In short, Bitcoin and Ethereum market caps are HUGE! Google, Amazon, Facebook everyone sells amazing products have earned billions in revenue to attain such valuation and, in turn, market capitalization. But what does Blockchain sell? What is their business model? Are these profitable? Let’s explore the answer to these questions in today’s post.

Blockchains are in the business of selling block space.

Blockchains generally have a limited about of block space. The higher the demand for blockspace, the higher the charges (fees) to use the blockspace. Simple, supply-demand dynamics at play. Now, why do people want to use this block space? What’s so special about them? How is it different than a single computer? This block space can be used to record information, run code, and transfer things (currency, digital objects). It’s a trustless, immutable, decentralized, and permissionless blockspace. It means, ideally, no one can alter or censor anything. This is often expressed via a single term “security”. Needless to say, security is the most important component. If it is compromised, the block space is not worth much. Therefore, the higher the security, the more valuable the blockspace. Security is essentially derived from independent miners/validators. High decentralization and high miners/validators mean higher security. Miners/validators are similar to employees of the blockchain enabling the ecosystem and ensuring security.

So, let’s see the business model of Ethereum!

Profit = Revenue - Cost

Revenue → Simply the transaction fees earned by the system. The fees users are willing to pay to use the blockspace. This revenue varies and is dependent on the demand. Over the last year, daily revenue ranged from $4 Mn - $80 Mn! On average around $10-$15 Mn per day!

With EIP-1559, a significant chunk of the fees is burned. When it’s burned, it is kind of equivalent to stock buybacks which adds values to the stocks or in this case coins.

Burn → Approximately 0.17x of ETH issued currently is burned. This is not a fixed amount and depends on a number of factors. This reduces the supply of ETH in the system. It is interesting to note that this is the primary mechanism of transferring value directly to ETH holders aside from an indirect mechanism of an increase in token value.

Therefore actual revenue of the system is transaction fees - eth burned

Cost → Fees paid to miners/validators

Currently in a Proof of Work mechanism, Ethereum issues ~4% to miners/validators as a block incentive reward. This incentive is necessary to attract a large number of miners/validators and therefore higher security. This amounts to a total of ~ $32Mn worth of Eth issuance every day.

Clearly, the Ethereum business model is not profitable currently. It’s similar to a new startup or company which runs promotional campaigns in order to attract network participants. However, the good thing is it soon will be profitable!

With Ethereum migrating to Proof of Stake, the issuance will reduce by 90%! Therefore, its issuance cost post-merge is around $3 Mn. This is less than Ethereum's current average revenue! Therefore, Ethereum will become a profitable business model with a profit margin of ~75%! Of course, with continuous innovations, the use cases Ethereum can support will increase. This will further increase the demand and therefore the revenue of the chain.

However, what about security, you may ask? Since the entire purpose of the issuance was to provide high incentive and therefore high security. Now here is the catch, the security is not compromised in any way. It’s like Proof of Stake is a highly efficient way of providing security. We will cover Proof of stake in another article in detail. However a quick brief, in the proof of stake consensus mechanism, miners do not need to run expensive hardware and incur high electricity costs for mining ETH. Instead, they can just stake their ETH and become a validator. It essentially significantly reduces the cost to mine ETH and therefore the entire cost of security to ETH reduces.

The Positive Flywheel!

As discussed before, with more and more dapps deployed on Ethereum, the demand for Ethereum block space increases. This implies high gas fees which in turn implies high gas burn. Reduction in supply means increasing ETH prices. Higher ETH prices draw even higher interest and demand. At the same time, increased incentive increases security as well which increases its utility again! This positive flywheel further improves the profitability of the blockchain in the long run. I am really excited to witness the post-merge era! Are you?

Before exploring if Bitcoin can go to 0, let’s try to understand why it is above 0 in the first place 😅. As we know, money is just a medium of exchanging value. What does Bitcoin enable? - A trusted, secure, permissionless, and decentralized medium for exchanging value. It does so in its native fungible token BTC. In my understanding, such cryptocurrencies derive value broadly out of 3 pillars -

1. Store of value - When you buy Bitcoin hoping that you will be able to sell it to someone later at a high price who will be buying with the hope that he will be able to sell it to someone at even higher prices. Scarcity is important for such assets. Scarcity is ensured with limited supply. For instance, gold has accrued a lot of value over the years for similar reasons. Although, it does have utility but its value is primarily attributed to its scarcity. Bitcoin has also done a wonderful job in accruing value positioning itself as a store of value with its limited supply of 21 Million Bitcoins.

