Will Blockchain/Crypto End of Traditional Firms?

From Nick Tomaino’s post The Slow Death of the Firm:

Economists typically suggest that firms exist for two main reasons: to minimize transaction costs and to aggregate capital and people.

Firms have played an important role in society for decades for these reasons (and likely a variety of others). Despite their prominence, most people dislike them.

He goes on to state that BitCoin is the first organization benefitting from both traditional firm characteristics as well as new characteristics made possible by blockchain:

Bitcoin is the first example of an organizational structure that has the beneficial characteristics of the firm (minimizing transaction costs, aggregating capital and mindshare, and providing job security for contributors) combined with some new characteristics:

  • Ownership isn’t controlled by an exclusive group of founders, employees, and investors
  • Data isn’t controlled by any one entity
  • Decision making power is not controlled by one person or group and there are checks and balances from a broad variety of market participants

These new characteristics may help billions of people around the world in the future, apparently by sidestepping law:

Blockchain-based organizations that aren’t bound to a physical location offer new earning opportunities to billions, as the elimination of a legal entity reduces the need for legal contracts and friction and opens up new short-term, global labor opportunities

While I agree that Bitcoin cannot be entirely regulated by laws, I’m not yet convinced that this extends to the earnings of billions of people around the world. Anonymity is a possibility, though he cites 21.co as an example, which requires Facebook authentication.

One of the biggest changes from a traditional firm is that users can become owners, which he touches on, and that:

Creating new products that weren’t possible with firms

More than merely creating “blockchain for X” projects, there’s entirely new possibilities. Blockchain technology and cryptoeconomics are more like adding a new dimension than changing the playing field compared to traditional firms.

Before we get to that point, Tomaino belives there will be steps in that direction along the way.

some centralization of decision making is generally necessary in the early days of a project. The best projects will likely be designed to be decentralized across all facets of the org for the long-term, but not necessarily right from the beginning.

Most labor still requires some centralized human judgement to effectively allocate resources. There are some interesting efforts in the works around proof-of-stake and other systems that may enable the decentralization of resource allocation across a wide variety of labor types in the future.

In the end, he believes the changes will come on two levels:

  • New decentralized organizations will emerge.
  • Traditional firms will transition to decentralized organizations.

 

Blockchain mergers

Dill Chen writes about the potential to merge blockchains, both for crptocurrency and tokens. He encourages forking as way of to innovate but states:

there needs to be a process to merge chains just as there is the process of forking.

He goes through two potential solutions for merging, citing the potential valuation problems:

Also, as we see in centralized mergers and acquisitions, the larger company often has to purchase the shares of the smaller company at a price premium. We’ll have to establish a better pricing mechanism beyond hash power and other matters.

Though he initially starts with crytocurrencies, he gives an example of how this could pertain to utility tokens as well:

These wouldn’t just have to be currency tokens, you could potentially also merge utility tokens as well. For example, looking at Sia and Filecoin. If Filecoin were to establish a dominant market cap and share position, it might behoove them to purchase the Sia network. An additional step would need to be taken. Individuals would need to, before they can acquire any of token A, transfer their files over to the new blockchain. Once this is performed, they can claim their Filecoin token.

Funding the Evolution of Blockchains – Fred Ehrsam – Medium

Coinbase cofounder Fred Ehrsam’s post, Funding the Evolution of Blockchains:

Ethereum is starting to suffer from a tragedy of the commons problem: while lots of people own ETH and would benefit from Ethereum improving, the economic reward for any single individual improving it is low.

Ehrsam looks at how to give incentive to developers to continue to work on core protocols, like Ether, when launching new tokens is more lucrative:

The lack of incentives to work on core protocols is reflected in the large number of people working on Etheruem tokens vs. the small number working on Ethereum itself.

And he projects there are significant improvements that can be made:

Improvements to these protocols would create massive amounts of value. For example, let’s say someone or a group of people implemented an Ethereum scaling solution like sharding or Plasma. Each of these improvements would likely increase the value of Ethereum by over 10%, creating roughly $3 billion in value at current Ether prices.

One possible solution he proposes is inflation funding:

Inflation funding is where things get interesting. It allows economic rewards that are otherwise unthinkable. Remember, if Ether holders believed an upgrade (ex: sharding) would make the price go up by >10%, they’d be happy to pay close to 10% of their tokens for it. That means Ethereum could crowdfund a $3bn feature bounty by inflating the number of ETH by 10% and pay the newly created tokens to the creator(s) of the upgrade.

Ehrsam points out that protocols that offer good incentives will become stronger over time, thus making it important to build that in correctly from the beginning.

So, perhaps the highest leverage thing protocol designers can do is think about how to engineer the evolutionary characteristics of their blockchains — specifically, the economic incentives for anyone to come along and improve them. The best engineered organisms can outpace others, even if they start smaller or later.

This can be the biggest step function change in the rate of innovation in the blockchain space if implemented well. By harnessing their decentralized nature they can evolve faster than a centralized organization ever could.

Would it be possible to use a built-in sink to create an incentivization pool to reward developers that enhance the protocol – or even are most active users of the token?

