Third Time’s the Charm

I first heard about Bitcoin from my classmate Bobby Lee, the co-founder of BTCC, in mid-2013, which prompted me to make a few test purchases totaling the handsome sum of 0.02 BTC. As BTC’s price soared above 1000 USD, the excitement around me was palpable, and the local meetups I went to became ritzier, with attendees flying in from all over the world. Then came the announcement from China’s central bank in December of 2013¹, banning financial institutions from trading Bitcoin or working with trading platforms. As the price of BTC took a dive and went into a slow decline for the rest of 2014, so went my attention on all things crypto.

Probably should’ve bought more than 0.02 BTC …

I first heard about blockchain from my classmate Alex Liu, the co-founder of MaiCoin, in late 2015. Alex suggested that I attend a hackathon sponsored by Deloitte in Shanghai. Blockchain, I soon learned, was the underlying technology that enabled Bitcoin, and had potential applications going far beyond just currency. I met a lot of interesting people at the hackathon: a startup founder named Vitalik Buterin, a blogger name James Gong, and a Canadian blockchain team named Rubix. However, as I dug deeper, the predominant wisdom at the time was that blockchain was a great piece of technology that could be leveraged to improve corporate efficiency in the form of private chains and consortiums, almost like the next iteration of ERP software, not exactly what I would call an exciting innovation. My attention waned once again.

Vitalik talking at the Wanxiang / Deloitte Shanghai hackathon in 2015

My third brush against blockchain was brought to me by another classmate of mine, Jianbo Wang, in mid-2017. His conversation went from “Do you know anything about blockchain?” to “I’m quitting my job to join a blockchain startup” within a span of a few weeks. His conviction was infectious, and for the third time I ventured in to investigate, and saw something quite different.

Putting the Pieces Together

Very early in my career as a strategy consultant, I was posed with a most fascinating question from a client’s CEO: how do I fairly allocate resources amongst my business units? It’s a question that made me realize something almost absurdly obvious: that modern corporations are in fact planned economies. In a competitive market, the natural pricing mechanism allocates resources. In a planned economy, the planners (or “managers”) decide how to allocate resources. But as any first-year economics student can tell you, unless the manager has perfect information, it’s next to impossible for her to make decisions that are as or more efficient than those made by the market — a limitation my client obviously appreciated.

How did we end up with these centrally-planned corporations with layers upon layers of management amidst our global market economy? There are undoubtedly many factors, but I believe a key driver is the need to coordinate ever-larger amounts of capital and ever-lengthening value chain operations to fully take advantage of technical advancements and economies of scale. The degree of centralized coordination necessary is of course dependent upon the type of economic activity — e.g., a legal advisory firm could be far more decentralized and flat than say a car manufacturer.

As technologies keep increasing in complexity (e.g., the industrial revolution, the information revolution), we’ll only see more corporations increase correspondingly in both size and managerial complexity. While necessary, this type of centralized, multi-layered coordination apparatus suffers from several pitfalls,

It tends to be highly resistant to change It creates ever-more administrative functions to facilitate internal and external coordination It invariably tries to leverage rent-seeking models and information asymmetry to maximize its profits

As a side-note, these are only pitfalls if the objective is to maximize society’s overall efficiency. In another light, some of these “pitfalls” may be alternately referred to as “competitive advantages” that directly contribute to the bottom line of the stakeholders involved. It’s only natural that corporations would look after their own self-interests, as should any free market participant.

Can we do better? How can we buck this trend? What’s blockchain’s role in this?

De-layering and Decentralizing the Corporation

Blockchain and smart contracts together enables the breakdown of the excessive layering of the corporate managerial structure and replace the planned economic model with a more market-driven one. The corporation could be broken down into the most basic participant entities with a much flatter managerial layer or none at all. Multiple layers of human managerial coordination could be replaced by smart contracts, and the participants are free to choose different smart contracts (in the process rewarding different smart contract writers) to execute in order to maximize their own economic interests — in today’s corporate structure, employees don’t usually get to choose their own boss, much less switch them out.

This decentralized ecosystem enables more autonomy and more choices for its participants. If it’s more profitable for the participants to work together, they will choose to collaborate. If, however, as is often the case, some of the existing participants are more or less efficient than external market alternatives, the participant mix will change. Choices also extend to existing participants adopting new innovations or introducing innovative participants into the ecosystem, sans interference from managerial fiat.

