makes crypto the ecosystem it is today. Without it, there is no Ledger, no DeFi delta-neutral strategies spread across 57 DApps, no obscure Solana memecoins: crypto just becomes another inflexible speculative commodity.

Self-custodial wallets allow thin applications and fat protocols to thrive, so let’s see how they benefit end users. As opposed to their centralized counterparts (CEXs), they do not take wild fees whenever users interact with on-chain applications to trade, swipe or gamble money away.

Actually, wallets are so hands-off they can even struggle to generate revenues. Most of them take fees whenever users make a swap or bridge natively in their UX. This model pushes them to integrate as many chains as possible to capture hot liquidity, and thus generate as much in-wallet movement as possible (we discussed it here).

Users are the main beneficiaries of this monetization struggle - for them, this is a free playground (minus the gas). However, the UX complexity that comes with with self-custody creates significant entry barriers for newcomers.

This is where custodial wallets and centralized products come in. They offer a familiar, Web2-like experience that lowers the barrier to entry, making crypto more accessible. This is made possible by the fact that CEXs run for the most part off-chain - including all the trading activities, order matching, and ledgers.

CEXs are fat applications, and as such, they take fat cuts, sometimes as high as 2% per transaction. But they onboard new users. Therefore, a legit question arises:

Is web2 just… Better?

By Web2, understand fat applications and thin protocols. The Binance or Coinbase of this world when it relates to crypto. Is a great UX better than a higher value sum for end users?

Let’s start with the good news: traded volumes on the DEX/CEX ratio are looking up. This means that more and more volumes are traded on-chain than off-chain. But DEXs are still loosing the custody war: as of October 24, 85% of the volume is still traded on CEXs. This shows that the majority of users prefer simplicity over profit. Put otherwise, custody over self-custody.

Onboarding new users remains a very hard problem to solve because of the steep learning curve required to navigate in Web3. The process of setting up a wallet, securing seed phrases, and navigating various blockchain interactions is far removed from the intuitive experiences users have come to expect from Web2 applications.

In addition to that, it’s easy to get lost in the plethora of wallets out there. The market isn’t consolidated, which means there are solutions in every directions for all users type. This is all pretty confusing. And the switching cost from one wallet to another is pretty low: winning products will always be the ones with the better UX.

Currently, the better UX belongs to custodial solutions. CEXs for wallets/ trading/ yield generation aren’t the only applications that have a lot of success: Wirex for cards, BitStack for DCA, or Stake for gambling - all with impeccable and fun experiences.

But all is not gloom and doom. Self-custodial, decentralised products are catching back up: Aave for credit, Uniswap for swapping and staking, Legends or Infinex for wallets, Kulipa for cards.

All of this points towards one thing: fat applications might currently have the better UX, but DApps are catching up, and they have the advantage of added value through ecosystem synergies. Web2 might be better for non-tech savvy users now, but we’ll likely see a reversal in the coming years. And after all, what’s even the point of using Web3 if it’s not to leverage the value that fat protocols provide?

If not self-custody, why crypto?

It’s in these words that Ian Rodgers, Ledger’s Chief Experience Office, opened WalletConnects’ 2024 market statement:

In each bull run, new crypto or blockchain-focused companies compromise on self-custody, security, or both. Each time they have a very rational explanation for why this compromise is necessary, usually related to usability and “onboarding the masses.” Each cycle results in users getting rekt and broad distrust in the ecosystem. Little is as predictable.

This is what happens when fat applications win: everyone else gets the bitter end. FTX, Celsius, BlockFi… There are too many bankrupt centralized products to count already. That’s why crypto was created in the first place - to cut intermediaries playing with their client funds.

So how do we make self-custody more accessible? Probably by embedding self custody in familiar applications. Let’s take an example, like creating the CAC 40 of cryptos. Users can understand it very easily, making it more comfortable for them - and they benefit from the juicy APIs. They don’t need to know that it’s market neutral, hedged on Uniswap, etc. All of this is secondary. The important thing is that they already know and trust the high-level product.

Another example is the rise of social logins, with solutions like Argent or WalletConnect’s web wallets. Users can create a non custodial wallet just with their Google account: Web3 embedded in products retail already knows. From there, they can explore the wonders of dapps and digital collectibles.

It’s easy to imagine other embedded experiences - like FaceIDs to help users log in their favorite websites where their digital collectibles are, or instant settlement at payments, with stablecoin transfers on the backend. That’s one of the things we’re working towards with Kulipa.

Conclusion

It’s fair to say this centralisation of crypto is temporary. The space isn’t mature enough yet to onboard billions of non-tech savvy users, and familiar experiences provided by fat applications offer a great alternative.

We’re achieving scale with the rise of layer 2s, anonymity with ZK/ FHE technology, security with solutions like Ledger, but we’ve yet to solve user experience. Web3 isn’t devolving into Web2, it’s only sharing the long tail of retail end users with custodial solutions, to give itself the time to create more delightful and fairer products for everyone around the globe.

About Kulipa

Kulipa helps non-custodial wallets issue crypto payment cards. With Kulipa cards, wallets can generate more fund movement, easily develop new use cases and maximize organic acquisition. Get in touch here!

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