2. Unit of exchange - With increasing acceptance and adaption, the utility and therefore the value of currency increases.

3. Equity like value - if proof of stake-based chain. This directly does not apply to Bitcoin.

Let us evaluate how Bitcoin is poised on these aspects.

Bitcoin transaction fees may rise up to $50-$100.

Bitcoin currently supports ~2750 Transactions per block. This roughly translated to 7 transactions per second. Currently, the average transaction fees range generally between $2-$4 which peaked at ~$62.8 back in April’21. These are the fees paid to miners as an incentive for validating transactions and securing the blockchain. Apart from the fees, miners are also paid block rewards (Currently 6.25 BTC in each block). This forms a significant part of the current rewards.

Considering $3 transaction fees which itself is significant for retail users, the total block reward would be around $8250. Apart from transaction fees, the block reward depends on the BTC price which varies significantly but has been around $30, 000 or above since Jan 2021. This amounts to $187, 250 with very conservative calculations. Therefore, total rewards are around $200, 000 per block broadly. So, the transaction fees generally do not even form 10% of the total reward. As we know, miners secure the network. The more the incentive, the more the number of miners, and subsequently the higher security of blockchain. This is because the chances of miners colluding to do a 51% attack reduced. Therefore, to summarise, the security of the network is directly proportional to the incentives to the miners.

As evident, the block rewards constitute ~95% of the incentive. Currently, 6.25 BTC are awarded to the number of bitcoins. It halves almost every 4 years. It was last halved in 2020 and therefore, the next halving will happen in 2024. And subsequently, when 21 million BTC are mined in 2040. These block rewards will cease to exist. Therefore (Not adjusting for inflation for simplification), in order to have similar security as of now, the total transaction fees revenue needs to be equivalent to $200, 000 K (inflation not accounted for). It means a transaction fee of $50-$100. And of course, If the fees are not enough, the network will not be very secure which means it will lose all its value! With high fees, the network can be used for high-value transactions. For instance, users may be willing to pay up to 1% as the transaction fees. Therefore, transactions of $5000 and above may seem feasible.

Bitcoin transactions are slow.

However, given the capacity of ~7 TPS, even high-value transaction confirmation may take significant time. The block time in Bitcoin is 10 minutes, therefore even if your transaction gets included in the first block itself, you may have to wait up to 10 minutes to get your confirmation. This makes it infeasible to operate on a day-to-day basis when users expect transactions to be confirmed within seconds.

Bitcoin is volatile.

Bitcoin price is highly volatile. It has depreciated in value by more than 50% multiple times in the last 1 year itself. That too when its price crossed $50, 0000. It is interesting to see that such a high-priced asset class can be this volatile! There is an argument that as the industry matures the BTC price will attain stability but it is yet to be seen. At the time of writing this article, Bitcoin was trading below its Dec 2020 levels.

Bitcoin needs a scaling solution.

Bitcoin seems to be performing well on the store of value aspect. However, it seems certain that the Bitcoin network itself can’t be used for performing day-to-day transactions. This limits the blockchain from being the unit of exchange. For becoming a global currency, Bitcoin needs a scaling mechanism. A mechanism that allows for fast, cheap, and safe transactions. Lightning Network seems to be a promising solution for addressing these pain points. However, there are certain risks associated with Lightning Network. It operates via a “Channel mechanism”. It means you can open a channel with any vendor and instead of putting all transactions on the ledger, you keep on transacting off-chain and interact with blockchain at a fixed frequency or while closing the channel. A simple analogy would be if you and Starbucks near you created a channel. Each day you buy coffee and both of you keep track. Instead of paying each day, you can just sum up and pay at the end of the month recording a single transaction on the main ledger. But there are some risks associated with the system.

