This short introduction to decentralization examines decentralization’s past, presence, and future. By tracing the history of past and existing decentralized systems and by examining emerging decentralized technology solutions, the author highlights the trends that lead to higher levels of decentralization in commerce and society.
Part 1 — The Past: examines how we got to where we currently are with decentralization. The author provides an overview and concrete examples of existing decentralization trends. The authors examine the different types of decentralization and show how they are interdependent. The authors show that the movement of decentralization creates many unknowns. Yet, technology has already decentralized many parts of society and empowered society at an unprecedented scale. Take for instance the emergence of smartphones and how they changed and enabled consumer behavior around the globe, putting an unprecedented amount of information and possible choices in the hands of individuals. Through smartphones, information is increasingly available real-time and comes unfiltered from the edge. This is just one example of a remarkable transformations that one technology has spawned by enabling consumers, and especially the unbanked. The open source movement in combination with the FinTech boom, powered by artificial intelligence (AI), big data, and machine learning provide other examples. For instance, AI enabled location-based marketing, among many other innovations that are seemingly overnight enabling tiny companies to compete with the leading worldwide financial and other institutions.
Part 2 — The Presence: examines the current state of decentralization and identifies the opportunities, disruption, and challenges that are associated with the increasing trend towards decentralization. To contrast existing decentralization attempts, to explain the associated opportunities and limitations, and to outline what is needed for truly decentralized commerce solutions, the authors examine Bitcoin and its features as one existing example of an unevolved decentralized culture. The underlying foundational infrastructure technology that enabled Bitcoin is blockchain technology. Given the complexity of the topics, the authors use analogies, storytelling and real-life examples to elucidate the core limitations and associated infrastructure needs for the evolving decentralized commerce. For example, the way in which in the 1880s electricity was invented and implemented as a foundational technology, including by way of creating standards to instantiate, transfer, and sell electricity etc., gives many opportunities to draw analogies. Similarly, the invention of the internet in the 1990s, the cyberpunk movement, the debate over who the president of the internet may be, among other stories, allow for the examination of real-life examples that underscore the complexities and opportunities of decentralization attempts and solutions. The authors also examine the factors that allow people to feel safe in a transaction at, for example, Starbucks in 2019 and connect the identified factors back to what would work in decentralized systems.
Part 3 — The Future: Addresses the future of decentralized systems and examines the impact of increased levels of decentralization on commerce and society. The authors discuss some of the core infrastructure elements that are needed before the first genuinely decentralized transaction can materialize, including: 1. The legal environment, 2. Underwriting in insurance, 3. A truly decentralized blockchain that can overcome the blockchain trilemma (decentralization, scaling, security), 4. Governance of blockchains, e.g. evolutionary protocol upgrades that address the economic cost of hardforks. After outlining the opportunities for commerce and society that are associated with a truly decentralized technology solution, the authors examine the associated risks and ethical challenges. The authors provide an outlook on what seems possible in the future of decentralization, based on existing models.
Part I: The Past
What is Decentralization?
No two minds will agree on a common definition or scope and scale of decentralization. Most people still see decentralization from the vantage point of centralized systems and hierarchical structures. That is very much understandable. Out of necessity, humans have engaged in centralized thinking since the emergence of tribal societies and throughout urbanization and the industrial revolution. To contrast centralized definitions of decentralization, here are some examples that show what the evolving phenomenon of decentralization is not:
· Terminologically, decentralization is not synonymous with partnership, delegation, de-concentration, disassortative, devolution, circulation
· Decentralization is not the addition of hierarchical levels in a centralized organization
· Decentralization is not just the redistribution of centrally organized authority or redistribution of centrally collected revenue
· Decentralization is not just the delegation of centralized authority to managers on all levels of an organization
Decentralization is a worldwide phenomenon that permeates all industrialized nations and affects most industries. The disruptive effects of decentralization on centralized systems provide powerful examples of the brave new realities that emerge through decentralization. Here are some examples of decentralized systems that have disrupted existing centralized commercial systems:
· Music Industry: Napster, Emule, Limewire, Pandora, Kazaa, Pandora, Spotify
· Telecommunication: Skype
· Advertising: Craigslist
· Payments: PayPal
Several historical examples help illustrate the emergence and effect of decentralized systems on parts of society. Take for instance:
· The attempted colonialization of the Apache tribe
· Alcoholics Anonymous
Decentralized commerce may generically be defined as the global exchange of financial instruments, goods and services via emerging decentralized technologies. Starting with various experiments in electronic cash, such as DigiCash, among others, the emergence of the Bitcoin protocol in 2009, the digital asset market is a market for investment opportunities in virtual assets. Stock is not inherently digital as it has strong ties to the real world. By contrast, Bitcoin is a purely digital asset because it only exists in the virtual world. Narrowly construed, digital assets are instantiated through computer code and depend on so-called “consensus computer algorithms” to trigger and validate a transaction in a given digital asset. Broadly construed, digital assets can include video games in the broadest sense and items sold in video games can be digital assets without a consensus algorithm that validates the transaction or provides a level of security.
Existing decentralized systems display several core commonalities that affect commerce and society. For instance, decentralized systems do not have a central intelligence or leadership system based on traditional hierarchies. Instead, the intelligence is spread throughout the system. Information and knowledge naturally filter in at the edges of the system, closer to where the action is and where most real-time information is created. Decentralized systems can also very easily mutate and change because the information flow is optimized through dynamic feedback effects. As a result, such systems become more attack resistant on multiple levels. In turn, the ability to mutate quickly allows the decentralized systems to grow incredibly quickly. For example, for hundreds of years people turned to experts to combat alcoholism and then AA became the accepted prevailing way to dig oneself out of alcoholism within a very short time period. Similarly, Skype offered free phone services at minimal cost and forced the telecommunications industry to reconsider its business models.
Types of Decentralization
Decentralized systems are constantly morphing and evolving with new features. The resulting diversity of facets of decentralization make categorization difficult. Yet, decentralization manifests itself through several applications that affect each other. Such applications can be categorized by core commonalities and interoperative feedback effects. The resulting five general types of decentralization are:
1. Governmental and Regulatory Decentralization
2. Technological Decentralization
3. Organizational Decentralization
4. Market Decentralization
5. Societal Decentralization
These five types of decentralization are each subject to iterative decentralization processes and affect each other by way of feedback effects. As one type proliferates, the other types are slowly but increasingly affected, leading to changes that, in turn, affect each other. The combined learning and feedback effects lead to the creation of new markets while changing other markets and, over time, create a slowly emerging new economy. The different forms of decentralized commerce affect society at multiple levels as different constituents begin to experiment with their own applications and new solutions which in turn create feedback effects for each of the four types of decentralization.
