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Demystifying Web 3 So Anyone Can Understand

Web3 is: read/write/execute with artificial scarcity and cryptographic identity. Should you care? Yes.

What?

Let’s break it down.

Back when I started my career, “web2.0” was the hot new thing.

Веб 2.0 — Википедия
What?

The “2.0” part of it was supposed to capture a few things: blogs, rounded corners on buttons and input fields, sharing of media online, 4th st in SOMA. But what really distinguished it from “1.0” was user-generated content. In the “1.0” days if you wanted to publish content on the web you basically had to upload an HTML file, maybe with some CSS or JS if you were a hotshot webmaster, to a server connected to the internet. It was not a user-friendly process and certainly not accessible to mere mortals.

The user-generated content idea was that websites could allow users to type stuff in and then save it for anyone to see. This was mostly first used for making blogs like LiveJournal and Moveable Type possible, later MySpace and Facebook and Twitter and wordpress.com where I’m still doing basically the same thing as back then. I don’t have to edit a file by hand and upload it to a server. You can even leave comments on my article! This concept seems so mundane to us now but it changed the web into an interactive medium where any human with an internet connection and cheap computer can publish content to anyone else on the planet. A serious game-changer, for better or for worse.

If you asked most people who had any idea about any of this stuff what would be built with web 2.0 they would probably have said “blogs I guess?” Few imagined the billions of users of YouTube, or grandparents sharing genocidal memes on Facebook, or TikTok dances. The concept of letting normies post stuff on the internet was too new to foresee the applications that would be built with it or the frightful perils it invited, not unlike opening a portal to hell.

Web3

The term “web3” is designed to refer to a similar paradigm shift underway.

Before getting into it I want to address the cryptocurrency hype. Cryptocurrency draws in a lot of people, many of dubious character qualities, that are lured by stories of getting rich without doing any work. This entire ecosystem is a distraction, although some of the speculation is based on organizations and products which may or may not have actual value and monetizable utility at some point in the present or future. This article is not about cryptocurrency, but about the underlying technologies which can power a vast array of new technologies and services that were not possible before. Cryptocurrency is just the first application of this new world but will end up being one of the most boring.

What powers the web3 world? What underlies it? With the help of blockchain technology a new set of primitives for building applications is becoming available. I would say the key interrelated elements are: artificial scarcity, cryptographic identity, and global execution and state. I’ll go into detail what I mean here, although to explain these concepts in detail in plain English is not trivial so I’m going to skip over a lot.

Cryptographic identity: your identity in web3-land consists of what is called a “keypair” (see Wikipedia), also known as a wallet. The only thing that gives you access to control your identity (and your wallet) is the fact that you are in physical or virtual possession of the “private key” half of the keypair. If you hold the private key, you can prove to anyone who’s asking that you own the “public key” associated with it, also known as your wallet address. So what?

Your identity is known to the world as your public key, or wallet address. There is an entire universe of possibilities that this opens up because only you, the holder of your private key, can prove that you own that identity. To list just a short number of examples:

  • No need to create a new account on every site or app you use.
  • No need for relying on Facebook, Google, Apple, etc to prove your identity (unless you want to).
  • People can encrypt messages for you that only you can read, without ever communicating with you, and post the message in public. Only the holder of the private key can decrypt such messages.
  • Sign any kind of message, for example voting over the internet or signing contracts.
  • Strong, verifiable identity. See my e-ID article for one such example provided by Estonia.
  • Anonymous, throwaway identities. Create a new identity for every site or interaction if you want.
  • Ownership or custody of funds or assets. Can require multiple parties to unlock an identity.
  • Link any kind of data to your identity, from drivers licenses to video game loot. Portable across any application. You own all the data rather than it living on some company’s servers.
  • Be sure you are always speaking to the same person. Impossible to impersonate anyone else’s identity without stealing their private key. No blue checkmarks needed.
Illustration from Wikipedia.

There are boundless other possibilities opened up with cryptographic identity, and some new pitfalls that will result in a lot of unhappiness. The most obvious is the ease with which someone can lose their private key. It is crucial that you back yours up. Like write the recovery phrase on a piece of paper and put it in a safe deposit box. Brace yourself for a flood of despairing clickbait articles about people losing their life savings when their computer crashes. Just as we have banks to relieve us of the need to stash money under our mattresses, trusted (and scammer) establishments with customer support phone numbers and backups will pop up to service the general populace and hold on to their private keys.