So where does this leave us? Using Bitcoin, users can send high-value international transactions in 10 minutes at any time across any part of the world with no currency conversion fees, no permissions, and no bank accounts. Bitcoin via design is not inflationary eliminating the concern of currency dilution. Bitcoin protects against local currency collapses due to bad governance or many external factors. For example, during the Russia-Ukraine war, the pound lost its value by 40%, and Ukrainians lost all money in their local banks as they flee the country.

There are still many structural issues with using Bitcoin as a unit of exchange. While Lightning Network seems promising for solving many of the issues we discussed but the likeliness of Bitcoin being used as a unit of exchange for day-to-day activities still seems low. But, even so, if we imagine a world where we have a valuable asset class not being controlled by any government, country, or entity. An asset class that can’t be seized, can’t collapse, doesn’t inflate, and, can be seamlessly used as a medium of exchange across borders. I believe it would be a valuable asset class. Among all other blockchains, Bitcoin has pioneered this revolution and has done exceedingly well in gaining trust and accruing value. Therefore, in my opinion, it seems unlikely that Bitcoin will ever go to 0!

Optimistic Rollups are a scaling solution for Ethereum. They scale Ethereum roughly by 100x by pushing computation off-chain and submitting minimum transaction data along with Merkle state root on Ethereum. They offer secure, fast, and cheap transactions, the way it was meant to be.

Need -

Ethereum is envisioned to be a World Computer. A world computer that could, one day, potentially hosts a substantial percentage of all digital transactions. This could range in million transactions per second if not billion. However, Ethereum currently offers a limited blockspace supporting 15-45 transactions per second. With increased user adoption and an increasing number of applications, the network is already becoming clogged with high transaction fees making it inaccessible for retail users. Therefore, scaling solutions are absolutely crucial to realizing this dream. Roll-ups are currently the most important type of scaling solution for L1s. Understanding Roll-Ups is important to understand the entire ecosystem. There are two types of Roll-Ups - Optimistic Roll-Ups and zk Roll-Ups. Let’s explore Optimistic Roll Up in the current article.

Idea -

Roll-Ups in principle are a mechanism for optimizing blockspace usage of Ethereum Mainnet. A not-so-perfect analogy would be to zip a file to reduce its size and therefore reduce the space it takes on the hard disk. Ethereum block size is around 80-100 Kb in general (It varies, the limiting factor is the Gas. Each block has a target size of 15 Million Gas. More on Gas later!). Hence, of course, we need to use this space very optimally. It typically takes around ~110 bytes to transfer ETH on a mainnet. Using roll-ups, the same transfer can be done in ~12 bytes[Source]. However, rollups not only save on data stored on-chain, but they also take the computation off-chain further saving on gas. This roughly creates an improvement of 150x allowing 2000-4500 transactions per second. Of course, the exact improvement depends on the implementation and the transaction type.

Implementation -

Now, let’s deep dive into how this happens for Optimistic Roll-Ups and if there are any associated security risks. The primary component of Optimistic Roll-Ups are -

1. A roll-up smart contract deployed on the Ethereum

2. A child chain (Ex- Optimism Chain) - Sequencer

3. A fraud-proof contract in case of disputing any faulty transactions

The sequence of events when a transaction is initiated is as follows -

1. As soon as a transaction is initiated, the roll-up contract sends the transaction off-chain to a sequencer.

2. The sequencer executes the transaction locally and confirms the transaction.

3. Sequencer bundles multiple transactions together into a batch

4. The sequencer then submits that batch back to Ethereum via a single transaction thus distributing transaction cost over multiple transactions and lowering the transaction cost.

   1. The bundle contains the minimum amount of information required for each transaction. Each bundle sent contains the old state Merkle hash, a bunch of transactions, and the new state Merkle hash.

Step 4 is critical to solving the data availability problem. This limits scalability but this is how L2 layer protocol inherits the security of Layer 1 protocol. Let’s see how.