In the pre-and-post internet era, companies have used decentralization of their organizational structures to their advantage without significant new technological innovation. Take for instance General Electric (GE) under Jack Welch. Before GE was run by Jack Welch, it was a highly centralized institution with a highly centralized bureaucracy that created significant inefficiencies and depressed economic performance. Welch decentralized GE by separating out GE business units that had previously been linked in a conglomerate with associated reporting duties etc. Under Welch, each new business unit maintained its own profit-and-loss statement and were so independent that if Unit A wanted to buy a product from Unit B, it had to pay the full market price. Segmenting the company and creating distance and, in fact, competition between departments and business units worked. Welch’s approach required each business unit to become fully accountable and removed inefficiencies. Welch’s method enabled each business unit to be run efficiently and profitably, while allowing unit heads significant flexibility and independence. GE’s market value skyrocketed as a result of its decentralization of business units.
In politics, the increasing crises of legitimacy resulted in democratically legitimized governmental decentralization. Decentralization reforms of government are typically motivated by public officials’ desire to handle responsibilities and decisions at the regional or local level, not the national level. In democracies, it is typically the role of conservative parties to advocate for a decrease in the role of central government. Conservative parties have proliferated and continue to proliferate in Europe and the United States. The rightward shift in government illustrates society’s desire to find solutions for new geopolitical problems, such as the emergence of a new automated workforce that replaces existing and traditional employment opportunities, the human migration from Africa to Europe, the disillusionment of large parts of society with existing political and social institutions, such as the European Union, the Brexit movement, among many other political issues that require solutions. Political decentralization can also be seen as counterpoint to globalization and as an attempt to address the perceived negative implications of globalization. Overall, the emerging political and regulatory decentralization of society is a public reaction to the increasing economic decline, demands of minorities for a greater say in local governance, the general weakening legitimacy of the public sector, government’s inability to fund services, the overall decline in government services, and global and international pressure on countries with inefficient, undemocratic, overly centralized systems. The most lasting consequence of the antiestablishment surge seems to be the erosion of the old technocratic consensus about how to run an economy. The disillusionment with existing political institutions’ ability to address economic hardships that emerged in the aftermath of the financial crisis of 2008–9 inaugurated a new form of technological decentralization. As one result, among many, the Bitcoin protocol emerged in 2009 as an attempt by its founders to provide an alternative to the shortcomings of the financial system. Bitcoin and its progeny spawned a slew of additional decentralized protocols and decentralized technology attempts and solutions that, while mostly still experimental, provide a gateway to future forms of technological decentralization. The evolution of decentralized protocols, ecosystems, and platforms, in turn, may provide unprecedented democratic forms of organizing society and coordinating human behavior.
Technological forms of decentralization started to become possible in the aftermath of the invention of the internet. By creating online communities and giving them the ability to communicate across borders in real-time, the internet created new forms of communication, e-commerce, and knowledge exchange on the edge. The initial pioneers of internet technology saw it as a fully decentralized network that could not be controlled by any one person or entity. This initial vision of the internet resulted in the cyberpunk movement when it became increasingly apparent that consumer preferences would require increasing political compromises in the internet architecture.
Technological forms of decentralization via the internet, in turn, enabled new hybrid forms of organization. Take for instance companies like eBay and Amazon as examples of centralized companies that decentralized the customer experience. These companies combined the best of both worlds. The used the structure, control and associated profit optimization of centralized entities and combined it with the bottom-up approach of decentralization in the form of customer reviews. This combination brought significant success to eBay but also created tensions. While people are willing to trust others by way of user ratings, they also require safeguards for consumers that typically require command-and-control centralized structures. EBay’s use of network effects and network growth made it increasingly useful and increased the likelihood that customers would stay with the network. While the user ratings eBay uses clearly have flaws (that illustrate the need for a decentralized reputation verification system — discussed in Chapter 6), so far, nobody has been able to come up with a better technology. EBays decentralized user ratings proved to be its biggest competitive advantage. Like eBay, Amazon is a hybrid organization in the sense that it has a centralized hierarchical control structure combined with a powerful set of decentralization features. Amazon also tapped into peoples’ generosity and desire for community by channeling it in to a decentralized network of reviewers in a reviewer system.
The evolving technological decentralization, in turn, has created new markets and continues to change existing markets. For instance, with the emergence of the Bitcoin protocol in 2009, the digital asset market began to evolve. Until the creation of the first known alt-coin (e.g. an alternative coin to Bitcoin) around April 15, 2011, Bitcoin virtually dominated the market and was in fact the only digital asset. Between 2017 and 2019, the alt-coin market proliferated significantly. Correspondingly, from 2016 to 2017, Bitcoin’s market share dropped dramatically. At the end of 2014, with the instantiation of smart contracting in the Ethereum ecosystem and the ETH currency, the market for digital assets started to diversify and proliferate substantially. New alt-coins emerged almost weekly, leading to over 2000 crytocurrencies in circulation in late 2018.
Such new cryptocurrencies created a new market for initial coin offerings (ICOs). The ICO market peaked from March 2018 to June 2018. The percentage of ICOs in relation to total fundraising of blockchain startups dropped from 80% to around 35% in August 2018 and only marginally recovered between September 2018 and February 2019 at around 40% to 50% before dropping to 20% in March 2019. From March 2017 to June 2018, ICOs were the overwhelmingly dominant fundraising tool for the blockchain industry. The demise of the ICO market turned the overall trend away from ICO funding to venture funding in the blockchain industry.
The emergence of the ICO market changed the market for venture funding. In the existing venture capital model, venture capital funds invest significant amounts of money in the hope of finding the next unicorn start-up. This investment process is subject to long, complex, and time intensive processes leading up to a late liquidity event in the form of an IPO or acquisition. By contrast, ICOs provide liquidity to investors much faster and allow venture capital funds to capitalize on existing profits early. Venture capital funds who invested in crypto start-ups gain access to much earlier liquidity via ICOs by converting their cryptocurrency profits into Bitcoin or Ether through any of the cryptocurrency exchanges and can thereafter transfer into fiat currencies via online services such as Coinsbank or Coinbase. During the ICO boom years, the venture capital market in the decentralized technology sector ground to a halt. In the aftermath of the ICO boom and collapse, venture funding has become, again, the predominant model for funding blockchain startups.
The altcoin market also created opportunities for new organizational design. With the emergence of Ethereum, the leading altcoin, and its smart contracting, a host of decentralized technology projects materialized. Several of such projects attempt to change organization design at a fundamental level. While it is still difficult to imagine a world without governance structures facilitated by agency constructs, Decentralized Autonomous Organizations (DAOs) have started to challenge the core believe that governance necessitates agency.
The first DAO, launched in May 2016 and instantiated on the Ethereum network (an altcoin), is the founders’ attempt to set up a corporate-type organization without using a conventional corporate structure. The first DAO had a governance structure that was entirely built on software, code, and smart contracts that ran on the public decentralized blockchain platform Ethereum. Because if was pure computer code it had no physical address, no jurisdiction that could claim jurisdiction/control over it, and it was not an organization with a traditional hierarchy as we know it from traditional corporate structures. The DAO did not use a traditional corporate structure that necessitated formal authority and empowerment flowing top down from investors/shareholders through a board of directors to management and eventually staff. Indeed, it had no directors, managers or employees. In essence, all the core control mechanisms typically employed by principals in agency relationships were entirely removed in the DAO. The first DAO was, in effect, a decentralized venture capital fund that allowed all of its 1800 members to vote on venture capital investments in technology startups.
