From web2 to web3: What e-commerce founders need to know
M13 shares insights on web3 and commerce, and why brands should consider a web3 strategy.
Last Updated: January 27, 2023
Published: January 27, 2023
This is the third article in a multi-part series on M13’s Future of Commerce thesis. View parts one and two.
We dive into the basics of web3 technology for e-commerce brands—and identify the specific use cases where we believe brands can use web3 technology in the near-to-medium term.
Read on to learn more about:
- How web3 fits into M13’s commerce enablement thesis
- A refresher on web2 vs. web3 for DTC founders
- What web3 means for brands
- The biggest LTV/CAC issues for brands today
- Why brands are turning to open loyalty
- How to evaluate the web3 loyalty landscape
- The future of open loyalty and web3 commerce
How web3 fits into M13’s commerce enablement thesis
The potential of web3 for e-commerce is at the intersection of two of M13’s core thesis areas. From a commerce standpoint, we believe there’s a significant opportunity to invest in sophisticated software and tooling for direct-to-consumer (DTC) brands. Our investment strategy is now focused on the infrastructure technologies that power DTC and consumer businesses.
We view web3 technology as an extension of our commerce enablement thesis—a horizontal enabling technology that will power parts of the future of commerce along with other key consumer verticals (work, health, and money). We’ve made select investments in web3-enabling technologies since 2019.
A refresher on web2 vs. web3 for DTC founders
There are fundamental differences in both the application and infrastructure layers between web2 and web3.
Web2 is the centralized ownership of data and networking across the application and infrastructure layer.
Web3 represents open blockchain protocols that enable the decentralized ownership of data and networking across the application and infrastructure layer.
What does this mean in practice? In web2 models, brands like Nike own a consumer’s data and use software like Klaviyo for cross-sell and upsell, which is hosted on and accessed through infrastructure controlled by Amazon Web Services (AWS).
Conversely, in web3 models, brands use loyalty software like TYB and Toki** for cross-sell and upsell while allowing consumers to use wallets like Bitski to access and use their data, which is readily available on open protocols like Polygon and Solana.
What does web3 mean for brands?
For many brands, it’s difficult to justify spending time and energy on web3. In 2021, brands were inundated with noise around non-fungible token (NFT) collections and custom metaverses, and it was difficult to distinguish value from hype.
Then in June 2022, the hype suddenly came to a halt as the crypto market imploded. The number of wallet addresses transacting on NFT marketplaces declined 88% in one week, and the average price of an NFT decreased by 92%. One of the more public casualties was FTX, which in November 2022, filed for bankruptcy.
With so much volatility in web3, it’s no wonder many brands remain skeptical. The web3 market correction and the FTX bankruptcy is a setback in many ways, but we also see a silver lining—a natural weeding out of hype-driven projects and companies creating solutions for problems that don’t exist. This should allow brands to more easily identify web3 commerce enablement solutions that drive real value to the business—increased revenue and reduced costs.
Notwithstanding the recent market setbacks and the FTX bankruptcy filing, web3 is still a powerful enabling technology that has the potential to change existing commerce models, and it’s still important for brands to continue exploring a web3 strategy. In the last couple months, Nike announced .SWOOSH, Mastercard published thoughts on the benefits of NFT loyalty, and Adidas launched Virtual Gear.
Before we get into specific web3 use cases for brands, it’s important to know the key enabling features of web3 technology and why we continue to see the benefits of these models. We believe that traditional brands can solve tangible issues by implementing web3 solutions with features like provenance, economic rights, incentive realignment, and interoperability.
Web3 shifts the platform incentives away from conventional commerce models that can be one-time in nature, both for the brand and the consumer, and enables new long-term loyalty and acquisition models. These models have already been applied successfully in similar verticals.
For example, let’s review how NBA Top Shot has reimagined economic rights and provenance to upend the traditional trading card market.
In a web2 model, the NBA and players don’t monetize the resale of Topps physical trading cards. This can add up to significant missed revenue opportunity for the league and players on web2 platforms like eBay, where trading cards are sold every two seconds.
With Top Shot, the NBA and the NBPA monetize the resale of their digital cards through royalties, and collectors have authentic proof of their ownership via the blockchain.