Minimizing Coordination Friction

Much of the administrative overhead could also be replaced by the blockchain ledger and smart contracts, hence minimizing the friction involved in the process of continuous coordination. Certain functions such as accounting and auditing could be almost entirely replaced by records on the ledger — almost, since you’ll still need people to ensure the integrity of the off-chain inputs. Any internal administrative functions and external third parties who exist to guarantee the integrity of exchanges can also be minimized or eliminated.

How is this different than business productivity software systems currently being used? Current systems create streamlined automation, but they do not enable trustless entities to collaborate without a third party, and they do not extend outside of a confined, centralized and carefully planned system. That is, existing business productivity software work great under a permissioned environment where all parties are known and could be trusted (private blockchain implementations are similar in this regard). What a public blockchain ecosystem allows is for the frictionless coordination between unknown and non-trusted parties outside of your immediate circle, creating more opportunities to freely collaborate and to compete.

The ability to collaborate and coordinate with a far larger set of trustless participants will also create a far more efficient market as information becomes increasingly symmetric across value chains, sectors, and geographies, further increasing overall market efficiency.

Maximizing Fairness

In our current economic ecosystem, a corporation does everything it can to maximize profits and shut out competitors, including unfair practices such as developing rent-seeking models (charging fees without adding value) and leveraging information asymmetry (gaining profits from having more information in evaluating true market price). In practice, the line between fair profit-seeking behaviors vs. unfair ones is often not clear cut, but let’s examine the underlying incentives that drive such behaviors, and how blockchain ecosystems are different as a result.

Blockchain ecosystems, by and large, tend to be built on open-source knowledge. This significantly lowers the barriers for new entrants to build new ecosystems based on the existing one by simply copying (forking) this knowledge. As more open-source decentralized ecosystems develop, it’ll become increasingly easy to replicate any given ecosystem with a few key strokes. This is not to say that participant habit, participant awareness, and the value of existing networks are non-factors during switching considerations, it just means that for the first time, means of production (decentralized participants) and know-how (encoded logic of the ecosystem) could be replicated without expending significant cost.

Should an ecosystem become perceived to be “unfair”, participants could therefore fork a new ecosystem, change the rules, and migrate. This creates an interesting incentive for existing stakeholders, especially the large ones, to ensure that the ecosystem is perceived to be fair. The larger the stakeholder, the more he is incented to increase the value of his stake, which in turn is directly tied with the number of transactions and the amount of meaningful participation in the ecosystem. To these stakeholders, it is definitely not a good idea for participants to leave en masse, hence they have a strong incentive to continuously drive fairness into the ecosystem.

The Vision

A recent New Yorker article² referenced an interesting statistic that hints at decentralization trends already at work. Looking at US historical data, there has usually been an uptick in the number of contract jobs (as measured by the number of Form 1099 filings) during economic downturns and a corresponding decline in contract jobs during economic recovery — as one would expect. This however was not the case during the most recent 2009 recession, as the number of contract jobs actually continued to grow even after the economy was well into its recovery. Apparently, working a steady job for a large corporation is becoming a less attractive for an increasingly large portion of the labor force. Even without blockchain, society is decentralizing, all by itself.

The 2009 recession has been a tipping point for decentralized economic models. It brought the sharing economy to the forefront of our collective consciousness with companies such as Uber and Airbnb, platforms that enabled strangers to collaborate. It also brought us Bitcoin, the first blockchain application, borne out of a fundamental belief that the world could be made more efficient if decentralized entities could collaborate in a trustless manner without the use of third-parties.

Blockchain technology isn’t disruptive, it’s merely enabling and accelerating a socioeconomic movement that has already been in motion. It has the potential to help society fundamentally reorganize its economic activities away from the centrally-planned economic entities we call corporations into a myriad of decentralized ecosystems, helping to create a more efficient and fair future.

I don’t know about you, but for me, the future couldn’t come fast enough.

[1] China bitcoin exchanges say certain banks to close their accounts, https://www.reuters.com/article/us-china-bitcoin/china-bitcoin-exchanges-say-certain-banks-to-close-their-accounts-idUSBREA3A11J20140411

[2] Is the Gig Economy Working? https://www.newyorker.com/magazine/2017/05/15/is-the-gig-economy-working