In light of increasing technological and organizational decentralization, regulatory decentralization has become a reality in many jurisdictions. For instance, in April 2016, the Financial Conduct Authority (“FCA”), the financial regulatory body in the United Kingdom, broke new ground by announcing the introduction of a “regulatory sandbox,” which allows both startups and established companies to roll out and test new ideas, products, and business models in the area of Fintech (i.e., new technologies aimed at making financial services, ranging from online lending to digital currencies, more efficient). The idea behind the sandbox is to provide a safe space for testing innovative and increasingly decentralized products and services without being forced to comply with the applicable set of rules and regulations. With the sandbox, the regulator aims to foster innovation by lowering regulatory barriers and costs for testing disruptive innovative technologies, while ensuring that consumers will not be negatively affected. What makes the regulatory sandbox so attractive is that, insofar as technology has consequences that flow into everyday lives, such technology will be open to discussion and democratic supervision and control. In this way, public entitlement to participate in regulatory debates can help to create a renewed sense of legitimacy that justifies the regulation. Given these benefits, other regulatory sandboxes have been introduced by other regulators, such as the Australian Securities and Investment Commission (ASIC), Singapore’s Monetary Authority (MAS) and Abu Dhabi’s Financial Services Regulatory Authority (FSRA).
Many other examples exist that illustrate the feedback and knock-on effects between decentralized technology, organizational decentralization, regulatory decentralization, and decentralization (and disruption) of markets. Many other feedback effects are constantly emerging and affect other parts of society. For instance, higher education has started to pick up on the decentralized technological opportunities for commerce. Institutions of higher learning have started to create basic courses on blockchain technology and coded distributed ledger technology solutions starting in 2018.
It is important to note that the decentralization movement is still in a nascent state in many industries. For instance, inside of corporations, smart contracts play no or only a negligible role. Similarly, in world economies, cybercurrencies only play a small role and still have a long way to go. Despite these existing underdevelopments, the decentralization phenomenon has been ongoing and has become a significant movement.
How We Got This Far
Disruptive innovation in the internet age creates an environment that enables ever increasing decentralization. Disruptive innovation is characterized by scientific discoveries that change the existing technological product paradigms and provide the foundation for more competitive new technologies and products to emerge. By enabling discontinuous innovations of processes, products, and services, disruptive technological innovations facilitate exponential improvements in the value proposition for customers. Disruptive technological innovation can be characterized by the emergence of completely new technologies, the new combination and application of existing technologies, and the application of new technologies to specific societal problem areas, each precipitating a significant paradigm shift for product technology or creating entirely new paradigms. Disruptive innovation exemplifies Schumpeter’s “Creative Destruction,” that is, the creation of competitive strength through innovation that is followed by new demand in new markets while destroying older and less competitive technologies and existing markets that are based on older and less competitive technologies.
The literature on management has addressed the implications of disruptive technologies and innovation since the mid-1990s. The literature warned businesses that disrupter startups would attract new lower-end consumers by offering inexpensive substitutes for products and would then gradually move upmarket by attracting higher-end consumers, suggesting that businesses act quickly when disrupters appear and either acquire the disrupter or incubate a competing business that embraces the disruptive technology. A market leader’s lack of investment in disruptive technologies often results in the abrupt loss of market dominance and often even total replacement in such markets. Market leaders often shortsightedly refuse to cannibalize their market dominance through the use of disruptive technologies. This enables small entrepreneurial firms with no established customer base to take advantage of disruptive technologies and redefine such markets. Market leaders, successful institutions, and managers fail when they do not distinguish sustaining technologies from disruptive technologies.
Successful disruptive products of the last fifteen years displayed shared core characteristics that were facilitated by growth and advancement in core disruptive technologies. Revolutionizing products in the past few decades that were based on disruptive technological innovation were typically smaller in size, lighter, cheaper, more convenient and flexible, more reliable, had better unit performance with higher efficiency, and were more user friendly than prior products. These characteristics typically require significant advances and growth in artificial intelligence and technologies including micro- or nanotechnologies, as well as materials and component technologies. A simple example is the disruption that came with the invention of the smart phone, which allows people around the world to access information instantaneously at an unprecedented scale.
Disruptive innovation via so-called big-bang disruptions differs from more traditional innovation. Big-bang disruptors not only often offer a much cheaper product in comparison with the established products, but they are also better integrated with other products and services and are often more inventive. In today’s age of social media, big-bang disruptors can successfully exploit consumers’ advanced access to product information and consumers’ ability to contribute to products and share such contributions and product improvements via social media and other outlets. Internet fads and products can be accessible to consumers in the entire world within a matter of days. Big-bang disrupters typically launch businesses without a foundation, using cloud computing, open platforms built on the internet, and fast-cycling mobile devices. Big-bang disrupters often produce multiple new products to identify which products may take hold in the market. While most such products fail, the payoff associated with the unconstrained growth of those products that succeed is substantial and facilitates and often accelerates other forms of disruptive innovation.
The telecommunications market and in particular the evolution of smart phones has revolutionized many markets and entire industries. Smartphones have revolutionized society in less than a decade.
With more than 1 billion users worldwide and 2.5 million ever increasing apps available across Google and Apple’s digital marketplaces, Smartphone’s role in shaping human interaction in the 21st century has been as dramatic as it is far-reaching. With the launch of the iPhone in 2007, smartphone adoption rates quickly exceeded other technological milestones such as the TV, the personal computer, the telephone, and the light bulb. The smartphone outpaced the TV as the consumer technology with the fastest adoption rate, reaching 40 percent market saturation in just 2 1/2 years. Over sixty percent of internet traffic today comes from mobile devices rather than desktops, which long served as the dominant online portal. Increasing evidence exists that smartphone-enabled search engines and digitally managed contact lists are affecting how the human brain processes information. Internet-connected devices have already become a kind of external memory source for many people. The role of smartphones for societal change can also not be underestimated. Take for instance, when the Arab Spring began rippling through the Middle East in early 2011. Demonstrators and journalists alike used smartphones to gather information quickly and disseminate it. The smartphone quickly proved to be a powerful tool for social change. For the unbanked, who lack access to traditional bank accounts but who nonetheless have high rates of mobile phone ownership, the smartphone and mobile money are playing a critical role in financial inclusion. For the unbanked the smartphone provides access to stored value accounts and a growing set of financial services that can change their life.
