Blockchains: A Cambrian Period for the evolution of the Corporation?

Painting by D.W. Miller

Blockchain networks may drive substantial evolution of what it means to be a modern corporation.

For certain projects, blockchain networks might displace traditional corporations as the ideal model. They have some advantages for organizing resources, and capturing and sharing in the economics.

Earlier, I wrote that Blockchain networks are perhaps the most exciting set of Internet related technologies I’ve seen since the advent of the web in the 90s.

The ability to securely store and exchange asset value across the Internet in a decentralized fashion via a blockchain is incredible.

But perhaps the most important element to these networks is that they are asking and answering questions pertinent to the nature of the corporation in very consequential ways.

Blockchains are going to put more power and compensation into the hands of developers and participants of a network, at the expense of the external sources of capital and organization.

Blockchain developers are running experiments to create incentives for developers and early participants that are materially better than the corporation for certain types of “projects”. Incentives matter

“Never, ever, think about something else when you should be thinking about the power of incentives.”

— Charlie Munger

Against the backdrop of the Tezos governance imbroglio, this may seem like poor timing to talk about a blockchain network economic model contributing to the evolution of the corporation. Many will take the governance issues at Tezos as proof that these structures are passing fads.

The opposite is true. We are witnessing a Cambrian explosion of experiments in the way we organize and and allocate resources and capital. Many experiments will fail. That is the nature of evolution. But rapid and varied experimentation could jump start a rapid iteration and evolution of this organism. It happened during the Cambrian period. And it’s happening again.

For certain projects, tokenized networks might displace corporations as the ideal model for organizing resources, capturing and sharing in the economics.

The most valuable blockchain projects of today (over $150 Bn) are built by open source development teams; there is no profit-seeking corporation, and the economic value of the network is capitalized in a fractional ownership of the network itself: a cryptographic asset.

What is going on? Why is this important? What could happen?

For what projects could this be most applicable?

The corporate model for organizing resources, attracting, allocating and distributing economic value has been around for over 1,000 years. The common myth that it started with the East India Company in Britain in 1600. But this turns out to be, like many things, a history that smacks of bias. China, Sweden and others had formed entities with joint ownership hundreds of years prior to those of the country of my birth.

Like many artifacts that are hundreds of years old, some cracks have started to appear in the modern stock corporation. These cracks are especially visible in software based corporations.

And those cracks are especially visible for software based aggregators pursuing network effects.

But you say, those are only a tiny fraction of the number of companies in the world.

Who cares? You do. Marc Andreessen was right: software is eating the world.

It turns out software networks underpin the majority of the top 10 list of most valuable companies in the world. Facebook, Google, TenCent: they are all software based information networks. But so are Alibaba and Amazon since they aggregated product and price information in a way that the incumbents did not. The iPhone (and therefore Apple) is valuable because of iOS, so Apple is also a software based aggregation network. So that leaves Microsoft, where Windows is the OG software aggregation network.

By the way, Priceline is a software network. As is Uber and Airbnb. VCs such as Bill Gurley search high and low for these types of companies. These winners have revenues larger than the other players in the industry, and more important, have profit characteristics that in many cases eclipse all of their competitors put together. Bill had a thesis around a network effect transportation system that lead him to Uber. Some, like Fred Wilson at USV, ONLY invest in businesses that are software based network-effect companies.

These software based network companies can create power law outcomes.

But are these projects successful because of the corporate stock model? Would something in a different area be more successful if it wasn’t a common stock corporation? Are there situations where the ideal model is not a common stock model?

Let’s see if there are cracks in the current model.

This post briefly touches on:

1. Blockchains can rapidly codify experiments with governance and economic models to increase the value of the network as a whole.
2. Blockchain networks can help solve the fundamental economic tension between free open source software (FOSS) and a private sector firm building applications and services in pursuit of economic rent

And the next post will show why blockchains solve the chicken and egg incentive for network effects…and why that matters.