 

Cryptoeconomics is not economics for crypto

Cryptoeconomics is one of the most exciting aspects of crypto and it doesn’t mean a simple adaption of economics to cryptoassets, as many naturally think. There are many new possibilities, which Josh Stark writes about in an overview of cryptoeconomics at CoinDesk:

In simple terms, cryptoeconomics is the use of incentives and cryptography to design new kinds of systems, applications, and networks. Cryptoeconomics is specifically about building things, and has most in common with an area of mathematics and economic theory.

Cryptoeconomics is not a subfield of economics, but rather an area of applied cryptography that takes economic incentives and economic theory into account. Bitcoin, ethereum, zcash and all other public blockchains are products of cryptoeconomics.

He begins by using Bitcoin as an example:

Bitcoin’s innovation is that it allows many entities who do not know one another to reliably reach consensus about the state of the bitcoin blockchain. This is achieved using a combination of economic incentives and basic cryptographic tools.

Stark explains that cryptoeconomics is more closely related to mechanism design than economics.

Mechanism design is often referred to as reverse game theory because we start with a desired outcome and then work backwards to design a game that, if players pursue their own self interest, will produce the outcome we want.

Stark includes examples of three different examples and concludes by discussing the difference between a centrally-managed blockchain and a truly decentralized blockchain.

Blockchains that are simplydistributed ledgers and do not rely on cryptoeconomic design to produce consensus or align incentives might be useful for some applications. But they are distinct from blockchains whose whole purpose is to use cryptography and economic incentives to produce consensus that could not exist before, like bitcoin and ethereum. These are two different technologies, and the clearest way of distinguishing between them is whether or not they are products of cryptoeconomics.

Secondly, we should expect that there will be cryptoeconomic consensus protocols that do not rely on a literal chain of blocks. Obviously, such a technology would have something in common with blockchain technology as we call it today, but labelling them blockchains would be inaccurate.

Lots more in his article on cryptoeconomics.

Cowen & Levine on Where Tech Will Take Finance

Two of my favorite writers discussed where fintech is headed.

From Matt Levine:

The point of most innovations in consumer finance has been precisely to reduce its presence in our lives: Instead of talking to a bank teller to get money, you use an ATM. Instead of physically walking into a broker’s office to talk about which stocks to buy, you buy index funds through a web page. Or, now, you click to enroll in an app and it does all of your asset-allocating and stock-picking and tax-harvesting and so forth for you. I think that a lot of financial technology is heading in the direction of perfecting that vanishing act, so that in 20 years you’ll just think about financial things less than you do now.

Really ambitious proponents of blockchain technology, though, envision a world in which a lot of identity information — your citizenship and marital status and college degrees and employment and certifications and whatnot, maybe your fingerprints and retinas and DNA, as well as of course your credit information — are encoded on a blockchain and used in every aspect of your life.

And from Cowen:

Perhaps I expect bigger changes than you do, so let me follow up on a few possible future scenarios. Here’s one to start with: Big data and algorithms will become so good that only the good credit risks will be able to borrow. Of course this will help many creditworthy people, but the social-insurance function of credit might disappear with large numbers of risky borrowers locked out of the loan market and perhaps some insurance markets too.

 

Levine is, as usual, quite level-headed about new developments and seemingly prepared to be underwhelmed. Cowen sees bigger potential problems, which he’s also wont to do.

How Token Hodlers Create Added Volatility

A post from late September by Primoz Kordez, an advisor at ICONOMI, on token “hodlers” create volatility:

…there will always be a certain share of token holders who act as investors, either active or passive. Even if these investors are passive in their behavior, do they really have no effect on a network at all? Interestingly, in the token economy an investor is someone who impacts the floating number of tokens that can be utilized. By having more “hodlers” or passive investors in the token ownership structure, they effectively take tokens out of circulation for use. Assuming velocity of tokens and total spending stay constant, the floating value per token must increase if more tokens are hoarded by investors.

Essentially, the number of active tokens is reduced thus making them more susceptible to large swings caused by a large buy or sell from a passive investor. If a number of tokens are suddenly dumped onto the market:

It can lead to a downward spiral in which investors’ decisions cause underutilization of tokens exchanged, leading to lower network value and causing additional investors to flee.

This problem is most costly when token utility users (as opposed to passive holder) need more tokens to meet increased utility demands. They must trade for the tokens from another coin at a poor rate and don’t benefit from a higher token value since they require tokens for real usage.

The best scenario for stable and predictive token dynamics is to have more actual users in the ownership structure, but this isn’t something that can really be controlled.

Good projects need to be owned by real users – not passive investors. Users get the most value out of the network and should be rewarded for usage. Perhaps it’s possible to reward heavy users with increased token values or additional tokens. Using Vitalik’s idea of a predetermined sink, some percent of unused tokens could be burned, thus slightly reducing the number of tokens held by non-users? (A holding tax of sorts).

The next phase of blockchain adoption

From Jeremy Epstein’s post The 2 Phases of Adoption: Marketing in a Blockchain World at Never Stop Marketing:

I expect the first phase of adoption within the marketing world to be focused on the question of “how do we use blockchain tech to do what we already do more efficiently?”

