Blockchain and the metaverse, part 1: Opportunities

In this two-part series, 451 Research looks at the link between blockchain and the emerging metaverse wave of innovation. Part 1 examines definitions, drivers for convergence, and distributed ledger use cases in the metaverse. Part 2 will consider the challenges involved in decentralized approaches to metaverse development and some barriers to applying blockchain. S&P Global's extended metaverse coverage is described in our metaverse primer.

For our purposes, "blockchain" refers to a distributed ledger technology that stores data in immutable, cryptographically secured and connected blocks with strict sequential ordering. "Distributed ledger technology" is a family of technologies that enables data storage across multiple locations in a network. "Metaverse" is the long-term vision for the next phase of the internet, which will feature a single, shared, immersive and persistent 3D virtual space where humans interact with one another and with data, enhancing the physical world as much as replacing it.

Blockchain is better understood as one of a number of architectural choices available to developers, rather than as a fundamental underpinning for the metaverse. Distributed ledger technology can prove valuable in multiparty environments where no party has a clear reason to solely own and control experiences or associated data. The technology can provide a high degree of assurance that data has not been tampered with and is maturing quickly to address challenges around interoperability and scalability. It is unlikely to be popular for all metaverse applications, however. This is because many developers will be more comfortable with alternative tooling, blockchain remains less efficient than centralized databases for many use cases, and integration into legacy architectures can prove challenging.

Drivers of blockchain and metaverse convergence

The concept of the metaverse has a long and storied past, but it has received additional attention with Meta Platforms Inc.'s prominent rebranding. In a post-pandemic hybrid work environment, the concept of the metaverse for richer communication has also driven interest in the trend. Blockchain has evolved in this new metaverse wave into one of the technologies most closely associated with the metaverse, alongside virtual reality/augmented reality technologies, internet of things and generative AI.

In their various components, blockchain is seen as a possible underpinning for the database layer, functioning as a distributed network. The technology can provide greater assurance of data accuracy due to its tamper-proof capabilities. It is valuable in scenarios where multiple parties want shared data visibility, and where allocating a single entity as a trusted ledger controller would be contentious.

Distributed ledger technology offers efficiency improvements in not having to rely on third-party verifiers of data, and guards against multiple parties having conflicting visions of the truth. This is valuable in the context of the metaverse, where numerous different parties are likely to have a stake in governing, using and creating digital assets that will often be built in a highly fragmented fashion.

A driver of the convergence of the distributed ledger and metaverse trends is the maturing of blockchain technology, with new protocols and scaling technologies improving the viability of applying the technology to use cases requiring high data volumes and throughput. An important component of this maturing is the reduced environmental impact of more modern generations of the technology, well represented by Ethereum's merge in September 2022. The network's energy consumption dropped by an estimated 99.95%. Some alternative blockchains, such as Solana, claim 0% net carbon impact.

A more cynical lens would scrutinize the low-value assets associated with public blockchain networks and view the metaverse as an answer to an existential crisis for some Web3 startups. With falling valuations in non-fungible tokens since the heights of late 2021, the metaverse is perceived as a means of increasing the utility associated with tokens. Rather than merely having access to a generative art piece with NFTs as unique assets hosted on the blockchain, the metaverse could allow designers to establish assets that are directly usable in a digital world (e.g., clothes for avatars, a piece of digital real estate, or a virtual membership card to access a service).

On top of a tendency commonly associated with emerging technologies, where marketing teams combine sometimes loosely related terms to take advantage of multiple hype cycles, the convergence in the public consciousness of NFTs is partly shaped by NFT projects fighting for greater relevance. With on-chain asset appreciation dented by lower investor confidence, claims surrounding the future utility of NFTs within the metaverse are a component of how many projects attempt to differentiate.

A misunderstanding around the role blockchain might play often centers on storage. Blockchain is unlikely to provide direct on-chain storage for most metaverse assets. On-chain storage costs are expensive, and often what is hosted on the blockchain effectively amounts to an acknowledgment of asset ownership and directions to where metadata is stored. Decentralized approaches to storage do exist, however, where files are broken and distributed between multiple locations. Decentralized file storage helps guard against blockchains hosting broken links, with assets going offline or becoming inaccessible.

Blockchain's role in the metaverse

Blockchain as a means of providing proof of ownership

As a distributed ledger, blockchain advocates suggest that the technology's architecture enables shared and verifiable visibility of who owns which asset. This differs from multiple parties across a history of transactions holding their own records, which may conflict. As an append-only database, it is very difficult for a malicious actor to manipulate a transaction's history, making reliance on third-party verifiers largely unnecessary.

Decentralized approaches also work as a valuable backup system, providing greater assurance that an asset remains available and untampered with. A digital asset purchased in a digital world solely hosted by a technology provider may become inaccessible if a platform goes offline, the vendor declares bankruptcy or the file becomes compromised. Decentralized storage reduces the vulnerabilities associated with a single storage point because malicious actors would require substantial control over a network to compromise files.

Related technology: Blockchain networks store records of ownership and transactions. These can be major public blockchain networks, such as Ethereum or Stellar, or permissioned networks, such as Corda or Hyperledger Fabric. Decentralized file storage and sharing protocols, such as Filecoin or the InterPlanetary File System, enable assets to be shared for more cost-effective decentralized storage. Wallets provide an interface with the blockchain, cryptographically sign transactions, and, to some degree, function as an on-chain identity. Notable brands include MetaMask, Exodus and Blockchain.com.

