The difference between Web2 and Web3 is how the revenue is split between the applications and the underlying infrastructure. Web2 applications capture the entire revenue and do not need to share with the underlying infrastructure operators. Web3 applications depend on a smart contract platform like Cardano, so the captured value is split between the first layer and the applications.
How Web2 applications work
Facebook is a profit-driven company and has grown due to its high network effect. If the Internet and TCP/IP protocols had not been created, Facebook would never have existed. The value of the internet is growing thanks to companies like Facebook and other IT giants as it is more widely used by people. Facebook is essentially an application. Web2 applications capture the value and don’t have to share revenue with the protocols that form the backbone of the Internet.
It is up to the app owners to create a sustainable business model. There is no need to share revenue with anyone. People can invest in Web2 apps and it is possible for the company to pay dividends to stockholders. A successful company is able to generate enough capital to develop the service.
People can’t invest directly in the Internet or specific protocols. But they can invest in companies that have built their business on the Internet.
How Web3 applications work
Decentralized Web3 applications are dependent on blockchain infrastructure. It provides basic services such as sending value, and the ability to create tokens, or deploy a smart contract (Plutus script). Applications cannot provide decentralization and security for themselves and therefore need blockchain. The blockchain infrastructure is common to all applications in a given ecosystem. This will allow them to easily interconnect with each other. Users can use all available applications from one web3 wallet.
Users must pay a fee to use Web3 applications. The competitive environment and incremental technological innovation will push fees down. Several questions arise. How will fees be split between blockchain infrastructure and applications? How will application revenue be split between the team and the app’s token holders? How will the success of the apps affect the value of Cardano and the value of native ADA coins?
Distribution of fees
The user pays a fee, which always includes the first layer fee (blockchain fee). The fee may include payment for the application service (application fee). The application fee may be further split between the team or owner of the application and the users holding the application tokens. Alternatively, some other token can be used.
No application has yet been commercially successful enough to have a market capitalization greater than the underlying blockchain. However, this may change over time. It is up to the project to share the revenue with the token holders.
Let’s look at one hypothetical example. If the user pays 2 ADA for a DEX service, the Cardano network can receive 0.5 ADA from it and the application 1.5 ADA. The larger part of the fee is the application fee. The team can keep 0.5 ADA and split 1 ADA between token holders. If the app is used by 1,000 users per day, the team will make 15,000 ADA per month and the token holders will split 30,000 ADA per month. 1,000 users is not a lot for a commercially successful app. If the app was used by 1,000,000 users per day, we get to revenue of 15,000,000 ADA for the team and 30,000,000 ADA for the token holders per month. If you had a 0.1% token share of such a successful app, you would get 30,000 ADA per month. However, it is possible that such a large amount of traffic would be happening on a sidechain and the fees would be lower.
Let’s not forget the Cardano network, which could earn 500,000 ADA in fees every day thanks to a successful application. However, there may be more successful applications on Cardano. If there were 5 of them, the network would earn 2,500,000 ADA each day. We will have to wait for that. In the beginning, there are more likely to be many applications with fewer users. It may take a few years before the first killer app appears. Currently, the Cardano network earns approximately 5,000 ADA per day.
If the applications are successful, the importance and relevance of Cardano will also grow very similar to the growing importance of the Internet. Blockchain networks, unlike the Internet, have native tokens. How will the success of the applications affect the value of ADA coins? Investors may be more interested in buying tokens of successful apps. The profit of successful applications could theoretically be higher if the application fee is significantly higher than the blockchain fee.
What will drive demand for ADA?
What will drive demand for ADA coins? Applications are dependent on Layer 1 security, so it is in the interest of teams to hold ADA coins. Cardano has a governance model that is linked to ADA coins. Only ADA coin holders can decide the future direction of Cardano and the funding of projects from the Cardano treasury. This is another reason to hold ADA coins. Teams building applications may have an interest in participating in the management of Cardano, just as IT giants have an interest in making the Internet work well. Users may be interested in balancing the power between them and the teams and can only do so through ADA coins.
The current architecture of the Internet does not allow sharing of success and revenue among all those who use the Internet. Neither Facebook nor Google has to invest in infrastructure and share profits. Many companies do, but only on a voluntary basis and for their own interests. Users have minimal chance of influencing the functioning of the Internet and, consequently, the functioning of large companies. Cardano will allow all ADA coin holders to share in the success of all applications and a portion of the profits will be split between them. Partly through fees and partly through the ability to own and decide on the infrastructure that the applications must use. Think of it as if there was an Internet token that allowed you to get a share of the revenue of all companies using the Internet.
Notice that the distribution of power is changing when blockchain is involved. Web2 applications must obey the laws, but users have no direct control over them. For example, users cannot force IT giants not to abuse customer data. Disgruntled users can pressure legislators to change the laws and then hope that IT giants will respect the new laws. This is very inefficient. Moreover, IT giants can influence the decisions of legislators. Cardano will allow all users to partially control the behavior of Web3 applications since applications are technologically dependent on what the first layers allow them to do. If people understand the point of decentralization, they will want to hold ADA coins.