Big data generated by mobile devices is also a significant driver of disruptive innovation. The idea of N=All, e.g. being able to access and evaluate the entire dataset rather than a small sample thereof, facilitated by big data, allows researchers to understand correlations that are completely unprecedented and to revolutionize our world. Big data in the form of digitized data that grows at exponential rates and can be captured and manipulated electronically draws on several core sources including the internet of things, public records, social media, and cameras, as well as satellite tracking. Big data benefits not only industry and researchers, but it also increases consumer choice through publicly available websites providing big data analyses intended to support consumers’ decision-making processes.
Despite the overwhelming benefits associated with big data, big data’s use of such disparate sources creates challenges for the integration of data and normalization. The literature mostly takes issue with the big data inaccuracies that occur when collecting data from databases that merely require generalized accuracy. Big data is often not the output of instruments designed to generate valid and reliable data suitable for scientific analysis. Foundational data issues of construct validity, measurement, reliability, and data dependencies are the same regardless of data quantities. Some critique the implicit assumption of big data researchers that big data is a substitute for traditional data collection and analysis rather than a mere supplement, while others see big data and small data not as mutually exclusive but as reinforcing and supporting each other. Big data shortcomings can largely be addressed with artificial intelligence (AI), and the combination of big data and AI opens up significant additional big data applications.
AI presents another significant field of disruptive innovation. AI is different from a regular computer algorithm. It tries to emulate human thought processes and rational human behavior through self-learning and storage of experiences. Because it emulates human behavior, AI can act differently in the same situations, depending on the actions previously performed. Many sectors of the economy are already significantly affected by the rapid advances in AI during the past decade. The exponential development of AI and the associated disruptive innovation pose substantial challenges for policy makers in education, financial markets, labor markets, and other areas.
Several examples help illustrate the power of disruptive innovation and its consequences. Corporate history is littered with numerous examples of successful companies that drifted into obscurity after failing to embrace change. Nokia, Kodak, and Blackberry are prominent examples. All these firms collapsed after fast changes in their respective markets rendered their products/services irrelevant.
Several core common denominators are often associated with companies that are less successful in a business environment of disruptive innovation. Less successful companies are also often slow in embracing algorithmic technologies, data analytics, big data, and platforms. Instead, such companies usually prefer to concentrate on the execution of established business models built around existing and successful products or services. Executives with a knowledge of, and focus on, innovation and consumer experience — i.e., those individuals responsible for the initial success of a company and best placed to deliver relevancy — often find themselves marginalized from core decision-making processes in companies that focus on established products. Less successful companies often share a myopic and short-term focus on shareholder value maximization that has led to an unhealthy emphasis on firm share price, market valuations, and financial metrics that obscure issues of relevancy. Listed companies, in particular, are prone to put too much emphasis on financial metrics, such as return on net assets, return on capital deployed, and internal rate of return. Of course, it is important to focus on financial metrics. However, it is also important to realize that an emphasis on measures that aim at quarterly earnings and short-term stock price performance can easily distract an organization from the important business task of identifying strategies that can help a firm remain relevant in the future.
A prominent example of a company that was successful under the old and established metrics but that did not meet consumer demands is Microsoft under Steve Ballmer. Microsoft was enormously profitable, even though it started to lose relevancy with consumers after Ballmer took over from founder Bill Gates as CEO in 2000. Ballmer oversaw a tripling of sales from 2000 to 2015, and that he doubled profits and created a tremendous number of jobs. Ballmer acquired Skype and launched Xbox. By any of the traditional metrics, Steve Ballmer is considered a success.
Ballmer was not successful when considering the purpose of a company in terms of maintaining relevancy and offering meaningful consumer experiences. Ballmer failed to understand the most important technological developments that were taking place during his tenure as CEO. While a new world of networked technologies and mobile consumption arrived, Microsoft under Ballmer failed to adapt quickly enough, and as a result Microsoft ceased to be relevant. Microsoft missed these developments because it focused on short-term financial metrics, rather than on designing products relevant for the next generation of consumers. Instead, Ballmer let younger firms and startups move in and reap the benefits. Microsoft was able to survive by re-inventing itself. After new CEO Satya Nadella took over, Microsoft changed direction, focusing on commercial cloud services (Azure), cognitive services (speech recognition artificial intelligence), and premium subscription and content services for Windows 10. From a relevancy perspective, this new strategic direction looks smart, even if Microsoft is unlikely to re-capture its dominance of the 1980s or 90s.
The disruptive change coming from technological innovation is often directly linked to the emergence of financial technology (fintech). Fintech — the intersection of finance and technology — has revolutionized the traditional landscape of many financial products and services and changed the lives of business owners. The merging of financial services and technology is one of the fastest growing markets in recent years. FinTech is not only improving financial services but also spurring economic growth and development in many parts of the world. The introduction of technology into the once obsolete financial system meant that service providers are now taking heed of customers’ needs. The innovation of financial services via technology has created systems that are faster, cheaper and more convenient for the consumer. As a result, customers turn away from the legacy institutions that once dominated financial services. To counteract this trend, established banks and financial services providers are now turning to technology companies to innovate and improve their products and services. Take for example the recent announcement by Goldman Sachs and Apple regarding their joint effort to introduce a Apple Credit card. This move is significant because it shows that Goldman Sachs is finally realizing that the future of banking is with the consumer market, a market it mostly ignored thus far. Fintech epitomizes the core principles of decentralization. Fintech brings information closer to the edge and serves the consumers, it disrupts centralized structures in finance and forces the disrupted financial conglomerates to serve the consumer better.
Like fintech, the merger of the regulatory and legal markets with technology (RegLegalTech) is changing the legal and regulatory landscape and decentralizes the application of regulation in many industries. The RegLegalTech sector has evolved from support systems to fully integrated and automated services that increasingly disrupt diverse sets of industries. RegLegalTech can generally be defined as information technology services and software, as well as platforms and their applications. Since the 1970s, with the invention of the first legal databases, RegLegalTech has supported existing ways of operating and practicing law. In fact, RegLegalTech created the need for additional lawyers to evaluate the new legal materials that are made more quickly available and more easily accessible by technology. At first, RegLegalTech made law firms and lawyers more efficient in performing their activities. Examples include automated billing, document storage, practice management, and accounting software. In the early 2010s, RegLegalTech became more advanced and started to include technology that assisted legal professionals in due diligence and e-discovery processes. Since 2015, RegLegalTech has continued to evolve in unprecedented ways. Multiple startup companies and their investors have started to capitalize on technologies, and their applications are already replacing some junior lawyers and disrupting the existing parameters for the practice of law.
Four categories of startups in RegLegalTech can be distinguished. The first category includes startup companies that offer a range of online legal services, removing the in-person legal consultation process and guidance process for clients. The second RegLegalTech startup category involves online “matching” platforms that connect lawyers with clients. Such platform startups help consumers find a fitting lawyer without the costly involvement of a law firm. The third category entails startups that use AI tools to take over their lawyer clients’ time-consuming and expensive legal research activities such as reviewing, understanding, evaluating, and reapplying contracts. Finally, startups with expertise in blockchain technology attempt to replace lawyers as intermediaries in certain types of transactions.
