I am creating these series of write-ups to assist people who are interested in jumping into Web3 and Crypto (I understand there is quite a negative connotation tied to the word crypto). My objective is to document everything that I have seen and learnt, and finally put it into a written format so that I can share all the good the bad and the ugly of this fascinating and growing industry.
With that, I would like to start by saying none of this is financial advice just like anyone else in the world creating content for crypto, you need to understand that with financial independence comes responsibility, and that responsibility is something you yourself have to contend with. If you prefer to ape into random things and become a true degen then you have to accept that there is an inherent volatility that comes with your investment decisions. Do your own research by consuming different content from different perspectives to ensure you don’t fall into an echo chamber.
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Let’s start with the evolution of the internet, there are three sections of how the internet has evolved overtime. I’ll be linking Him Gajria’s medium post on his take of this Web1 to Web3 evolution.
the tldr; Web1 - read-only | Web2 - read-write | Web3 - read-write-own
Blockchain technology - distributed and censorship resistance
The advent of Web3 is only possible by the introduction of the blockchain technology. In essence blockchain system is about creating a system of distributed open ledger database to ensure transparency and accessibility of the content is upheld, as well as decentralising the database itself by having multiple copies of the database across the globe to allow for resistance to any attack or censorship attempts by malicious actors.
Contrast to how a company may hold a simple oracle database hosted in a server cabinet in an office, the sole authority to manage the data within that database rests with the company. If an attack occurred which resulted in a different entity taking over the server, the authority to censor and filter any incoming or outgoing changes made to the database now rests with the attacker. We can no longer assume information coming from that database to be 100% valid.
Having multiple copies of the database across different node operators around the globe helps mitigate risks of invalid information being fed into the system, even if one operator is compromised or turned malicious, there are multitudes of other honest operator that continue to uphold the validity of the chain.
Blockchain miners
Miners across the world contributing computation power to secure the network are required to run the same software, which contains all the transaction history from the beginning of the chain.
Having all node operators run the same software creates the ability for the network to withstand targeted attacks or attempts to dilute the database byway of inserting bad information. This is why a 51% attack is such a big problem, as any entity able to control 51% of the network can control the network and censor transactions. ETC (Ethereum Classic) network suffered these type of attacks multiple times already.
This is also the reason why crypto assets are always trading 24/7 as the chain is always running constantly writing to the ledger all the transactions or activities that had happened on-chain.
Every n-seconds a new block is produced by block sequencer (miners or validators), the selected sequencer are able to select which transactions are included into each block and once completed the block is broadcasted back into the network and other nodes come to a consensus regarding which block is the true canonical chain.
To be able to produce a block on the bitcoin network you will need to have enough hash power, which is derived from how powerful your computation ability is (in bitcoin’s case your ASIC miner hardware). Currently in the Ethereum network you’ll need GPUs (Graphics Processing Unit) still in order to produce a block.
However, for gamers or casual miners that want to utilise their GPUs during times when they are not used, it is much more common to join a mining pool to combine their hash power, which allows for the pool to produce blocks more consistently where the rewards are then shared across all the miners within that pool.
This is the only realistic option if you are only mining with 2-4 GPUs, otherwise you will have to invest in your own GPU mining farm in order to hold enough hash power to produce blocks by yourself.
Bitcoin, Litecoin and Ethereum are all currently running on a consensus mechanism which enforces the sybil resistancy called Proof of Work system, it means you are securing the blockchain by providing computation power and are being rewarded the base asset (BTC, LTC, ETH). Every time you are selected as the sequencer and is requested to produce a block. However, Ethereum is rapidly moving into Proof of Stake system similar to AVAX (Avalanche) and SOL (Solana).
On digital scarcity
Why do any of these crypto assets hold value? The same way the dollars are considered money because it is socially accepted as a form of trading object; we as a society have accepted bitcoin and other crypto assets as money. In contrast to fiat currency (dollars), bitcoin the asset is limited in total volume (21,000,000) hence the term ‘digitally scarce’, as Satoshi have mentioned in the Bitcoin whitepaper, the total amount to ever exist is limited to the above number.
As the parameters have been specified in code, everyone utilising the bitcoin asset can rest assured there is a very slim chance that the total volume can be tampered with. Blockchain technology also ensures the nature of finality, trustless-ness and validity of each transaction; restricting the ability of someone to double-spending their crypto asset.
The trilemma - scalability decentralisation and security
There are a wide variety of implementations of blockchain technology. This ranges from focusing on providing as much scaling room and high security or vice versa; there are plenty of examples where blockchain technology has sacrificed decentralisation in order to provide dirt cheap gas fees to end users as a way to attract and build the ecosystem.
The important factor to remember is; sacrificing one aspect to pursue the other two is inevitable. However, most projects have made the decision to do so with the objective to improve on whichever aspect is being sacrificed as part of the long-term upgrade roadmap.
See Certik’s post on Blockchain Trilemma if you are interested to dive deeper into why this is important.
Obtaining Crypto Assets
How do you obtain a crypto asset? The easiest would be to get someone you know to send you some assets from their address to yours. This costs nothing on your part and will allow you to immediately experiment and experience the new frontier.