NBA Top Shot generated $1B in cumulative sales as of May 2022—an estimated 5% of which is shared between Top Shot, the NBA, and the NBPA.
Similar to Top Shot, e-commerce brands can apply web3 technologies that enable provenance, economic rights, incentive realignment, and interoperability. This is already happening today with some of the largest commerce brands.
Collect virtual wearables for avatars in the digital world
Earn rewards for co-creating Nike concepts, earn digital assets that grant access to exclusive experiences, and trade digital assets
Earn stamps for accomplishing different challenges, buy limited edition stamps, and buy/sell stamps with other customers
Murder Head Death Club (MHDC)
Access gated experiences and products
Use proof-of-custody digital twins to secure valuables and establish secondary-market trust for Breitling products
While web3 applications can have long-term impacts on a brand and consumer experience, most DTC brands don’t have the same R&D budget as the companies above to prioritize web3. The dozens of brands we’ve spoken with as part of our web3 research have confirmed this: it’s not their top priority. We can appreciate the need to prioritize while still shedding light on long-term benefits for those brands that decide to explore web3 applications.
While these technology advancements are powerful in theory, brands need to ask themselves: “What are the tangible benefits that provide a 10x better solution and experience for consumers?” These are the web3 solutions that brands should prioritize.
As we’ve considered many different web3 applications in the commerce world, one area has risen to the top of the priority list, as it can deliver a 10x better solution than current web2 model: web3 loyalty applications, which can solve a major pain point for DTC brands and help improve topline and profitability metrics.
To understand why, we must first contextualize the acquisition and retention issues that brands are experiencing today.
The biggest LTV/CAC issues for brands today
Shopify lowered the barriers to entry for online brands. The number of Shopify brands has grown at a 43% compound annual growth rate (CAGR) from 2015 to 2021 to reach over 2M merchants today.
The proliferation of digitally native brands and resulting increased competition has caused a significant increase in digital advertising costs as merchants compete for the same customers.
For example, Google’s cost per thousand (CPM) increased 75% and Facebook’s CPM increased 61% since last year. Rising customer acquisition costs create a customer lifetime value (LTV) relative to the customer acquisition cost (CAC) problem that can result in negative unit economics DTC brands.
Layer on Big Tech’s shift to eliminate third-party cookies and you’ll see this problem magnified. Apple is blocking third-party cookies, and Google plans to eliminate them by 2024. These changes make it harder for brands to target customers most willing to pay for their products, and their return on ad spend (ROAS) is suffering.
While CAC continues to rise for DTC brands, there are meaningful adjustments that companies can make to the LTV half of the equation to boost unit economics. And some of the most innovative applications are being ushered in via web3 technology.
Why brands are turning to open loyalty
Brands are turning to open loyalty to drive community, retention, and new customer acquisition.
Open loyalty is a web3 concept where customer loyalty is stored on the blockchain. This provides brands the ability to engage and reward customers across partner brands. It also enables secondary markets for loyalty rewards.
Web3 loyalty applications are enabled by a technology called token-gating—a website architecture that allows digital storefront owners to restrict access to website sub-sections to utility token (NFT) holders.
Utility NFTs have functional, intrinsic, and monetary value within and outside of the brand. This is similar to a paywall architecture, but there are a few key differences.
|Paywall (web2)||Token-Gating (web3)|
|Billing model||Subscription||One-time NFT purchase|
|Security||Less secure: users can share their passwords||More secure: can’t transfer or share ownership of a token unless it’s sold or rented|
|Brand value||Offers little to no brand value||NFTs drive brand recognition|
|Consumer value||Offers little to no consumer value other than what the subscription is for||Offers intrinsic community value, secondary market value|
At its core, web3 loyalty uses NFT identity instead of traditional logins. NFTs show proof of a customer's loyalty to a brand—provenance. This allows commerce architecture to function as an open system. In other words, NFTs stored on-chain serve as an interoperable customer data layer across brands.
In a web2 architecture, brands run closed e-commerce systems. Provided that customers have supplied their name, email, and phone number, these systems are typically integrated and allow brands to track, engage, and reward customers across brand-owned channels.