The idea behind Optimistic rollups is that it is optimistic and assumes that the sequencer behaves in good faith. It does not censor any transaction, validates all transactions appropriately, and then submits the updated Merkle state of the child chain. After submitting, everyone gets a chance to report an invalid transaction for a pre-decided period of time (challenge/dispute period). The assumption is that at least one actor will be monitoring the chain and reporting fraudulent transactions if any. This is a good assumption given the incentive mechanism in place. The sequencer submitting transactions is required to deposit a certain amount of money (Ex - ETH). The money is locked until the end of the challenge period. If a challenger reports a fraudulent transaction, the entire block is executed via Fraud Proof contract on the Ethereum mainnet. It is possible because the old state Merkle root and transaction data is already available. If the challenge is successful, the challenger is rewarded an amount from the locked sequencer amount. The fraudulent transactions are reversed and the correct state is stored. Since any transaction can be validated on Ethereum, optimistic roll-ups inherit the security of Ethereum and at the same time offers fast and cheap transactions. Therefore, the only risks associated are smart contract risks and Ethereum security risks.

Optimistic roll-ups provide a secure, fast, and cheap alternative to Ethereum. Optimism and Arbitrum are two major projects. Since they are EVM compatible, any smart contract can be easily migrated from the Ethereum mainnet to L2. They will surely form a critical infrastructure layer in the Web3 ecosystem. But are they enough? Even though they typically scale up the Ethereum by 100x which could serve for a few years, it seems to me that we may still need further scaling solutions as the ecosystem and the users on Web 3 evolve!

1. Custodial Wallet - trusted 3rd party keeping your private key like Binance

2. Non-Custodial wallet - decentralized wallet where the user has to keep their key

   Recovery phrase used for getting access in case private key is lost

   1. Software/Hot wallets - Where the key is stored on browser extensions or Mobile Apps like MetamaskCoinBase Wallet.

   2. Hardware wallets - Where the key is stored offline on a hardware device. These are safer as the key is stored offline.

Of course, I realized I was using a custodial wallet. But for interacting with the Defi world, I needed a non-custodial wallet. Therefore, I set up a quite popular Metamask wallet. During the step-up came the step of storing my recovery phrase and the warning that if I lose this phrase, I will lose complete access to the wallet including all my assets, and no one can help me! It was recommended to not store it digitally. Knowing myself, I knew I can lose it any time. That spooked me but yet I continued scribbling the catchphrase in a notebook deciding to just use it for exploration and buildspace projects. When I started putting in some money, this recovery phase became important. The problem was that I could not store too many copies since if anyone found the key, they could just drain my funds right away. But I had to keep as many copies as possible so that I could recover. This is a critical pain point and problem right at the start of the crypto journey for the user. Potentially blocking and scaring many people away from the space even the enthusiasts.

Tip: I have memorized one word of the catchphrase and stored 11 others physically. This way even if someone finds my catchphrase they can’t recover and I only have to remember one word which is easy!

There are many companies working in this direction. Multisig wallets and Social recovery wallets seem most promising to me. Multisig wallets refer to multi-signature wallets. As the name suggests, it requires 2 or more users to sign the transaction individually before the transaction is signed. This is really helpful in case a hacker steals your keys. Social recovery wallets are more interesting. These are based on the concept of attestations. The concept is that you can choose your guardians (Which can range from 3 to any odd number). In case you lose your wallet key, you can initiate a special transaction to generate a new key, and if more than 50% of guardians sign the transaction. You would be able to recover your wallet. Of course, there is a possibility of your guardians colluding and stealing your money away. But this can be addressed if you choose Guardians from different social circles and people you absolutely trust. Argent and Loopring wallet are the major players providing this solution. I am planning to switch to these soon and so should you!

This becomes abundantly clear when we switch to the gaming world. Imagine that you could just buy a rating at Chess.com. The entire rating/score will lose value if this could have been possible. Instead, every user has to showcase their skillset and beat the best of the best in order to increase their rating. Every player knows and trusts that a person with a very high score must be a kickass chess player. This is what soulbound NFTs will enable in the Web3 ecosystem.

While users owning NFTs can signal wealth and skills in acquiring/selecting such NFTs. Such NFTs can’t signal the inherent skills associated. The primary use case of Soulbound NFTs is to ensure - Merit or skill or interest tokens are not buyable/transferable. This is critical and powerful. Imagine a doctor having a degree token that he just bought from someone. Or an engineer building bridges leveraging such degrees. That will be catastrophic. Therefore, the underlying primitive behind such tokens will be that the user will have to complete these tasks/projects/activities themselves in order to earn Soulbound NFTs. Using Soulbound NFTs, users will signal and be recognized in the blockchain ecosystem. These tokens will help build the reputation required to shoulder important tasks. For many of the activities including governance, such skills could be mandatory for casting a vote towards any decision. More on governance in another article.