The decentralization that is a central part of the RegLegalTech startup companies’ purpose and that disrupts existing practices has broad repercussions for the legal and other professions. First, existing legal and intermediary services are either rendered increasingly irrelevant or replaced by RegLegalTech. Junior professionals and support staff are likely the first victims of the RegLegalTech evolution. RegLegalTech applications will be able to perform most of a junior lawyer’s work in the near future without the human elements that create imprecision, flaws, inaccuracies, possible lawsuits, and delay. Second, and most importantly, the legal profession will be forced by such startup companies to innovate, a task that is not easily accomplished by overextended, and often cumbersome, legal organizations that have lost the capacity for agile reinvention.
Part 2: The Presence
The Brave New World of Decentralization
Emerging technology enables the evolution of decentralization. A review of blockchain technology provides the earliest possible insights into how decentralized technology solutions may continue to shape and transform commerce and society. The emergence and proliferation of distributed applications (DApps) in the aftermath of the invention of the Bitcoin protocol in 2009 demonstrate that a nascent market for such applications and consumer demand already exists. Consumer preferences will continue to shape the DApps market and the solutions it may offer for commerce and society.
Blockchain technology creates a platform for trust through truth and transparency for parties. Because the blockchain (at the least the public blockchain) is in fact public and immutable, the technology increases transparency, while at the same time significantly reducing transaction costs. Blockchain technology provides formal guarantees to participating parties. Because of the blockchain guarantees, the technology allows a qualitatively different solution for agency, a foundational element of capitalism. The immutability of the blockchain and its cryptographic security systems provide transactional guarantees and create trust between parties. Such guarantees ensure no participant can circumvent the rules embedded in blockchain code. Blockchain guarantees include contract execution only if and when all contract parameters were fulfilled by both parties and verified by a majority of miners/nodes in the system. Hence, in the blockchain infrastructure, there is no need for the principal to institute oversight and monitoring with the associated agency costs. Because of the governance guarantees embedded in code, blockchain addresses the inherent agency problems in modern finance and corporate governance comprehensively.
Blockchain technology secures the integrity of contractual relationships by removing fraudulent transactions. Compared with existing methods of verifying and validating transactions by third party intermediaries (banking, lending, clearing etc.), blockchain’s security measures make blockchain validation technologies more transparent, faster, and less prone to error and corruption. While blockchain’s use of digital signatures helps establish the identity and authenticity of the parties involved in the transaction, it is the completely decentralized network connectivity via the internet that allows the most protection against fraud. Network connectivity allows multiple copies of the blockchain to be available to all participants across the distributed network. The decentralized fully distributed nature of the blockchain makes it practically near impossible to reverse, alter, or erase information in the blockchain. Blockchains’ distributed consensus model, e.g. the network “nodes” verify and validate chain transactions before transaction execution, makes it extremely rare for a fraudulent transaction to be recorded in the blockchain. Blockchain’s distributed consensus model allows node verification of transactions without comprising the privacy of the parties. Blockchain transactions are therefore arguably safer than a traditional transaction model that requires third-party intermediary validation of transactions. Blockchain technology is also substantively faster than traditional third-party intermediary validation of transactions.
Cryptographic hashes used in blockchain technology further increase blockchain security and removes trust barriers in commercial relationships. Cryptographic hashes are complex algorithms that use details of the existing entirety of transactions of the existing blockchain before the next block is added to generate a unique hash value. That hash value ensures the authenticity of each transaction before it is added to the block. The smallest change to the blockchain, even a single digit/value, results in a different hash value. A different hash value in turn makes any form of manipulation immediately detectable. As such, hash cryptology provides another level of guarantee in commercial relationships executed through blockchain technology.
In summary, blockchain technology creates an independent and transparent platform for establishing truth and building trust. Intermediaries, bureaucracy and old-fashioned procedures are replaced by: code, connectivity, crowd, and collaboration. The technology increases openness and speed, while at the same time significantly reducing costs. But perhaps the most significant feature of blockchain is that it is so adaptable. There are multiple possible applications relevant in a business context.
Technology-enabled decentralized commerce is subject to far fewer and rather different transaction costs compared with centralized legacy businesses in the same industries. The decentralized emerging technologies used in decentralized commerce can increase the overall trust of consumers and market participants at an unprecedented scale. Trust can help lower transaction costs, but it also increases consumer and overall market confidence and certainty, which facilitate economies of scale that may not be possible in centralized structures. Moreover, because of their lower cost structure, decentralized platforms have the ability to remove consumer fees that are an integral part of their centralized competitor businesses. Removing such centralized fees also allows for the eradication of downward pressure on the platforms’ worker compensation because costs are less likely to increase and be passed on to workers and consumers. The lack of fees can help create a more efficient marketplace through the removal of the rent seeking intermediators.
Blockchain technology has vast disruptive, innovative properties. Despite the very early-stage development of blockchain technology, the possible applications are significant. Consider the blockchain-based currency, Bitcoin. Until recently, most commentators viewed Bitcoin as a hype — susceptible to fraud, price manipulation, and corruption. But today, the issue is no longer whether cryptocurrency will survive, but rather how it will evolve. The high levels of investor activity in the blockchain area appear to provide a reliable indicator of the commercial maturity of blockchain technology. Venture capital (VC) investment in startup companies that utilize blockchain technology has increased exponentially since 2012 but diminished during the crypto winter. Investor interest in the technology will likely further increase as new applications and uses materialize. Particularly, the applicability of blockchain-based smart contracts to digital marketplaces, the sharing economy, the IoT, and AI will further accelerate its development.
Take for example, business, administrative, and legal processes that rely on intermediaries. Any such processes may become redundant because of advances in, acceptance and implementation of blockchain technology. Corporate processes that have ledger functionality but rely on legal intermediaries could be streamlined very quickly by implementing blockchain technology. When blockchain technology becomes more widely accepted and applications spread into consumer territory, existing processes and structures will likely be among the first processes to become redundant. For instance, forms of keeping legal ledgers — such as notary and registry services, motion practice in court, and legal title searches, among several others — may be among the first services to disappear in the not-too-distant future.
The combination of blockchain technology startups with platforms, AI, and machine learning offer opportunities for developing new technologies. Leveraging the big data that is collected by using tech solutions and blockchain applications in combination with machine learning creates more creative and faster tools. This, in turn, creates a surge of new and innovative platforms with disruptive effects for many industries.
Decentralized payment systems’ ability to rely entirely on cryptocurrencies creates comparative advantages in orders of magnitude over centralized systems. Centralized fiat payment systems and platforms typically require some form of an existing banking relationship in order for consumers to utilize their services. Holding and storing cryptocurrencies does not require a banking relationship. Centralized fiat payment systems are subject to payment processing issues and slow processing times for payments. They also require high fees for intermediaries that facilitate the payment process such as banks and PayPal, among others. The fees make it only economically viable for higher volumes of transactions, creating barriers to entry in the process. Decentralized payment systems are not subject to these limitations. Finally, while money laundering has traditionally been a problem in these markets, anonymity of market participants in cryptocurrency networks can also increase participation in certain markets and economies. As the technology and its uses evolve, traditional markets are increasingly encapsulated by it.