Staking ADA coins is the safest way to ensure passive income in the Cardano ecosystem. It’s not necessarily the most profitable form, but for conservative users, it may be enough. That’s another extra reason to hold ADA coins. Staking can be seen as sharing in the success of Cardano and all applications. Not only can the value of the ADA coins naturally grow, but additionally, approximately 5% of ADA coins can be earned annually.
ADA will always have the largest cash flow in the Cardano ecosystem. It is difficult to predict the future, but it is safe to assume that ADA will become a native payment in the Cardano ecosystem. Although I think that stablecoins will take over this role, past experience shows that native coins are the universal mean of exchange across the Cardano ecosystem.
Last but not least, let us not forget the speculative nature of cryptocurrencies. If the Internet had tokens representing the ability to vote or share in profits (as we said, TCP/IP protocols do not generate profits), it is likely that they would have value. ADA coins will have value because any success at the application level will be partly the result of the possibilities offered by Cardano as a platform. The success of applications will reinforce Cardano’s success. Additionally, success means the network will collect more in fees, so the number of coins in the treasury will grow. This means that investments can be made to further develop the ecosystem.
There may be applications that will not have their own token and will only use ADA coins and stablecoins. This could directly enhance the value of ADA coins. On the other hand, the question is whether a meaningful governance model around ADA coins can be built for a Web3 application. Having custom tokens for this makes sense if the distribution is fair.
Network effect and direct user interaction
All successful Web2 applications are based on the network effect phenomenon. Firms can profit from the network effect. In the case of blockchain, the same is true. How to measure success? Direct user interaction and paid fees are much more important metrics than Total Value Lock (TVL). TVL may only be a big number, but without users who use the value in some way, it is useless.
The growing network effect increases the value of the service. Blockchain is ubiquitous and available worldwide. Like services on the internet, Defi applications can be used by people around the whole world. It can be expected that as new services mature technologically and are able to compete with existing services, their growth will skyrocket. We have seen the first signs of this with the advent of the NFT. Although the sector is not doing well in a bear market, this is the first indication of how quickly decentralized services can make headlines.
Blockchain always benefits from user interaction first and this will always lift its value. Blockchain has the property that it can easily connect not only users but also different businesses. Many fans see blockchain as a Peer-to-Peer network, but Peer-to-Business and Business-to-Business are also valid options. Imagine a Cardano wallet that allows you, through a decentralized identity, to connect to banking and apply for a loan. The same wallet will allow two businesses to exchange value with each other. For example, stablecoins for tokenized stocks or tokenized goods.
Once large companies or even countries start using Cardano, the network effect will grow much faster than it is now. We could see adoption leap. The social and financial benefits that Cardano will bring to people, companies, and countries must necessarily be reflected in the value of the Cardano network. The value of the Cardano network is expressed economically in terms of the value of ADA coins.
Teams building Web3 applications will aim to achieve the maximum possible revenue from user interaction and will want to keep it to themselves at the expense of the blockchain network and token holders. Teams have to cover the costs of running the service (for example, UI can run on cloud services) and new project development. If they get too greedy and don’t want to share the profit fairly with token holders, it may be that the service gets copied somewhere. This is another advantage of Web3. The open-source nature will not allow for the creation of service with a dominant position. Just as it is possible to use existing technology to create a new network, it is possible to copy an existing Web3 service. This may overwrite current models regarding the network effect.
On the other hand, token holders need to be aware that teams need to keep some of the profit and that they are entitled to a reward for successful service. Companies like Facebook and Google don’t talk much with people about profit sharing and investing in the future. Web3 can change this to some extent as cash flows will be more transparent.
The source code is easy to copy, but not the user base. One can expect that in a decentralized world, there will always be more pressure to share revenue fairly between the team and token holders. People will have more control over what happens to users’ data and fees. Future development is hard to predict.
Blockchain is a new paradigm and initiates the emergence of new business models. It is clear that a whole new layer of interconnected blockchain networks will rise over the internet. Cardano will be one of them. Cardano will be a decentralized layer that redefines trust on the Internet. The current power of third parties will be weakened in favor of Cardano. Logically, this will affect the profits of the current internet giants, which may be lower. People will pay for Web3 services and part of the fees will be earnings for Cardano and other blockchain networks.
It certainly makes sense to hold ADA coins, because not only are you betting on the success of the Cardano network and thus some Web3 applications, but you also hold decision-making power over the infrastructure that the applications must use. This gives you some degree of control over how they operate.
If our future is to be decentralized, we must all hold the keys to it. PoS networks make this possible through native coins. If we have them, we will have control. If a large number of coins are bought by one successful Web3 service, we as users may lose control, and thus decentralization becomes meaningless.
This article was prepared by Cardanians with support from Cexplorer.
Read the article: How Success of Applications Will Affect the Value of Cardano | Cardano Explorer