Not only IDs and Degrees, but such tokens can also represent the interest and help express your identity in a native manner. Imagine, you could get a Friends Platinum Golden Token for watching the Friends series 10 times! This just indicates your interest and expresses an important part of your identity. If someone is looking at your NFT collection, they will be interested in understanding your genuine interests which could partly be reflected by the tokens you ‘bought’ but more so reflected by the tokens you ‘earned’. Imagine having tinder matches based on your NFT collections which represent your identity and genuine interests. Soulbound NFTs serve a better use case in such scenarios as well. POAP, Proof of Humanity, Bright ID are solutions already working in this direction.

Restricting transferability is as much a technical challenge as an operational challenge. If tokens were made non-transferable, what if a user loses access to his account/wallet! Or if the user just wants to transfer his tokens to a different account? Can wallet recovery solutions like Multi-sig wallets or social recovery wallets provide a solution? This is yet to be seen. Of course, privacy is another aspect becoming critical with the trend of an increasing number of activities on the chain! With many unanswered questions, the Web3 ecosystem is uncertain which often makes it more exciting 😀

Tokens are the fundamental building block in Web3. The crypto movement started primarily with fungible tokens. BTC, ETH, Matic, Mana, Dot, and many more represent a currency in their ecosystem/network. Ethereum made it extremely easy to create tokens with just a few lines of code. The demand and supply of these individual tokens like any other currency determine the value of these tokens. More recently, the interest in the Web3 community shifted to a new kind of Non Fungible Tokens i.e. NFTs. The basics of NFTs can be read here. These are unique tokens representing any specific asset. In our real life, we deal with NFTs all the time! Every time you buy any kind of membership to a gym or even an online streaming service, you essentially bought an NFT. When you buy a property, insurance, art, or even a car, the legal ownership document you receive is a kind of NFT. Buying a mobile or phone number is also equivalent to buying an NFT. Even when you buy a T-shirt, you get an ownership token embedded within the product itself. You have full autonomy on usage and transfer. From buying a property to a t-shirt, everything can or are generally Non Fungible Tokens. NFT generally represents one or a mixture of the following -

1. Service - Often implemented via subscription or membership models

2. Product

Talking about service, any membership has a utility that cannot be copied or replicated. It is scarce as well. They were in some way already implemented in the digital world with different kinds of subscriptions tied to a specific account at the server. Netflix, Youtube, and Spotify subscriptions are such examples. Now, they can be represented via NFTs which can even be traded. This itself can open up endless possibilities.

The more interesting use case that a crypto-based NFT solves is for digital products. Let us look at physical products first. Usually, physical items are bought for one or more of the following reasons -

1. Utility - Convenience, Functionality, Beauty, etc.

2. Ownership -

   1. Expressing Identity

   2. Signaling wealth/status

NFTs fundamentally provide both utility and ownership of the entity they represent in the digital world. Remember the T-shirt buying example, we discussed? Now, I agree calling a T-shirt an ownership-enabled token may be a bit too much, this is because ownership is embedded in the product. However, ownership becomes really important in the digital arena where anything can be replicated with 0 effort and cost! Imagine every time you bought a T-shirt, anyone could just duplicate it right away and use it. This will derive the value or utility of the item to 0. Digital NFTs face a lot of heat due to the same reason of ease of duplication which can move their value towards 0. However, the interesting aspect is that even with 1000s of NFTs out in the world, the number of projects actually cloning the NFTs are very few and rather looked down upon for doing so in the community. Therefore, even when people can use or show collections of the Crypto Punks or Bored Apes, they don’t. Even though I can mint and use any of the famous NFTs but I am not doing it as it would be evident that I have cloned the NFT. This is because the entire history of any NFT can be tracked from its inception. This means that everyone in the world has a consensus on who owns the original one and everyone else using it if at all are just using a copied one, the likeliness of people using copied ones is not high. Even though they might not mind using replicas in private but not in public. Digital Scarcity is truly at play!