A growing body of evidence suggests that stable cryptocurrencies may play a role in the world economy. In 2018, the IMF estimated that 11 countries are at 20% or higher inflation. Using black market exchange rates measured weekly, the Cato Institute’s Troubled Currencies Project estimates that the real rates are significantly higher than the IMF estimates. Currency devaluation is rampant in many countries, e.g. Venezuela (2018: -99%), Argentina (2018: -53.2%), Turkey (2018: -38.4%), and Brazil (2018: -20.6%). In the United States, transacting in cash costs the consumer around 200 billion dollars annually — about $637 per person. The cost of cash is primarily associated with counting, managing, storing, transporting, guarding, and accounting for bank notes. The theft of cash alone costs U.S. retail businesses lose around $40 billion annually. Similarly, according to one study, one in every $12,400 of cash notes printed may be counterfeit. The effect of corruption on economic welfare is significant. More corrupt countries also experience significantly lower rates of investment in the respective country. Corrupt countries are also subject to a significantly higher inflation rates. Several studies demonstrate that the poor and those with less access to institutions bear a disproportionate share of these costs of using cash.
Cash and bank notes are gradually losing ground to other payment systems. Whereas the overwhelming majority of humans live in cash economies where at least 90% of transactions are conducted in cash, consumers in wealthier economies tend to favor noncash alternatives. Cash usage in the United States, the United Kingdom, the Netherlands, Sweden, Finland, Canada, France, among other industrialized nations, has fallen well below 50% of total transaction volume. Most significantly, in Northern Europe as few as one in every five transactions are made in cash.
Central banks and governments around the world have been experimenting with government-sponsored digital currencies and cryptocurrencies since 2015. In the case of central banks, such experimentation is already close to launch or fully operational. Several governments have issued their own digital currencies. Most major tech companies in the private sector have been experimenting with cryptocurrency projects since 2017. Examples include Tunisia (eDinar), Venezuela (Petro), Senegal (eCFA), Sweden (eKrona), Dubai (EmCash), Japan (Jcoin), and Estonia (Estcoin), and Ecuador, among others.
Several factors explain such early experimentation in the public sector. The end of technological life cycles of legacy systems and associated emerging trends in payment systems necessitate central banks’ enhanced examination of cryptocurrency solutions. Central banks in countries with rapidly declining cash usage are subject to the most pressure to find solutions for bank note alternatives.
The private sector also continually engages in cryptocurrency experimentation. Most cryptocurrency exchanges are creating their own stable cryptocurrency. On February 14 2019, J.P. Morgan introduced the first prototype of its blockchain settlement product: JPM Coin, a stable cryptocurrency backed one-to-one by JPM’s fiat currency reserves. Finally, Facebook’s Project Libra is developing a stable cryptocurrency in an attempt to break into the financial services business.
The rise of an early stable cryptocurrency design, Tether, in terms of its total market capitalization, its stability around $1 value, and investors’ uses of Tether as a temporary safe haven, provides some support for stable cryptocurrencies’ ability to create market stability, even if only temporarily. Like all other stable cryptocurrency projects, Tether is still afflicted with significant design challenges.
The total volume of stable cryptocurrencies relative to the rest of the cryptocurrency market is growing consistently. The growth of stable cryptocurrencies can largely be traced back to attempts to combine the utility and benefits of cryptocurrencies and blockchain technology with remedies for the existing fluctuation and volatility in the cryptocurrency markets. The growth data suggests that demand for products that help manage the volatility inherent in other crypto assets is likely to continue to increase.
Many leading legacy businesses are actively involved in attempts to neutralize disruptive decentralized innovation. The smartphone sector provides a prominent example. The smartphone sector has demonstrated that 24/7 hour transactions are possible worldwide, bringing knowledge and information to the edges, in any language or currency, across borders, regardless of communication technologies. The smartphone technology thus created new markets with smaller players that are competing with leading legacy businesses. Take for example what Skype did to the telecommunication market. The competition to win the resulting technology battle is intensifying at an alarming pace. In their attempts to neutralize their decentralized competitor businesses, legacy businesses are acquiring little-known companies with highly competitive decentralized technologies. Microsoft’s acquisition of Skype provides a prominent example. Legacy businesses’ attempts to control decentralized competition is still in its infancy. The effect of curtailing decentralized solutions by integrating them into centralized power structures may actually be the long-term incremental proliferation of decentralized solutions.
Some examples help illustrate the impact of technology on industries and its accelerating pace. The travel industry, which moved from established brick and mortar business to fully online service providers, is just one example that illustrates the impact of technology on industries and its accelerating pace. Even formerly disruptive businesses, such as Amazon, as its platform ages after over a decade without much change other than added categories, are now forced to try to preserve their place in the respective industries. Amazon has started to offer delivery as a service after getting a lesson from the more aggressive Chinese providers, demonstrating that Amazon had been out of touch with today’s technology offerings.
Governmental decentralization trends (discussed above) are counteracted by a political shift around the world. The lack of legitimacy and antiestablishment surge in politics in combination with growing public concerns about inequality, stagnating wages, trade sanctions, immigration, the debt crisis, and China’s rising power have fueled a recent political shift. Political parties in Europe have started the gradual process of moving away from markets back to the state. Political parties across Europe are emphasizing increased welfare spending, renationalization of formerly privatized public service providers, bigger pensions, and higher taxes for the corporations, among other measures aiming to reverse decades of pro-market policy. Political parties employ such measures in an attempt to stop the exodus of voters to populist and antiestablishment parties. Some analysts see this as a continuing countertrend to the political decentralization in the 1970s under Thatcher and Reagan, arguing that the zeitgeist of globalization and liberalization is over.
The distributed app economy and decentralized commerce are subject to multiple limitations. Currently, smart contracting and DAOs are the focal point for the future of decentralization. Yet, in 2019, decentralized commerce is relegated to the trading and exchange of cryptocurrencies and basic smart contracting. DAOs are in their infancy and cannot currently overcome core governance problems while maintaining a decentralized structure. The low transaction throughputs of public blockchains is a core limitation that holds back more advanced DApps. Some examples from centralized businesses may suggest that these limitations can be overcome relatively quickly in the future, if centralized technology solutions are guideposts. For example, the proliferation of open APIs by start-ups have influenced the financial sector significantly, allowing companies like Facebook and Salesforce to rise from nothing to dominance in a decade,
Other core infrastructure products that do not exist in 2019 but are needed for the evolution of decentralized commerce include: (1) truly decentralized consensus combined with higher levels of transaction throughput. Currently, the data mining required to provide scarcity also slows creation so that high speed transactions cannot be achieved for the foreseeable future. (2) evolutionary governance designs that overcome the need for hardforking, (3) decentralized underwriting protocols that enable democratized access to insurance, and (4) verification protocols for smart contracting, among other decentralized infrastructure needs.