Artificial scarcity: this one should be the most familiar by now. With blockchain technology came various ways of limiting the creation and quantity of digital assets. There will only ever be 21 million bitcoins in existence. If your private key proves you own a wallet with some bitcoin attached you can turn it into a nice house or lambo. NFTs (read this great deep dive explaining WTF a NFT is) make it possible to limit ownership of differentiated unique assets. Again we’re just getting started with the practical applications of this technology and it’s impossible to predict what this will enable. Say you want to give away tickets to an event but only have room for 100 people. You can do that digitally now and let people trade the rights. Or resell digital movies or video games you’ve purchased. Or the rights to artwork. Elites will use it for all kinds of money laundering and help bolster its popularity.

Perhaps you require members of your community to hold a certain number of tokens to be a member of the group, as with Friends With Benefits to name one notable example. If there are a limited number of $FWB tokens in existence, it means these tokens have value. They can be transferred or resold from people who aren’t getting a lot out of their membership to those who more strongly desire membership. As the group grows in prestige and has better parties the value of the tokens increases. As the members are holders of tokens it’s in their shared interest to increase the value the group provides its members. A virtuous cycle can be created. Governance questions can be decided based on the amount of tokens one has, since people with more tokens have a greater stake in the project. Or not, if you want to run things in a more equitable fashion you can do that too. Competition between different organizational structures is a Good Thing.

This concept is crucial to understand and so amazingly powerful. When it finally clicked for me is when I got super excited about web3. New forms of organization and governance are being made possible with this technology.

The combination of artificial scarcity, smart contracts, and verifiable identity is a super recipe for new ways of organizing and coordinating people around the world. Nobody knows the perfect system for each type of organization yet but there will be countless experiments done in the years to come. No technology has more potential power than that which coordinates the actions of people towards a common goal. Just look at nation states or joint stock companies and how they’ve transformed the world, both in ways good and bad.

The tools and procedures are still in their infancy, though I strongly recommend this terrific writeup of different existing tools for managing these Decentralized Autonomous Organizations (DAOs). Technology doesn’t solve all the problems of managing an organization of course, there are still necessary human layers and elements and interactions. However some of the procedures that have until now rested on an reliable and impartial legal system (something most people in the world don’t have access to) for the management and ownership of corporations can now be partially handled not only with smart contracts (e.g. for voting, enacting proposals, gating access) but investment, membership, and participation can be spread to theoretically anyone in the world with a smartphone instead of being limited to the boundaries of a single country and (let’s be real) a small number of elites who own these things and can make use of the legal system.

Any group of like-minded people on the planet can associate, perhaps raise investment, and operate and govern themselves as they see fit. Maybe for business ventures, co-ops, nonprofits, criminal syndicates, micro-nations, art studios, or all sorts of new organizations that we haven’t seen before. I can’t predict what form any of this will take but we have already seen the emergence of DAOs with billions of dollars of value inside them and we’re at the very, very early stages. This is what I’m most juiced about.

Check out the DAO Dashboard. This is already happening and it’s for real.

And to give one more salient example: a series of fractional ownership investments can be easily distributed throughout the DAO ecosystem. A successful non-profit that sponsors open source development work, Gitcoin, can choose to invest some of its GTC token in a new DAO it wants to help get off the ground, Developer DAO. The investment proposal, open for everyone to see and members to vote on, would swap 5% of the newly created Developer DAO tokens (CODE being the leading symbol proposal right now) for 50,000 GTC tokens, worth $680,000 at the time of writing. Developer DAO plans to use this and other funds raised to sponsor new web3 projects acting as an incubator that helps engineers build their web3 skills up for free. Developer DAO can invest its own CODE tokens in new projects and grants, taking a similar fraction of token ownership in new projects spun off by swapping CODE tokens. In this way each organization can invest a piece of itself in new projects, each denominated in their own currency which also doubles as a slice of ownership. It’s like companies investing shares of their own stock into new ventures without having to liquidate (liquidity can be provided via Uniswap liquidity pools). In this case we’re talking about an organic constellation of non-profit and for-profit ventures all distributing risk, investment capital, and governance amongst themselves with minimal friction that anyone in the world can participate in.

Global execution and state: there are now worldwide virtual machines, imaginary computers which can be operated by anyone and the details of their entire history, operations, and usage is public. These computers can be programmed with any sort of logic and the programs can be uploaded and executed by anyone, for a fee. Such programs today are usually referred to as smart contracts although that is really just one possible usage of this tool. What will people build with this technology? It’s impossible to predict at this early age, like imagining what smartphones will look like when the PC revolution is getting started.

From Ethereum EVM illustrated.