One other interesting aspect is that duplicate in the digital world is the exact duplicate and there is no “quality” difference. When people buy branded products, they tend to justify it with the difference in quality even when it is often not present or very minimal in comparison to the price difference. However, this helps buyers to psychologically justify that they are buying products because of the utility also and not merely as a means for signaling wealth/status. However, in the digital world when this reason is not applicable and it would be interesting to see how it impacts buying decisions. Since these digital NFTs can be copied, these original NFTs often come with access to additional perks like club membership with events and invites. A kind of service NFT model. This utility cannot be copied at all and this could potentially serve as a value differentiator to justify the uniqueness of the NFTs.

NFTs have many other use cases as well. NFTs can be used for access and governance where the authentication can happen via NFTs. NFTs have naturally gained a lot of traction in gaming as well which actually has a digital world with digital goods. NFTs can even be used for loyalty rewards, community building, event ticketing, royalty distribution, etc.

So while buying overpriced NFTs can seem insane from the outside, there is definitely a potential use case for buying them. I also bought an ENS NFT - avigupta.eth! As we move towards a digital world, towards Metaverse, the culture of buying digital goods for your avatars can become common. These digital goods will provide both utilities as well as a means to express identity and status. Here is a whacky idea. Believe it or not, we are already in a kind of a Metaverse! Our photos are the digital avatar of ourselves. Currently, we also buy things and take a picture with them and upload it on the digital universe (Instagram) for our social circles. The time is not far when we will buy digital goods for our digital self and use them directly in the metaverse to attend virtual events & parties. You will own these things and use them on your unique avatar as you please. Although a lot of this seems far-fetched, the rate of change is remarkable and strong indicators are already present. Will you buy a JPEG? Maybe you will, you just don’t know it yet ;)

1. Layer 0 - Hardware & Networking Layer

2. Layer 1 - Consensus Layer

3. Layer 2 - Scaling Layer

4. Layer 3 - Smart Contracts Layer

5. Layer 4 - User Interface Layer

Layer 0 - Hardware & Networking Layer: Everything we do is processed at a Silicon chip essentially computers. It could be in your local PCs or Google or Amazon or any other server. These computers are processing the information from the hardware layer. In Web3, it is an open, decentralized networking layer like never before. You can even become a part of this layer anytime you want and leave as you please. That’s the meaning of decentralized. When you become part of this layer, you will be running the computations on your computers. Of course, with decentralization complexity increases for managing and processing the computation.

Layer 1 - Consensus Layer: A consensus layer is one that is responsible for maintaining consistent information agreed upon with all network participants. This information could be anything from how many ether one account hold to how many NFTs any address holds. This is at the heart of blockchain. The network needs to have consensus on key parameters which define the fundamental property of blockchains like block size, block rate, consensus algorithm (POW and POS the most famous ones). We have many layer 1 protocols available today - Bitcoin, Ethereum, Solana, LiteCoin, Binance Smart Chain, DogeCoin, Avalanche. All have different tradeoffs and the most appropriate one can depend on the use case. Bitcoin and Ethereum are among the largest and most popular Blockchains currently existing**. Users need to be part of the network to interact with the blockchain.** Yes for buying, transferring, or doing anything for that matter users need to be part of the network. There are different options of taking part in the network. They can run their own node either a full node or a half node. If you have bought a cryptocurrency without doing any of this ever, it is because of the product Blockchain Node as a Service!! It essentially means the service provider will run the Blockchain Node for the user. User does not have to get into the complexity of running a node for interacting with Blockchain. Yeah, your service provider did all this for you when you bought your crypto! Major players are Infura, Alchemy, Moralis, QuickNode, etc.

Layer 2 - Scaling Layer: This layer is primarily applicable for Ethereum. Blockchains are chains of blocks. Each block can store a fixed amount of data. Therefore, blockchains have limited space. Simplistically, users need to pay fees to use this block space. This fee is paid in native token ETH. The current Ethereum blockchain can handle 15–45 transactions per second. Recently, these fees on Ethereum skyrocketed from around Jan 2020 due to the increased demand. The two core reasons were - Massive growth in applications being built on Ethereum and increased adoption. This made transacting on Ethereum extremely expensive. A host of scaling solutions emerged to combat this. We will not go into the implementation technologies of these scaling solutions. The most notable ones are Polygon, Arbitrum, Optimism, Immutable X. This formed a layer over Ethereum with low transaction fees and fast transactions while locking into Ethereum’s security. Since then, many of the dApps have moved to Layer 2 for cheap and fast transactions. Any dApp can be built on Ethereum or L2 solutions. Ethereum itself is building its L2 scaling solution to support up to 100, 000 transactions per second.