Without a core use case, other than the store of value (in Bitcoin), decentralization technology is less likely to proliferate. Banking and money transmission related services and triple entry accounting via blockchain technology are natural use cases, but they fall short in their application as the universal use cases for public blockchains. While these use cases will likely be implemented sooner or later, the proliferation of public blockchains may necessitate what is commonly known as the “killer app.” Presently, it is still unclear what that killer app may be. The recent experimentation by Facebook’s Libra system can help provide some guidance on what system requirements may work at scale.
User access and usability of existing decentralized technologies fall short of mass adoption needs. In the current decentralized system requirements, users are required to know quite a bit about their security and overall system operations. Consumers need to manage their own security access points. Currently, no system exists that give consumers and an experience comparable to iTunes, helping consumers manage access to decentralized currencies, decentralized services, and other products. Without such intuitive consumer support access points, it is difficult to see how decentralized systems can ever reach mainstream consumer adoption. It will be very difficult to educate the public sufficiently to seamlessly adopt decentralized protocols in their daily life if users have to discern and manage public and private keys to wallets, among other concerns.
Finally, people will not enter into a long-term smart contract unless they have a stable currency to refer to. The current level of volatility in cryptocurrencies does not lend itself to consumption. In other words, if the consumer has to consider the investment implications of using Bitcoin for a consumer transaction, e.g. “my banana is twice as expensive this week if I pay in Bitcoin,” cryptocurrencies are less likely to be used in consumer transactions. Similarly, a renter and a landlord will not gamble their future wealth on a smart contract lease that may halve or double in value in any given month.
The transferability of stores of value entailed in cryptocurrencies creates core points of attack and undermines the very nature of decentralization. Because of the store of value entailed in cryptocurrencies (and really any currencies or store of value), exercise of power over such value inevitably leads to centralization due to economies of scale.
Unleashing the Power of Decentralization
The existing limitations for decentralized commerce can be overcome. Emerging technological improvements, such as the proliferation of smartphones, among others, enable overall higher levels of applications of big data solutions and higher transaction throughput in decentralized systems. The rapid advances of AI in combination with big data and machine learning have already affected many of the sectors of the economy. The combined effect of AI, big data, sensors, and blockchain technology foreshadows a market expansion for DApps.
Stable cryptocurrencies facilitate decentralized commerce. The adoption, evolution, and acceleration of decentralized commerce depends, in part, on the functioning and stability of cryptocurrencies. Stable cryptocurrency designs allow most cryptocurrency platforms to function better and provide more stability for their users, if currency stability can be attained. Stable cryptocurrencies can be expected to create widespread usage in cryptoasset trading, payments for products and services in decentralized applications, commerce across industries, and as a treasury currency for decentralized projects. Because of their disciplining and market stability enhancing effects, stable cryptocurrencies are part of the future financial technology infrastructure that will form the backbone of any emergence of the distributed app economy and decentralized commerce. In turn, decentralized commerce has knock-on effects for the evolution of stable cryptocurrencies.
Decentralized underwriting is of core importance in any iteration of future decentralized technology solutions. Without someone or something that functions as an insurance policy should risks in commerce materialize, the public has no reason to try to benefit from the potential benefits of decentralized commerce, such as substantively lower transaction and agency costs. Most sophisticated smart contracts will require a form of insurance/underwriting to offset the risks of possible failure. Most legacy insurance companies will not consider underwriting a smart contract that is not subject to the traditional legal framework. Even if legacy insurance companies should over time begin to offer insurance product for the DApp market, it is questionable if they will be able to provide insurance products that actually fit the need of emerging decentralized commerce. Actuarial methods for risk assessment under traditional insurance metrics may be only partially compatible with rapidly evolving decentralized products. Decentralized underwriting is more adaptable and serves a particular function in the proliferation of decentralized commerce.
Decentralized underwriting democratizes the functions of banking and insurance. This makes these features of finance more efficient because it frees untapped sources of knowledge. Democratizing underwriting in this manner is also more secure and stable because:
1. It diversifies lenders and underwriters, which adds liquidity in all states of the economy;
2. This diversity silos losses so there is less cascading during economic crises;
3. Moral hazard detection and selection bias detection is distributed, to access greater knowledge at the edge with more opportunity for transparency, accuracy, and opportunity;
4. Blockchain technology is more transparent and therefore more easily auditable, so an underwriting DAO is theoretically capable of being more responsive to regulation (if its governance process is well designed);
5. Democratized banking is more responsive to regulation because ideas at the edge have a greater opportunity for affecting policy than centralized structures such as the existing global hierarchy which leads to a single group in Basel, Switzerland providing the dominant voice.
Decentralized banking frees economic resources that are less optimally released in legacy banking. The slow, transparent evolution of decentralized finance solves the multiple equilibria problem of acquiring public confidence in the system that underwriting provides in many areas. Banking works measurably better when it reaches an equilibrium state that comes from public confidence in the institution, and that public confidence is supported by public confidence in a feedback loop that raises the efficiency of an economy. Traditionally, this leap was made by governmental fiat, e.g., FDIC underwriting backed (implicitly) by the US government. Decentralized banking uses blockchain technology’s property of complete transparency, a permanently uneditable record, and equal access to all, in order to provide a continually auditable system to slowly and stably build toward this higher equilibrium of public confidence. As decentralized underwriting emerges, it may someday in the future become a decentralized supplement to FDIC insurance for banking services.
Emerging decentralized reputation systems facilitate and accelerate evolving decentralized commerce. Why is decentralization enhanced through decentralized reputation systems? Smart contracts allow anonymous parties to engage in decentralized commerce by providing automated contracting that self-executes and self-regulates according to mathematical strictures. Smart contracts are evolving quickly. Their evolution enables most business logic to be included in smart contracts over time.
A simple example involving smart property may help illustrate the uses of smart contracting. The example illustrates that smart contracts can self-execute in a decentralized environment with anonymous actors. Consider the example of a home owner making her house available for rent. The home owner posts a smart contract with the terms she will accept, including length of stay, price per night etc. After encumbering an asset in the smart contract, a renter would be able to unlock and use the house with a private key digital signature which would only work for the contractually agreed period paid. The smart lock of the house allows the renter to enter if and when all conditions specified in the contract have been satisfied, e.g. the deposit was encumbered and other qualifying criteria for the renter were fulfilled. On the one hand, if the home is not in the agreed upon condition at any time the rental contract started, the smart contract could automatically reimburse (part of) the encumbered deposit. In turn, if the house was not returned at the agreed upon time, the renter would lose (part of) the encumbered deposit.