The standard way would be by providing security to the network as a sequencer / block proposer (i.e. bitcoin miner / ethereum miner) and you will be rewarded some $BTC every time you/your pool is selected to produce a block. This is also true for $DOGE, $LTC, $ETH. If you are securing the network by providing computation power you will be rewarded some of the network native asset.
Another way you can obtain a crypto asset is by converting your fiat money ($USD, €EUR, £GBP) into your preferred crypto asset ($BTC,$DOGE,$SHIB,$ETH,$SOL). In order for this conversion to occur you will need to use a service that is able to facilitate this transaction. You can use a CEX (Centralised Exchange) such as Binance, Coinbase, Kucoin, which acts as a Crypto Bank from which you can deposit your money into and withdraw from.
CEX vs DEX
A Centralised Exchange is a one stop shop where you can start depositing your fiat money and they are the sole custody of your assets. In a way it is a simpler path to the introduction of Web3 and Crypto ecosystem in comparison to a fully BANKLESS experience.
However, it is important to note that this means you are not in full control of your assets as you are willing to trust an entity to do that for you. It is intended for newcomers or the mainstream population to easily start trading and investing in various speculative assets.
A popular saying in CT (Crypto Twitter) is not your keys not your crypto; this symbolises the financial freedom that many have sought after. If you are in control of your private keys (crypto wallet) then your crypto asset is yours, however if you are still relying on crypto banks / CEX then ultimately they are in control of your private keys.
On the other hand, a DEX (Decentralised Exchange) functions similarly to CEX where the platform/protocol facilitates peer to peer trading functions, however there is no central entity in control of your crypto asset. You will connect your crypto wallet to the protocol and perform those trade / automated trading functions.
The open nature of decentralised finance has also given rise to many DEX aggregators where new platforms focus on monitoring various different DEXs and attempt to provide you the best swap rate with minimal slippage.
Automated Market Maker
In the early days of blockchain technology and crypto ecosystem, it was quite difficult for someone to make a swap of their crypto asset. This is due to the lack of necessary infrastructure to allow for a seamless trade to occur on the blockchain. Liquidity was a big issue in the early days as there were no guarantee that there would be enough users/entities with assets to be converted from and to. For example, trading from $USD to $ETH without affecting the market price.
It was necessary to ensure that someone was willing to trade you for your intended crypto asset at the time you are wanting to make that trade, however it may not be at a price that you were willing to let it go for or at a quantity that you are looking for.
A concept that is important to any blockchain ecosystem is an AMM (Automated Market Maker). Platforms such as Uniswap, Sushiswap, Balancer, or Pancakeswap is what you would called an AMM. Different platforms may have different implementations or their own niches, however the overarching theme still applies; providing liquidity pools to allow for any swap to occur 24/7. To ensure AMM would function, a pool of assets are combined to create a new trading pair such as ETH/USDT or SHIB/USDT or DOGE/ETH.
People who are willing to pool their assets into these trading pairs are called liquidity provider. The primary driver of liquidity is the promise of return on investment whenever a trade occurs between the asset pairs (every time a swap takes place). Bear in mind this is directly affected by your share of the liquidity in that pool.
This works in conjunction with the introduction of liquidity provider token, which represents your claim/ownership of how much liquidity you own within a single pool. You will hold a significantly higher amount of LP token if you put in $5000/1Ξ compared to say your friend who is only providing $500/0.3Ξ.
LP Token also promotes decentralisation and fairness in the AMM system, which means that you are still in control of your assets and not requiring any custody service to ensure ownership. This also allows anyone to withdraw their asset at any time of their choosing without the need of interaction with any human or 3rd party.
Bootstrapping Liquidity & Incentivised Mining
To attract new users, growth and liquidity to a brand new blockchain ecosystem, it is normal to see yield farm opportunities be advertised by various AMM providers. Yield farming is the process of locking up your asset into a specific AMM pool and staking the LP tokens to earn more rewards by receiving the AMM native tokens.
This process is generally what yield farmers are looking for; AMM platforms will normally allocate a certain amount of their native tokens to generate and encourage liquidity bootstrapping by giving rewards to any liquidity providers that stakes their LP Tokens. Staking LP Tokens in essence is a gesture to signal that liquidity is here to stay, which helps other use cases of crypto to flourish within that particular ecosystem.
Liquidity providers will seek to maximise their profit by calculating how much return they are making from providing those liquidity and staking their LP tokens to earn as much as the AMM native tokens as possible before prices start to crash; this means that they would calculate the opportunity cost of providing liquidity in platform A or B. If they are able to obtain let say 5% from Platform A or 8% from Platform B for the same duration, liquidity providers who are less risk-averse may choose instead to go to Platform B for the highest return possible.
AMM native tokens will inevitably crash in terms of price due to Liquidity providers selling all the generated tokens for profit at a time of their choosing, when this cycle is repeated too many times it is generally hard to get the token price to recover to what it was prior without further fundamental improvements to the smart contract(s) that could rejuvenate the token demand. Although some aspects of governance may sway some large liquidity providers from dumping all the tokens into the market.