These virtual machines are distributed across the planet and are extremely resilient and decentralized. No one person or company “owns” Ethereum (to use the most famous example) although there is a DAO that coordinates the standards for the virtual machine and related protocols. When a new proposal is adopted by the organization, the various software writers update their respective implementations of the Ethereum network to make changes and upgrades. It’s a voluntary process but one that works surprisingly well, and is not unlike the set of proposals and standards for the internet that have been managed for decades by the Internet Engineering Task Force (IETF).

A diagram showing where gas is needed for EVM operations
Ethereum virtual machine. More pictures here.

Also worth mentioning are zero-knowledge proofs which can enable privacy, things like anonymizing transactions and messaging. Of course these will for sure be used to nefarious ends, but they also open up possibilities for fighting tyranny and free exchange of information. Regardless of my opinion or anyone else’s, the cat’s out of the bag and these will be technologies that societies will need to contend with.

History of the Web Infographic: Web1, Web2, Web3.

Why should I care?

I didn’t care until recently, a month ago maybe. When I decided to take a peek to see what was going on in the web3 space, I found a whole new world. There are so many engineers out there who have realized the potential in this area, not to mention many of the smartest investors and technologists. The excitement is palpable and the amount of energy in the community is invigorating. I joined the Developer DAO, a new community of people who simply want to work on cool stuff together and help others learn how to program with this new technology. Purely focused on teaching and sharing knowledge. People from all over the world just magically appear and help each other build projects, not asking for anything in return. If you want to learn more about the web3 world you could do a lot worse than following @Developer_DAO on twitter.

As with all paradigm shifts, some older engineers will scoff and dismiss the new hotness as a stupid fad. There were those who pooh-poohed personal computers which could never match the power and specialized hardware of mainframes, those who mocked graphical interfaces as being for the weak, a grumpy engineer my mother knew who said the internet is “just a fad”, and people like Oracle’s CEO Larry Ellison saying the cloud is just someone else’s computer. Or me, saying the iPhone looks like a stupid idea.

The early phase of web3 is cryptocurrencies and blockchains (“layer 1”) solutions. Not something that non-technical people or really anyone can take full advantage of because there are few interfaces to interact with it. In the phase we’re in right now developer tools and additional layers of abstraction (“layer 2”) are starting to become standardized and accessible, and it’s just now starting to become possible to build web3 applications with user interfaces. Very soon we’ll start to see new types of applications appearing, to enable new kinds of communities, organizations, identity, and lots more nobody has dreamed up yet. There will be innumerable scams, a crash like after the first web bubble, annoying memesters and cryptochads. My advice is to ignore the sideshows and distractions and focus on the technology, tooling, and communities that weren’t possible until now and see what creative and world-changing things people build with web3.

For more information I recommend:

How to Trade Crypto in Your Sleep With Python

The defi revolution is in full swing if you know where to look. Serious efforts to build out and improve the underlying infrastructure for smart contracts as well as applications, art, and financial systems are popping up almost every week it seems. They use their own native tokens to power their networks, games, communities, transactions, NFTs and things that haven’t been thought up yet. As more decentralizated autonomous organizations (DAOs) track their assets, voting rights, and ownership stakes on-chain the market capitalization of tokens will only increase.

Avalanche is one new token of many that is an example of how new tokens can garner substantial support and funding if the community deems the project worthy.

There are as many potential uses for crypto tokens as there are for fiat money, except tokens in a sense “belong” to these projects and shared endeavours. If enough hype is built up, masses of people may speculate to the tune of hundreds of billions of dollars that the value of the tokens will increase. While many may consider their token purchases to be long-term investments in reputable projects with real utility, sometimes coming with rights or dividend payments, I believe a vast majority of people are looking to strike it rich quick. And some certainly have. The idea that you can get in early on the right coin and buy at a low price, and then sell it to someone not as savvy later on for way more money is a tempting one. Who doesn’t want to make money without doing any real work? I sure do.

Quickstart

If you want to skip all of the explanations and look at code you can run, you can download the JupyerLab Notebook that contains all of the code for creating and optimizing a strategy.

Now for some background.

Trading and Volatility

These tokens trade on hundreds of exchanges around the world from publicly-held and highly regulated Coinbase to fly-by-night shops registered in places like the Seychelles and Cayman. Traders buy and sell the tokens themselves as well as futures and leveraged tokens to bet on price movement up and down, lending tokens for other speculators to make leveraged bets, and sometimes actively coordinating pump and dump campaigns on disreputable discords. Prices swing wildly for everything from the most established and institutionally supported Bitcoin to my own MishCoin. This volatility is an opportunity to make money.