Layer 3 - Smart Contract Layer: Smart contracts can be deployed on L1 or L2. Smart Contracts are fundamental building blocks that ever get built on top of Blockchain. This allows contracts to interact with the addresses on that particular blockchain. Smart Contracts are self-sustaining immutable code submitted to the network. It cannot be altered. Smart Contracts allow any logic to be encoded and enforced paving the way for all innovations. Ethereum has made it extremely easy to create own tokens both fungible or non-fungible with just a few lines of code. The majority of the tokens present are at this Layer. Examples are Uniswap, Compound, The Graph, etc. These are independent organizations developed over Ethereum. They have their own native token to drive incentives and governance.

Layer 4 - User Interface Layer: This is the bridge to connect the entire blockchain ecosystem to the people. A more familiar UI/UX layer as Web 2. For example, all exchanges and wallets are at this layer. Web3 addresses serve as your identity on the blockchain.

This is because today’s Web 2.0 lacks a critical identity layer. The Identity Layer refers to the natively built-in identity on the internet as a whole that can be used across applications. Instead, we are accustomed to the current identity management practices in place where identity is managed at the application layer but is there a better way? Let’s take an example of a physical setting when you go to an airport or train or police station even any pub, you don’t need an ID issued by the respective organization to enter or use these services. Instead, your ID which is issued by a central authority works everywhere. This is a user-centric architecture. Imagine a setting where every time you have to use a service you had to create an ID of that particular institution. This still happens when you go to college, school, or bank. This happens because the IDs issued by the authority are not extendible being physical. As an individual, you can freely roam around and use products and services by paying. Of course, some organizations do try to register but it is in general optional and the intent of such registration is to provide a more customized experience or rewards by collecting data and creating an internal profile. However, as a user, generally speaking for non-financial services, you need not provide any information or authentication for using the services/products.

Let us contrast this with our internet experiences with identity management implemented at the application layer as a workaround. Currently before using any product, the identity needs to be created at each website which then requires authentication. Entire data associated with the identity is stored centrally at the service provider. This means that user data is stored in a fragmented, siloed, and spread all across the web with little to no control whatsoever. With ever-increasing services and products, the number of accounts or IDs explodes making it a terrible user experience. It means you have to create your Gmail, Facebook, LinkedIn, Twitter, Uber, Amazon, and many many more profiles. Users have to fill in the same details again and again at the different websites for accessing the services. This has also resulted in the current password management fiasco. With so many passwords to manage, users often end up using the same passwords across websites compromising security. While ‘single sign on’ has provided some relief where users can use their Google or Facebook credentials for logging in but that too creates a profile inside an organization that often needs to be updated and verified. On the other side, these centralized ID providers have all the data about users and they can even deplatform the user arbitrarily. This is definitely far from ideal with no data or ID control.

Now let us consider this, an internet with user-centric IDs. It means you have a single ID and you can use that ID to log in anywhere. You have one single password. This ID is completely protected from any downtime. It is permissionless meaning anyone can create it and at the same time, no central authority controls it. Of course, it has to be censorship-resistant meaning no one can block your ID. It would simply be a parallel of your physical IDs in a sense which works everywhere and rather better where this ID can be linked to store other information required to maintain a single ID. You can instead maintain a single wallet with a single password. This will serve as a single wallet where all your IDs can be stored with the user having complete control over the bits of information they intend to share with the websites. Users own and control their data in an unprecedented manner. Web 3.0 implements this architecture with a native identity. One password for the entire web! No more “Forgot Password” :)

Of course, there are some critical concerns - the major ones being privacy & ID recovery. There are many protocols actively working for solving these problems. For example companies are working on solutions like multi-sig wallets, social recovery wallets for ID recovery. Similarly, many startups are actively working on the privacy aspect as well. But the ecosystem is evolving fast and surely seems promising. It would be interesting to see how Digital Identities evolve and come together in the future.