1. Governance:

This is where it’s really interesting to me. There’s the importance of being able to embed governance into the software itself, rather than leaving it up to the vagaries of the management of a corporation. Or having no or few proscriptive rules for governance and for updating the protocol, but rather a consensus agreement via the developer community.

You could chip away with the agency problems relating to voting (Facebook), or stock based compensation (Twitter), or acquisitions (Tesla/Solar City). Investors must trust corporate leaders to make many small and large decisions, and they also trust a board and the CEO to make large decisions. Because of the nature of the way corporations work, and the relatively open ended degrees of freedom available to a CEO and his or her board, investors sometimes end up delegating decisions they may not want to delegate, for example, decisions which increase the number of shares outstanding, limit the rights associated with their shares, or dilute their ownership via business combinations which enrich the management team. With smart contracts, we can run experiments with rules that cannot be overwritten — they are embedded into the existence of the network. I put forward neither specific examples, nor a sense that this path is inevitable nor superior; instead we will likely see many failed experiments and we may see something interesting evolve here.

As an investor in some private companies, one of the most critical issues I see is a capital allocation problems. CEOs issue too much stock for too little cash in order to spend too much cash to build their business. And once the company is going, the CEO needs to dilute the shareholders even more to keep fueling growth and attracting and retaining more talent. The notion of investing in a network that is codified against rampant inflation is quite compelling to me personally.

Finally, what if we could do away with rent-seeking or rent collecting behaviour? What if there’s just agreed upon value of the network (agreed to by a market mechanism), and fractional ownership of that network (agreed to by the rules governing the network). How you earn or buy or spend or sell your fractional ownership is set out in code. But there’s no tax collector on the network.

Imagine a decentralized network of autonomous cars that essentially is run like Vanguard — there are some expenses, but the users accrue all the value — there is no separate set of conflicted shareholders capitalizing the value of their ability to extract rent from the network. That’s where things might really get interesting.

Take these blockchain powered zero marginal cost software networks, which allow for the exchange of value directly between users in a decentralized way. Do they become the Index funds of the corporate world, blasting away the profits from shareholders and putting them back to the users? In some markets, such as machine to machine payments (think autonomous cars talking to each other), the protocol layer network with no rent seeker may become an insurmountable competitor vs a Visa, PayPal or other corporation who wants the car networks or users to pay a fee. The lazy counter to the existence of such networks is that a variable price cannot stand. The lazy answer to that counter could be a system where the price per fractional asset is constant, but holders are granted additional assets on a market mechanism. Whether or not it works, Basecoin is experimenting with exactly this approach.

2. Open Source

Open source software and protocols are a hugely useful common good. Two examples are Linux, an operating system for datacenters, and MySQL, a free database. Another good example is SSL, which allows secure ecommerce.

There are a few amazing qualities of FOSS.

1. Non-exclusive, ad hoc contributions from a wide community. Contributions can literally come from around the world, reflecting a wide variety of of expertise and experience.
2. As a common good, they have the feature of sitting as a Switzerland in the tech stack. If Uber, Lyft and Tesla wanted a payments mechanism for machine to machine payments between autonomous cars, would they use a payment system own by one of them? No. Perhaps they might use a system that is owned by no-one. And anyone. The faceless man. Properly designed and resourced, a common payment protocol might be far better than an independent but jointly owned profit seeking consortium or joint venture, which hardly ever work because of incentives.
3. Security: Open source software can be made very secure and trustworthy. Since anyone can inspect the code, problems and security holes and attack vectors can be inspected by hundreds or thousands of developers. Properly managed, and given enough sunlight and time on a test network, bugs can be found and dealt with before there are material consequences.

But there’s a tension: because of the incentives. In a subsequent post, I will show how blockchains help solve the incentive issues for network effects.

Thanks especially to @sbmckeon and @robinwolaner for reviewing and improving on this post.