With enough patience anyone can try to grab some of these many billions of dollars flowing through the system by buying low and selling higher. You can do it on the timeframe of seconds or years, depending on your style. While many of the more mainstream coins have a definite upwards trend, all of them vacillate in price on some time scale. If you want to try your hand at this game what you need to do is define your strategy: decide what price movement conditions should trigger a buy or a sell.

Since it’s impossible to predict exactly how any coin will move in price in the future this is of course based on luck. It’s gambling. But you do have full control over your strategy and some people do quite well for themselves, making gobs of money betting on some of the stupidest things you can imagine. Some may spend months researching companies behind a new platform, digging into the qualifications of everyone on the team, the problems they’re trying to solve, the expected return, the competitive landscape, technical pitfalls and the track record of the founders. Others invest their life savings into an altcoin based on chatting to a pilled memelord at a party.

Automating Trading

Anyone can open an account at an exchange and start clicking Buy and Sell. If you have the time to watch the market carefully and look for opportunities this can potentially make some money, but it can demand a great deal of attention. And you have to sleep sometime. Of course we can write a program to perform this simple task for us, as long as we define the necessary parameters.

I decided to build myself a crypto trading bot using python and share what I learned. It was not so much a project for making real money (right now I’m up about $4 if I consider my time worth nothing) as a learning experience to tech myself more about automated trading and scientific python libraries and tools. Let’s get into it.

To create a bot to trade crypto for yourself you need to do the following steps:

  1. Get an API key for a crypto exchange you want to trade on
  2. Define, in code, the trading strategy you wish to use and its parameters
  3. Test your strategy on historical data to see if it would have hypothetically made money had your bot been actively trading during that time (called “backtesting”)
  4. Set your bot loose with some real money to trade

Let’s look at how to implement these steps.

Interfacing With an Exchange

To connect your bot to an exchange to read crypto prices, both historical and real-time, you will need an API key for the exchange you’ve selected.

Image

Fortunately you don’t need to use a specialized library for your exchange because there is a terrific project called CCXT (Crypto Currency eXchange Trading library) which provides an abstraction layer to most exchanges (111 at the the time of this writing) in multiple programming languages.

It means our bot can use a standard interface to buy and sell and fetch the price ticker data (this is called “OHLCV” in the jargon – open/high/low/close/volume data) in an exchange-agnostic way.

Now, the even better news it that we don’t really even have to use CCXT directly and can use a further abstraction layer to perform most of the grunt work of trading for us. There are a few such trading frameworks out there, I chose to build my bot using one called PyJuque but feel free to try others and let me know if you like them. What this framework does for you is provide the nuts and bolts of keeping track of open orders, buying and selling when certain triggers are met. It also provides backtesting and test-mode features so you can test out your strategy without using real money. You still need to connect to your exchange though in order to fetch the OHLCV data.

Configuring the Trading Engine

PyJuque contains a number of configuration parameters:

  • Exchange API key
  • Symbols to trade (e.g. BTC/USD, ETH/BTC, etc)
  • Timescale (I use 15 seconds with my exchange)
  • How much money to start with (in terms of the quote, so if you’re trading BTC/USD then this value will be in USD)
  • What fraction of the starting balance to commit in each trade
  • How far below the current price to place a buy order when a “buy” signal is triggered by your strategy
  • How much you want the price to go up before selling (aka “take profit” aka “when to sell”)
  • When to sell your position if the price drops (“stop loss”)
  • What strategy to use to determine when buy signals get triggered

Selecting a Strategy

Here we also have good news for the lazy programmers such as myself: there is a venerable library called ta-lib that contains implementations of 200 different technical analysis routines. It’s a C library so you will need to install it (macOS: brew install ta-lib). There is a python wrapper called pandas-ta.

Pandas TA

All you have to do is pick a strategy that you wish to use and input parameters for it. For my simple strategy I used the classic “bollinger bands” in conjunction with a relative strength index (RSI). You can pick and choose your strategies or implement your own as you see fit, but ta-lib gives us a very easy starting point. A future project could be to automate trying all 200 strategies available in ta-lib to see which work best.

Tuning Strategy Parameters

The final step before letting your bot loose is to configure the bot and strategy parameters. For the bollinger bands/RSI strategy we need to provide at least the slow and fast moving average windows. For the general bot parameters noted above we need to decide the optimal buy signal distance, stop loss price, and take profit percentage. What numbers do you plug in? What work best for the coin you want to trade?

scikit-optimize: sequential model-based optimization in Python — scikit- optimize 0.8.1 documentation

Again we can make our computer do all the work of figuring this out for us with the aid of an optimizer. An optimizer lets us find the optimum inputs for a given fitness function, testing different inputs in multiple dimensions in an intelligent fashion. For this we can use scikit-optimize.