Smart contracts provide multiple benefits for businesses. Smart contracts are intended to simplify and automate business, removing transaction costs, and creating certainty for counterparties. They make business transactions fully secure and efficient. It is also inexpensive to run smart contracts on a blockchain. The smart contract near optimally coordinates the relationship between the anonymous parties and removes the need for agency / intermediaries almost entirely. Negotiation between counterparties is near minimal, transaction cost typically associated with contracting are almost entirely removed by the automation. The inherent mathematical logic of computerized code in smart contracts can optimally clarify parties’ intent. It also increases certainty and creates unparalleled efficiency which in turn incentivizes commerce. Most importantly, the smart contract removes centralized guarantors. The smart contract self-regulates. Only limited legal recourse is available if something goes wrong in the execution of the terms of the smart contract.
Despite the significant benefits of smart contracting for business and society, smart contracts are subject to significant limitations. Human business interactions require a flexibility that is at odds with merciless mathematical logic of smart contracts. Human interaction requires flexibility in interpreting intent that cannot be ensured by smart contracting because smart contract code does not follow the same logic on similar terms as natural human language. Smart contracts also undermine counterparties’ ability to continue collaboration when unanticipated eventualities arise. In most cases of unfulfilled parameters, the smart contract will simply cancel out. Human business interaction also typically requires the possibility that each party may fulfill only a portion of any intended collaboration. While more sophisticated smart contracts over time can fulfill some of these human business requirements, the needed flexibility in existing decentralized protocols will unlikely ever be attained unless a decentralized verification system is built into decentralized commerce.
In as much as reputation enables truly decentralized solutions, reputation is also the key ingredient that enables commerce. Centralized capitalist institutions have been built entirely around centralized and hierarchical reputation systems. Bitcoin proved that a decentralized system can automate the transfer of valuable digital currency without intermediaries, no centralized authority for recourse, efficiently, securely, cheaply, and expeditiously. Until blockchain technology was introduced via Bitcoin in 2009, decentralized reputation systems mostly relied on the roughly 25 year old corruptible concept of the Web of Trust. Yet, Bitcoin and other cybercurrencies have repeatedly been attacked successfully and are plagued by security incidents. Whether such security incidents are occurring on centralized cryptocurrency exchanges or in other centralized systems that are appended to the decentralized structures or the decentralized systems themselves is immaterial in this context. The security concerns are seen by the public as a technology risk across technologies.
Decentralized reputation verification systems enable mathematically rigid smart contracts to become more adjustable for the needs of business. Reputation verification becomes the backstop for smart contracting. While the rigorous standard of “code is law”, associated with smart contracting, can be upheld, reputation verification enables smart contract template verification. Validated templates of smart contracts increase trust for counterparties. The validation removes the need for costly back-testing and experimentation with smart contract templates.
Part 3: The Future
How to Make Money in Decentralization
Decentralized technology inaugurates new forms of economic exchanges. Historical evidence has demonstrated that every time decentralization emerges in a given industry, profit margins disappear. Examples include Skype’s effect on the telecommunications industry and Emule’s and Napster’s, among other file sharing systems, effect on the music industry. Yet, these are examples that predate the emergence of decentralized technology. With the emergence of the Bitcoin protocol, decentralized technology has created early structures that are emerging into new forms of economic value systems and economic exchange.
Human society and economic systems have revolved around political doctrines for organizing society and allocating resources for the last two centuries. First and foremost among those are the dichotomies of capitalism and socialism which are seen as mutually exclusive for the most part. Society is organized around those notions and has formed power structures and political hierarchies to serve these ideas.
Decentralization transcends traditional economic notions of capitalism and socialism. Decentralization uses elements of profit generation and redistribution in a way that in effect combines capitalistic and socialistic ideas. Decentralization allows for the organization of society in economic structures that generate profits while at the same time redistributing resources.
Take for instance, the ability to sell one’s personal (e.g. social media etc. consumption) data, preferences, opinions etc. in decentralized systems, including in real time. Such assets, e.g. one’s data, preferences, opinions etc. can only limitedly be commercialized in existing centralized structures. In decentralized structures such assets can be tokenized, valued, and mobilized. Similarly, tokenized hard assets, such as real-estate, can be tokenized and sold in unprecedented fractional forms. The ability to control one’s data and fractionalized (hard) assets enables new forms of consumption for consumers. For instance, many startups are already working on a barter system in which services, such as free car rides etc., become available in return for disclosure of consumer’s data and personal preferences etc. These are only early examples of what decentralized systems may facilitate for consumers in the new economy.
Centralized businesses will change as a result of the new decentralized business structures that are emerging. Existing centralized businesses have started to evaluate ways to expand existing business lines or adapt other business lines to continue to stay competitive with both centralized and decentralized business competitors.
Common ethical principles define most governance structures. Defining the boundaries for such a common ethical denominator has proven difficult in any prior attempts to organize society. Decentralized systems are no exception. Without a core common ethical denominator, decentralized systems cannot last, they lose coherence, become attackable, and can be corrupted, leading to suboptimal societal outcomes.
Ethical governance is at the core of any ethical design of decentralized systems. Blockchain technology offers humanity new tools that directly address the problems at the root of why governance has continually been plagued by corruption throughout the ages. Blockchain technology gives uncensorable transparency with its opposing tension of privacy; decentralization of power with strict accounting for that power. As such, decentralized technology has the potential to provide a better incentive design for ethical decision making.
Ethical governance asks: how will power over decision making be distributed, i.e., as the system progresses in time, who will be rewarded with more power and who will be punished with loss of power? Secondly, who changes the rules governing the day-to-day functioning of the decentralized system, and who changes the rules governing how to change the rules? The first question concerns executive governance and the second addresses legislative governance.
These are essential questions that have plagued every human organization that has ever existed. However, blockchain technology gives humanity new tools for anonymity, transparency, and permanency of records that can enable fully decentralized governance, while maintaining privacy, distributing power justly and efficiently, and preventing censorship.
By way of overview, the core objective of decentralized governance designs is to create the proper incentives that help independent and selfish actors to be organized and to collaborate productively towards a common goal. From a quite pragmatic perspective, addressing precise choices of parameters in algorithmic token design, it is important to underscore which choices relate to which values a group may prefer.
As a simple example, the profits of a DAO must be chosen to be distributed in some ratio with the members who do the present work which garners the profit, members who have previously done such work which built the reputation of the DAO, members who designed the protocols for how to do the work, and with members who designed the governance structure which initiated the DAO. The choice of distribution weights which determines how much each of these four groups shares in the profit should match the current values of the DAO. A greater share for new workers will attract new workers, a greater share for the older workers will signal long-term stability, while a greater share for the protocol designers will attract more innovation.
Another core ethical governance problem revolves around system attacks. Someone can always game the system. It is a mathematical fact that is essentially encapsulated in the “Folk Theorems of game theory”. For any static set of rules in an infinitely repeated game using reputation (stakes), there is a way to subvert the rules for an individual’s profit at the expense of the group. A dynamic, changing set of governance rules can address the conundrum, and can set up the incentives necessary to stop the abuses.
** Professor of Law, University of St. Thomas School of Law (Minneapolis, USA)