Phase 2 is going to require the most forward-thinking CMOs to ask themselves “ok, what new business opportunities and threats are going to emerge because of the arrival of blockchain technologies that we can take advantage of and need to defend ourselves against?”

Clearly, we’ve seen an onslaught of ICOs recently with teams looking to launch projects quickly while the money is flowing in. As may be expected, this hasn’t resulted in the best quality projects. A lot is going to change in the 2nd phase, It’s likely years away either, as cycles are sped up immensely in the crypto world.

Star Ratings and Blockchain Stock

Matt Levine shared some thoughts on the upcoming ICO from Overstock.com’s subsidiary, T0 (t-zero)

There are two fundamentally different ways to think about “the blockchain” in finance. One way emphasizes the qualities that originally made bitcoin interesting: its trustless, decentralized nature, in which no one owns or controls the system as a whole. This is of course the philosophy behind bitcoin and Ethereum, but it is also the philosophy behind some of the more interesting and successful initial coin offerings. “The point of an ICO, done right,” I wrote recently, “is that you are not building a business; you’re building an unowned system for everyone to use.

The other way to think about “the blockchain” ignores those philosophical ideas and just treats blockchain as a technology improvement.

He goes on to portray what a mere technology improvement would look like for T0:

“All stock securities will eventually become tokens” [Overstock CEO Patrick Byrne’s quote] sounds ambitious, and in a way it is. If it’s true, then the opportunity for blockchainy stock exchanges like tZero’s to displace incumbent banks and exchanges is enormous. But in another way it is a retreat from the more interesting ambitions of blockchain proponents. It’s not a new form of business organization, a new way to build decentralized protocols to displace corporations as the engine of technological innovation. It’s just the regular old form of business organization, through public stock corporations, but on the blockchain.

Not exactly the future most crypto-enthusiasts are looking for. It needs to be more than that.

“Mainstream [blockchain] adoption is still pretty far ahead”

Alexander Lange published a piece titled Mapping the decentralized world of tomorrow, which includes an infographic showing the landscape of many of the tokens launched so far. He lays it out in a graph, beginning with platforms and protocols and followed by middleware, financing methods, and decentralized applications. A few interesting points:

On token value:

Value is created on token level rather than on equity level, therefore opposing everything we experienced in conventional software businesses. Tokens represent an atomic unit of a company’s business model. Some are sold to finance the project but their main purpose is to monetize products and services in the long run. Tokens don’t make sense for any business model and need to fit into the company’s landscape of services to be useful….. A more objective approach of valuing a token would be to define its “utility value” by analyzing real life KPIs.

On fundraising:

The fundamentally different value creation allows for new kinds of venture financing in form of ICOs attracting developers, technologists, early adopters and mainstream investors in that order.

On possible new business models:

We might see a paradigm shift from the “data economy” towards an “attention economy”. As soon as the infrastructure for self sovereign data ownership is in place and users get back the control over their data…think of being payed by the network for writing high quality stuff on reddit, medium or facebook… think of google with a transparent ranking algorithm fighting fake news and corruption.

Lange believe it will take time, since users don’t care about the backend technology, rather they care about the functionality. Still he believes the potential for major adoption is there:

Mainstream adoption is still pretty far ahead, maybe 5 years or more. People don’t care whether or not software is built on blockchain technologies, what counts is utility and price.

Some similar points to what Balaji S. Srinivasan wrote about recently, specifically in regards to looking at the bigger picture of the technology and temperament of timeframes.

 

“A 1000X improvement over the status quo”

Balaji S. Srinivasan, CEO of 21.co, published a list of 16 Thoughts on Tokens. He summarized:

The most important takehome is that tokens are not equity, but are more similar to paid API keys. Nevertheless, they may represent a >1000X improvement in the time-to-liquidity and a >100X improvement in the size of the buyer base relative to traditional means for US technology financing — like a Kickstarter on steroids. This in turn opens up the space for funding new kinds of projects previously off-limits to venture capital, including open source protocols and projects with fast 2X return potential.

And a few highlights:

Because token launches can occur in any country, the importance of coming to the United States in general or Silicon Valley / Wall Street in particular to raise financing will diminish. Silicon Valley will likely remain the world’s leading technology capital, but it will not be necessary to physically travel to the United States as it was for a previous generation of technologists.

Tokens will break down the barrier between professional investors and token buyers in the same way that the internet brought down the barrier between professional journalists and tweeters and bloggers.

After the early kinks are worked out, the token launch model will provide a technically feasible way for tech companies (and open source projects in general) to spread the wealth and align their userbase behind their success. This is a better-than-free business model, where users make money for being early adopters. Kik is the first example of this, but expect to see more.

He ends by acknowledging it’s early, saying a crash is likely, and that things are going to change quickly. It feels like many art starting to look at the bigger picture changes made possible by tokens beyond the ICO-craze, and how it change business models, fundraising, etc. and finally:

But the world has changed. Tokens represent a 1000X improvement over the status quo, and those don’t come around very often.