Blockchain as a means of providing proof of identity

Existing approaches to digital identity, where different organizations collect and store data from users, create some challenges in the context of the metaverse. A major issue is that user identities are fragmented. This may make it difficult to build portable identities that can easily transition between spaces or services. Users may well expect or desire a single identity over which they have a high degree of control and ownership.

User experience and privacy concerns face another set of challenges. Users probably will not want to repeatedly provide different snippets of personal information to different providers, and some may have concerns about how that data is used or secured. Companies also face expenses in securing this information and staying abreast of evolving legislation around personally identifiable information.

Blockchain is a possible underpinning to a decentralized identity framework where users and devices control their identifiable information and can evidence identity without relying on third-party authorities. A decentralized identifier can consist of several credentials, with data encrypted and the owner able to choose what data to make available and to whom. Some offerings apply zero-knowledge identity proofs to enable a user to verify criteria as true (such as being over 18) without revealing the underlying data — in this instance, their age.

Related technology: Blockchain networks can include blockchains built specifically to support decentralized identity such as Hyperledger Indy. Packaged decentralized identity products or services include Indicio Proven or International Business Machines Corp.'s IBM Digital Credentials.

Blockchain as a means of payment

Blockchain is an architectural option to underpin the metaverse economy, with cryptocurrency advocates positioning it as a decentralized alternative to the siloed digital currencies seen in other digital worlds, like Roblox Corp.'s Roblox. Cryptocurrency was designed as a global payment method that would not have to rely on the intermediaries that traditional cross-border payments do. Although many cryptocurrencies are highly volatile, others — commonly referred to as stablecoins — have value pegged to an external reference, such as fiat currencies or commodities. Lower volatility makes such assets better suited as a medium of exchange, but collateralization levels vary, and stablecoins face increasing regulatory scrutiny.

Related technology: Cryptocurrency tokens are cryptographically secured digital currencies. Popular cryptocurrencies include bitcoin, ether and Ripple Labs Inc.'s XRP. Exchanges, fiat on-ramps and off-ramps are used to exchange different cryptocurrencies and transfer funds on- and off-chain. Binance Holdings Ltd. and Coinbase Global Inc. are the largest cryptocurrency exchanges.

Blockchain as a means of governance

Metaverse governance will be a hotly contested topic, with large numbers of entities having a vested interest. Blockchain networks are designed to be decentralized. Rather than granting authority to a single organization — which controls the data generated in a virtual world it would have ownership of — each member has the same information, and much of the technology is open source.

Arguments for making users the decision-making authority within the metaverse rely on a technology underpinning that can provide auditability, a means of identifying stakeholders, and being secure. A popular governance mechanism in public blockchain projects is to allocate tokens to stakeholders or allow invested individuals to buy in and delegate responsibility in shaping the project to those members. Rules are designed to be transparent, with operations commonly automated through smart contracts — executable programs on the blockchain.

Related technology: Decentralized autonomous organizations are more of a governance style than a concrete technology, but it is a methodology that has gained popularity in public blockchain ecosystems. Governance mechanisms vary, but the model surrounds stakeholders voting as a means of decision-making.

Blockchain as a means of automation

Blockchain has evolved from its earliest generation as merely a means of supporting a currency and a store of value as with Bitcoin, to a technology that can support complex decentralized applications. The Ethereum blockchain was established with its own programming language, Solidity, which allowed executable code to be hosted on the network. This allows complex rules to be set, which can cause transactions to take place when certain criteria are met. Parties wanting to transact within the metaverse may not operate with mutual trust. A party that promises to buy an asset if its valuation falls below a certain level or that a sale will be invalidated should a sensor detect a good is being stored above a certain level can be secured as a self-executing agreement on the blockchain using third-party data feeds, for example.

Even where execution is not required on-chain, distributed ledger technologies can be seen as an opportunity to further automate business practices. Greater data assurance — parties in a metaverse space being in accordance as to who owns an asset, for example — creates greater confidence in the ability to use that data to automate a workflow. By ensuring data consistency between all parties, automated workflows that span businesses also become easier.

Related technology: Smart contracts consist of computer code that runs on the blockchain. They can self-execute when predefined factors are met and enforce automatically without the need for intermediaries. Smart contracts support different codebases, and some are considered Turing Complete, meaning that the programming language they use could in theory be applied to solve any computational problem.

Blockchain may become increasingly invisible

A user of a service is rarely aware of the database underpinning it. In the same way, we would not expect denizens of the metaverse to be conscious of the role distributed ledger technology plays. That said, the attributes blockchain proponents associate with the technology around decentralization, security or trustlessness — the mechanism that is in place so that no individual party that participates in blockchain processing needs to be trusted — may be extended to the metaverse, and blockchain as an architectural underpinning may be used as justification.

However, few developers are likely to dedicate significant resources to managing or configuring blockchain infrastructure, with most building at a higher level of abstraction. Blockchain-agnostic development platforms and node hosting services are already reshaping the need for in-house blockchain expertise for many technology providers.