Ownership Will Eat the Software That’s Eaten the World
Network effect businesses — like social media platforms, peer to peer lending platforms, and marketplaces across a variety of verticals — derive most of their value from the actions of their users. In almost every case, these users receive a minimal portion of the value they create relative to the owners of those platforms; even worse, users are manipulated to act in the best interests of owners, often at their own peril. Network owners were always incentivized to maximize value (having a fiduciary duty to their shareholders), but when the network effects became too strong, locking users into these closed, monopolistic platforms, the way of extraction changed: owners recognized they could push new, morally questionable boundaries to extract even more value without losing these users, and they did. Software ate the world, but then it started eating us, or rather the owners started harvesting us — for our time and attention, our money and data — because they were incentivized to.
While everyday users are finally starting to wake up to this and the subsequent fallout effects in certain verticals, developers are already intimately aware: platforms that had worked with outside developers in the past shifted their approach and became competitive instead, for many resulting in the destruction of their businesses and an erosion of trust in these companies that never deserved their trust in the first place.
The value of decentralized, open source platforms that didn’t require trust in a 3rd party (nor offered the ability for a 3rd party to abuse that trust) became overwhelmingly obvious to a group of developers, and gave birth to the Web3 movement. Unfortunately for these developers, translating that value into a product experience on par with centralized offerings has been outright impossible given the established network effects and coordination ability of closed systems. And the fact is, no matter how much we preach about the benefits of decentralization, the overwhelming majority of users, even those intimately aware of the downsides of centralized networks, won’t change their behavior until the experience and incentives of decentralized networks make this choice clear.
Ownership Experience: a New Experience for Users, but not a UX
Network Mining is a programmatic ownership distribution mechanism that attempts to dynamically allocate ownership of a network to the users performing actions that drive value to it. Given DeFi protocols currently require deposited capital to operate effectively, this mechanism became known as “liquidity mining,” as the distribution of tokens is based on the proportional liquidity provision to the platform. Incentivizing initial liquidity helps bootstrap these two-sided marketplaces and alleviate the chicken-and-egg problem, getting them off the ground and eventually to a point where liquidity can snowball organically. Further, additional liquidity 1) drives more efficient markets with lower price and interest rate slippage; 2) offers higher capital availability allowing for larger trades/positions (and more fee revenue, sometimes passed to tokenholders); while 3) establishing a competitive moat (you can’t fork liquidity, just reallocate it short term; see Uniswap vs. SushiSwap).
Protocols allocate these rewards differently based on the ecosystem participants and their specific roles in driving value, and most try to optimize for a distribution proportional to the value each user created. The concept of ownership distribution isn’t new: even Bitcoin’s mining process employs this mechanism, rewarding miners (who provide value to the Bitcoin protocol by securing the network) with BTC (a piece of the network) for their work. What is new is that ownership is becoming a part of (or creating a new, separate category of) user experience: an Owner Experience (OX).
OX is a powerful and compelling experience driven by incentives that, for the first time, creates an environment where value (to users) of newer, less established platforms can become larger than the costs of leaving centralized platforms (i.e. value > switching cost). Ownership, when distributed effectively and early enough in a network’s life, creates a powerful alignment between teams, communities, users, and open source software developers that collectively control the evolution of the platform and participate in the value creation of the network. Given that centralized platforms can’t offer ownership (or the associated incentive alignment) due to their business models fundamentally requiring platform control while scaling, the ability to offer ownership early in a network’s life also creates a fundamental competitive advantage for these new, community-owned open source platforms. In this context of competition, ownership is a Zero to One for cryptonetworks.
Note: Some platforms like AirB&B have attempted to offer equity to their users, but have been unable to due to regulatory barriers. While this may eventually change, these companies fundamentally require control over their platform for the period of exponential value creation; later stage ownership incentives launched by these platforms will still disproportionately reward founders and investors over users for value creation, and result in a misalignment of incentives.
Ownership Changes Behaviors
The power of ownership as an early user acquisition and network effect bootstrapping mechanism is evidenced by the boom in DeFi over the last 4 months. Compound is a great single-project example as it has been in production for just over 2 years, most of that time without ownership incentives present, offering a relative view of performance pre and post-introduction (it was also the first protocol to popularize an ownership distribution model and execute it successfully as scale).
In the first 21 months, the protocol grew to ~$117M in TVL (peaking at ~$183M in Feb 2020); in the 3+ months since offering users ownership incentives, TVL grew to ~$789M (as of Oct 1, peaking at over $911M in Aug 2020).
Compound’s TVL growth the year prior to the introduction of liquidity mining was 197%; the annualized growth rate since (108 day period through Oct 1, 2020) was 1941%. Therefore, it can be said the “Liquidity Mining Growth Rate Multiple” on TVL was 9.85x; in other words, the protocol’s TVL grew almost 10x faster after ownership incentives were introduced.*
Since Compound, over 40 projects have launched with liquidity mining incentives, leading to a 10x growth in TVL in 3.5 months (from $1.1B to $11B as of Oct 1), and 2.7x growth in users** over the same period.
*This multiple works well for projects that existed for a statistically significant period of time prior to launching (or the community “thinking” there would be a launch of) ownership incentives
**Measured by unique wallet address interactions; a single user can have more than one wallet address.
Where do we go from here?
Ownership, as an incentive model and an experience, is a competitive Zero to One: it will continue to be applied rapidly, at scale, and disruptively via cryptonetworks, creating an opportunity for these community owned networks to have “real-world” adoption (at the expense of misaligned, centralized networks) across a variety of verticals. However, this disruption will occur as a result of experimentation, and therefore won’t be linear (or without pain along the way).
In DeFi, we are seeing this experimentation in practice. We are determining which ownership distribution structures — fair launches, programmatic decentralization, or growth marketing — will best drive long-term value accrual to the communities and networks they distribute ownership of, and how to quantitatively measure this success. We are also witnessing live, community driven improvements to incentive models, changing the incentive structures that, when in production, don’t reward the right actions to drive long term value to the network.
The iteration of ownership driven by community participation allows users to directly impact the value of something they own, creating a reflexive incentive loop that can’t be offered by centralized networks. These incentives and experiences, when eventually optimized through experimentation, will lead to new (and better) forms of corporate structures, and offer a superior user (owner) experience where alignment is provable. This is the catalyst needed for cryptonetworks to penetrate mainstream user bases and finally compete with centralized offerings.
Many thanks to Robert Leshner, Dmitriy Berenzon, Jacob Phillips, Avi Felman, Sam Hallene, Rui Zhang and Miko Matsumura for their discussions and feedback.
