Understanding the Web3 Stack

At times, investors in digital assets can lose sight of the broader scope of what blockchain and crypto projects are ultimately working to create: a new type of decentralised internet known as Web3.

Web3 is typically distinguished from two previous eras of the internet.

In the early days of the internet, Web1 users were able to read data – a one-way communication channel from the internet to the users.

Web2 users were able not only to read data, but to write and publish – the internet became interactive in real-time. This era coincided with the smartphone and became the era of the multi-sided platform business models such as marketplaces and social media.

Web3 is the next generation of the internet that is being built today. Here users are able not only to read, and to write, but to own. They can directly hold or control their digital assets and data. While other eras of the internet developed on hardware technologies (personal computers, smartphones) and infrastructure (high-speed internet connections), it is most useful to understand Web3 as a stack of decentralised, composable, and permissionless digital infrastructure.

Individual blockchain and crypto projects today are ultimately building parts of this Web3 stack. In this article we tease out some of these constantly evolving layers including blockchains, smart contracts, identity infrastructure and bridges. These tools are constantly evolving us towards a new type of decentralised economy.

Blockchains

The base layer of the Web3 tech stack is a blockchain network. The blockchain network provides the infrastructure for digital ownership.

While previous eras of the internet relied on centralised databases maintained by large tech companies, blockchain is a digital technology that combines peer-to-peer network computing and cryptography to create a secure, decentralised database. This foundational blockchain database enables ownership by recording the creation and transfer of scarce digital assets.

The code of a blockchain provides a mechanism for validating transactions. There are many ways to achieve this consensus, each with different economic incentives. For example, the Bitcoin protocol relies on computing power for network security (Proof of Work) while other blockchains, such as Ethereum, Cosmos and Algorand, rely on collateral that validators put at risk (Proof of Stake). Meanwhile, Solana uses time-stamped transactions (Proof of History) and Ripple uses trusted validators (Proof of Authority).

The digital assets that exist on blockchain networks are often called tokens. These tokens are digital ownership property rights. Most broadly these tokens can be fungible or non-fungible. Fungible tokens, such as a cryptocurrency, can be pooled and interchanged with each other. Non-fungible tokens, such as a credential or identity (see below) are unique digital identifiers.

This blockchain infrastructure is the foundation of the Web3 stack, recording digital transactions in a shared ledger and enabling digital ownership through tokens.

Smart Contracts

Smart contracts integrate automation and self-execution into the Web3 stack.

Smart contracts are essentially programs – additional pieces of computer code – that run on the top of a blockchain network. Smart contracts enable transactions to automatically execute if specific predetermined conditions are met.

These technologies extend a blockchain’s functionality from simple transfers to more complex applications. For instance, smart contracts can be deployed to create new types of self-executing decentralised finance (DeFi) or supply chain management platforms.

Smart contracts are also a key component of decentralised autonomous organisations (DAOs), which are Web3-native digital organisations.

As blockchain transactions generally cannot be reversed once executed, professional auditing of smart contracts is becoming increasingly important for Web3 projects to avoid potential exploitation of bugs that might exist in the smart contract code.

Oracles

In the ancient world, an oracle was a revered source of divine wisdom, offering guidance and knowledge that was otherwise inaccessible to ordinary people. Oracles in Web3 serve a similar purpose, acting as external data feeds that channel information from the outside world into the blockchain-enabled smart contracts.

Blockchains and smart contracts operate in a closed environment because they cannot access or verify real-world information independently. As such, smart contracts need oracles to be contingent on exchange rates, price information of stocks or commodities, temperature readings from a physical device, or indeed any other piece of information.

As smart contracts are automatically executing, access to reliable, fast and trusted data feeds is crucial. There are many oracle service providers, each with different trade-offs in their design. For instance, some providers are centralised which introduces a single point of weakness into the system, so trust and security are increasingly important. Other providers (e.g. ChainLink) have a decentralised structure, which comes with potentially higher costs associated with network infrastructure and aggregation.

Identity

Identity technologies aim to improve the usability, interoperability, and privacy of Web3. They push ownership of identities towards the user.

In previous eras of the internet, a user’s digital identity was tied to governments (e.g. your passport) or tech companies (e.g. hosted email addresses, social media profiles).

Centralised identity structures can create honeypots for data breaches and identity theft. Web3 introduces a decentralized approach to identity management, empowers users to own and control their personal information.

Systems like the Ethereum Name Service (ENS) allow users in the Ethereum ecosystem to convert blockchain addresses into easily readable names (e.g., alice.eth). This simplifies the process of sending and receiving transactions, interacting with smart contracts, or accessing decentralized websites, making the blockchain more accessible to everyday users.

Decentralised identifiers (DIDs) enable users to create and control their own identity across different platforms without relying on centralised authorities. In addition to privacy and control, they reduce dependence on usernames and passwords, streamlining access to services and enhancing user experience.

Bridges

Bridges connect two blockchains ecosystems, enabling users to transfer data and assets across Web3.

Imagine a user who wants to take a digital asset from the Ethereum network and use it on the Cosmos network. A bridge facilitates this by "locking" the ETH on the Ethereum network and "minting" a corresponding wrapped asset on Cosmos, often referred to as "wrapped ETH" (wETH) in this context, ensuring the asset's scarcity is preserved across both ecosystems. Upon returning, the process reverses, with the wrapped asset being "burned" on Cosmos and the original ETH being unlocked on the Ethereum network, maintaining a balanced ledger.

There are different ways that bridges achieve this interoperability objective. In the broadest sense there are two types of bridges. Centralised bridges depend on a trusted entity to oversee transfers. Decentralised bridges use blockchain-enabled smart contracts. Both categories have unique security challenges that must be addressed to prevent vulnerabilities.

Data storage

Web3 requires a file management layer because not all data is stored on a blockchain network. In Web3, data storage is evolving beyond the centralised servers of Web1 (e.g. Netscape or Microsoft) or the cloud storage platforms of Web2 (e.g. Google Cloud or Amazon Web Services).

InterPlanetary File System (IPFS), for example, uses ‘content addressing’ to facilitate the peer-to-peer storing and sharing of files, making data available across multiple nodes. Filecoin takes this a step further by offering a marketplace for storage through token incentives.

Web3 data storage solutions aim to offer a more secure, resilient, and censorship-resistant foundation for digital assets and decentralized applications.

Towards the next generation of the internet

What we’ve described above are just some of the parts of the Web3 stack. This stack is constantly evolving, shifting the foundations of our digital economy. While Web3 infrastructure is highly diverse, we can identify the general characteristics of infrastructure and applications that constitute Web3.

Compared to previous generations of the internet, Web3 is:

• More open source – often source code is public and freely available, encouraging collaboration and rapid innovation. This improves competition between different projects.
• More decentralised – relying on a distributed network of nodes encourages resilience, security and transparency. Communities begin to own the networks that they participate in.
• More composable – creating complex systems and applications by combining different services and protocols in a modular way, like building blocks. Composability is good for innovation and consumers.

Individual investors in digital assets rightly focus on individual businesses and opportunities. Yet each of the experiments underpinning those assets are helping us to overcome issues in Web3, including user experience, governance, and scalability. Investors should not forget that ultimately these projects are building out the stack of a new type of decentralised digital economy.

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Dr Aaron Lane, Dr Darcy Allen and Dr Max Parasol are with the RMIT Blockchain Innovation Hub, RMIT University