See further reading on Liquidity and and LP Tokens from Gemini
Price Oracle Network
Another important infrastructure to an ecosystem would be an oracle network, which obtains real-time data from various sources, be it off-chain or from the real world. One popular oracle network is Chainlink oracle network. If you are a developer you can configure a specific data feeds from Chainlink that acts as an API for your application to draw data from to ensure that you are serving the most up to date pricing.
Refer to Gemini’s post for further understanding of how Chainlink works
Further reading on how Chainlink performs its data aggregation
By applying the above concepts it is now easier to explain how arbitrage opportunities can surface; price fluctuations and inefficiencies in crypto exchanges can pose as opportunities for daily traders.
By buying and selling crypto assets on the same exchange or within various exchanges it is possible for traders to turn a profit. This also gave birth to the crypto trading bot which automates different strategies that traders may be familiar with and sells the strategy as an automated crypto trading bot service.
Essential Infrastructure within the ecosystem
Indexing Services
There are also infrastructure services like The Graph that is essential to providing indexing capability to display metrics and data to front ends like Dune Analytics or even some NFT related dashboard such as NFTGO.
Endpoint/Blockchain API services
Another important infrastructure includes Blockchain API services; Famously Metamask utilises Infura API infrastructure for its transanction submissions. There are other API services providing similar services like Alchemy, Quicknode, Chainstack
What is DeFi (Decentralised Finance) - Pronounced like Dee Fi not edgy like Defy
Money protocols such as AMM is only one example of what DeFi is all about. Just like how traditional banks offer various financial options, DeFi aims to provide similar facilities but without the need to interact with any human at all. The decentralised aspect comes from the nature of how money protocols settle transactions on the blockchain ecosystem such as Ethereum, TERRA, Solana, or Avalanche.
Famously during DeFi Summer of 2020 we saw an explosive growth of various money protocols such as AAVE, Compound, MakerDAO, Yearn, Curve
Due to the open nature of DeFi, it is inevitable for other people to try and simulate the success of the existing DeFi protocols by forking the existing smart contract codes and deploying it under a different brand. This may succeed if the team behind this new fork is bringing new value to the table by improving or providing a different service that may not have existed on the original protocol. Different teams may have a different take on how each service should be provided.
Forking an existing project such as money protocol is very popular, and the direction of how the protocol evolves can be very different depending on how the community and the team in charge envision the future.
Sushiswap platform began their journey as a very close mirror of Uniswap (forked codes); however as the team put their heads down and continue to build, they headed to a different direction especially with their Sushiswap Trident announcement in comparison to Uniswap V3 announcement.
Forking projects can be seen as a negative connotation, however I believe it really depends on how forked projects plan to differentiate themselves and aim to exploit specific niches as the project moves forward.
Tokenomics and Governance
Tokenomics is the breakdown of how the total amount of tokens of specific projects are to be allotted to different shareholders. Similar to how Ethereum first launched or how Uniswap UNI tokens were allocated and airdropped to early users it is important to be aware of this segment of the industry.
Tokenomics can be detrimental for the long-term sustainability of a token value, especially if majority of the tokens are allocated to select few Venture Capitalist (VCs); a token price could plummet if large token holders such as VC decided to dump the tokens in the market early.
A project’s token is primarily used to assist in the governance i.e. development or decision making of the project by its shareholders (token holders). If tokens are concentrated within a few select entities who were able to obtain large amount of tokens early on (presumably VCs or Angel Investors) it could lead to undesirable effect such as the recent controversy with UNI token voting for supposedly DeFi Education Fund by Harvard Law Blockchain & Fintech initiative.
Generally speaking, a project’s whitepaper shows the breakdown of who the project’s shareholders are and the vision and mission of the project; it would also include the breakdown of how the tokens are to be distributed. On top of that, other technical or mathematical specifications are normally found on the whitepaper. It is always recommended to at least be aware, or even better, attempt to understand on a high level how the project aims to grow or perform over the long-run by reviewing things like the whitepaper and the proposed tokenomics.
By holding a certain project’s token you automatically become a part owner of the project (that being said it does not translate to having equal control as the founding members). If a project excels and is able to grow its userbase, it is usually reflected in an increase in its token value i.e. an increase in price of its token in the trading market. So if you are a big bag holder of certain tokens, it is in your best interest to be involved in the voting and governance aspect of the project as this directly relates to advancement or pathways the project would take. A recent example of this would be the Uniswap vote to implement their V3 contract on Polygon sidechain and Arbitrum One Optimistic Roll-up.
The community that is involved with the operation and the governance of a project is usually referred to as DAO (Decentralised Autonomous Organisation). Individual token holders may be able to sway voting results if they have enough tokens; however, other DAOs have implemented delegated personnel to vote on their behalf when they are not inclined to participate themselves and feel that the person they’ve entrusted shares the same mindset and vision as them; refer to this site to see popular delegates for Gitcoin project as an example of this structure.
Trading crypto - Hot wallet & Cold wallet
To start trading you are only required to have an active wallet; this is divided into hot and cold wallet in terms of security. For a more in-depth explanation on how to start your crypto journey, read the next blog about Getting started - Leap of Faith.