But in a closed web2 architecture with several siloed retail and e-commerce systems, it’s difficult to track and reward behavior across third-party channels, establish partnerships, and understand purchase behavior across brands.
For example, North Face XPLR members can’t earn or spend rewards at REI.
Because web3 creates an open and interoperable loyalty system where the customer’s identity is tied to the NFT, it improves partnerships, customer acquisition, and cross-sell and upsell ability.
For example, let’s look at the Delta and Lyft partnership, where Delta SkyMiles members earn miles for every Lyft ride they take.
This partnership incentivizes Delta SkyMiles members to use Lyft and Lyft members to join Delta SkyMiles. But for customers to realize the benefits, SkyMiles members need a Lyft account and Lyft customers need to sign up for SkyMiles. Then, customers need to link their accounts on Deltalyft.com.
In a web3 architecture, customers no longer need to double opt-in to receive benefits from the partnership. If every Lyft ride is recorded on-chain as a Lyft token, Delta can automatically drop SkyMiles tokens to those wallets. This means that customers no longer need to link their accounts or even have SkyMiles accounts to receive rewards.
Web3 architecture expands the partnership’s total addressable customer base and customer acquisition capabilities.
The web3 loyalty landscape
There are several players in the web3 loyalty space. While there’s some overlap, we can segment applications into two models that serve either enterprise or small and medium-sized (SMB) brands: embedded and customer-facing.
Embedded: The initial focus with this model is to embed web3 capabilities into the existing e-commerce stack, storefront, and checkout workflow. In other words, this is a white-label approach that exists in the back-end and limits consumer friction.
Customer-facing: The initial focus with this model is to create a more robust consumer-facing application to manage customer loyalty and engagement. This model creates an initial network of brands to drive cross-brand opportunities.
Brands should assess the financial, internal adoption, and customer adoption viability when identifying an open loyalty strategy.
Considerations: Assessing an open loyalty strategy
Financial viability: Do solutions improve LTV?
- Focus on solutions that drive net-new revenue through community engagement, rewards, partnerships, and customer acquisition.
- Consider solutions that maximize customer touchpoints with the brand
Internal adoption viability: How easy is it for the business to adopt?
- Consider out-of-the-box integrations to existing commerce enablement platforms and applications.
- Understand solutions built for web3 native projects will have more friction during implementation.
Customer adoption viability: How easy is it for the consumer to adopt?
- Ask: Do my customers want and value a web3 product?
- Weigh tradeoffs between friction and engagement when considering an embedded vs. customer-facing model. Do you care more about reducing customer friction, or do you want to create a new communication channel for customers to engage with the brand?
- Consider that embedded models may reduce overall customer adoption time, but customer-facing models may provide a powerful communication channel for customers to engage with the brand.
- Understand solutions built for web3 native projects will have more friction during customer adoption.
The future of open loyalty and web3 commerce
We’re entering a new era of brand building as digital marketing becomes more expensive and less effective. As brands search for creative new customer acquisition channels and ways to improve LTV, an open loyalty strategy is a viable solution to improve LTV/CAC.
Open loyalty has the potential to unlock new customer interactions and turn traditional loyalty programs into robust customer acquisition channels. Onboarding web3 technology is not the right solution for every brand today, but the time is right for brands to explore a web3 strategy.
We don’t see a return to the hyperfocus on inflated NFTs like $1M Bored Apes. Rather, we believe open loyalty is part of a broader shift toward utility NFTs that hold real consumer and business value. Utility will become the focus, and consumers and brands may even stop calling them NFTs altogether: for example, Starbucks is already calling them “stamps.” Over time, open loyalty should increase the usage of utility NFTs and conceal web3 native terminology.
While open loyalty is more mature, it’s not the only web3 commerce use case for utility NFTs. We see other categories—like proof-of-custody—as developing applications that are enabling the shift to utility NFTs. We’ll continue to watch these new developments.
How to get in touch
We at M13 continue to spend time and deploy capital into the future of commerce. If you’re building, investing in, writing about, or just curious about web3 and commerce, we hope you’ll join us on the journey.
Gaelen Hendrickson | Anna Barber | Brent Murri
@Gaelen_H | @annawbarber | @brentmurri