To use the optimizer we need to provide two things:

  1. The domain of the inputs, which will be reasonable ranges of values for the aforementioned parameters.
  2. A function which returns a “loss” value between 0 and 1. The lower the value the more optimal the solution.
from skopt.space import Real, Integer
from skopt.utils import use_named_args
# here we define the input ranges for our strategy
fast_ma_len = Integer(name='fast_ma_len', low=1.0, high=12.0)
slow_ma_len = Integer(name='slow_ma_len', low=12.0, high=40.0)
# number between 0 and 100 - 1% means that when we get a buy signal, 
# we place buy order 1% below current price. if 0, we place a market 
# order immediately upon receiving signal
signal_distance = Real(name='signal_distance', low=0.0, high=1.5)
# take profit value between 0 and infinity, 3% means we place our sell 
# orders 3% above the prices that our buy orders filled at
take_profit = Real(name='take_profit', low=0.01, high=0.9)
# if our value dips by this much then sell so we don't lose everything
stop_loss_value = Real(name='stop_loss_value', low=0.01, high=4.0)
dimensions = [fast_ma_len, slow_ma_len, signal_distance, take_profit, stop_loss_value]
def calc_strat_loss(backtest_res) -> float:
    """Given backtest results, calculate loss.
    
    Loss is a measure of how badly we're doing.
    """
    score = 0
    
    for symbol, symbol_res in backtest_res.items():
        symbol_bt_res = symbol_res['results']
        profit_realised = symbol_bt_res['profit_realised']
        profit_after_fees = symbol_bt_res['profit_after_fees']
        winrate = symbol_bt_res['winrate']
        if profit_after_fees <= 0:
            # failed to make any money.
            # bad.
            return 1
        # how well we're doing (positive)
        # money made * how many of our trades made money
        score += profit_after_fees * winrate
        
    if score <= 0:
        # not doing so good
        return 1
    # return loss; lower number is better
    return math.pow(0.99, score)  # clamp 1-0 
@use_named_args(dimensions=dimensions)
def objective(**params):
    """This is our fitness function.
    
    It takes a set of parameters and returns the "loss" - an objective single scalar to minimize.
    """
    # take optimizer input and construct bot with config - see notebook
    bot_config = params_to_bot_config(params)
    backtest_res = backtest(bot_config)
    return calc_strat_loss(backtest_res)

Once you have your inputs and objective function you can run the optimizer in a number of ways. The more iterations it runs for, the better an answer you will get. Unfortunately in my limited experiments it appears to take longer to decide on what inputs to pick next with each iteration, so there may be something wrong with my implementation or diminishing returns with the optimizer.

Asking for new points to test gets slower as time goes on. I don’t understand why and it would be nice to fix this.

The package contains various strategies for selecting points to test, depending on how expensive your function should be. If the optimizer is doing a good job exploring the input space you should hopefully see loss trending downwards over time. This represents more profitable strategies being found as time goes on.

After you’ve run the optimizer for some time you can visualize the search space. A very useful visualization is to take a pair of parameters to see in two dimensions the best values, looking for ranges of values which are worth exploring more or obviously devoid of profitable inputs. You can use this information to adjust the ranges on the input domains.

The green/yellow islands represent local maxima and the red dot is the global maximum. The blue/purple islands are local minima.

You can also visualize all combinations of pairs of inputs and their resulting loss at different points:

Note that the integer inputs slow_ma_len and fast_ma_len have distinct steps in their inputs vs. the more “messy” real number inputs.

After running the optimizer for a few hundred or thousand iterations it spits out the best inputs. You can then visualize the buying and selling the bot performed during backtesting. This is a good time to sanity-check the strategy and see if it appears to be buying low and selling high.

Run the Bot

Armed with the parameters the optimizer gave us we can now run our bot. You can see a full script example here. Set SIMULATION = False to begin trading real coinz.

Trades placed by the bot.

All of the code to run a functioning bot and a JupyterLab Notebook to perform backtesting and optimization can be found in my GitHub repo.

I want to emphasize that this system does not comprise any meaningfully intelligent way to automatically trade crypto. It’s basically my attempt at a trader “hello world” type of application. A good first step but nothing more than the absolute basic minimum. There is vast room for improvement, things like creating one model for volatility data and another for price spikes, trying to overcome overfitting, hyperparameter optimization, and lots more. Also be aware you will need a service such as CoinTracker to keep track of your trades so you can report them on your taxes.