The Carrot and The Stick: On the Missing Incentives for Cryptonetworks
Why most of today’s cryptocurrencies and dapps will fail — even though decentralization is disruptive to Big Tech
Of course the age of abundant information is prone to beg, borrow, and steal your attention. Reading blogs, news, and research has always been an inefficient user experience — finding needles in haystacks. But now, Annotote is the antidote, check it out: Don’t waste time or attention; get straight to the point.
Michael —
You share a widely-held belief that ‘Big Tech companies will soon launch their own native cryptocurrencies’. But, the problem is that your hypothesis is missing both a carrot and a stick.
The closest thing you come to providing a stick is this:
“If Amazon doesn’t do it, someone else will, whether that’s Facebook, Telegram or some other altcoin that becomes a dominant means of transaction.”
…in other words, FOMO!?
You also cite this stick:
“Big Tech needs to opt-in to cryptocurrencies because young consumers prefer them, trust them and want to deal and play with decentralization and tokens; they like the game. If you monetize blockchain products on the Cloud, you can monetize cryptocurrency hype into your existing products and business model.”
…in other words, leverage millennials’ hype!?
Finally, you propose the following functions that crypto can either unlock or optimize:
Amazon could give coins away to application developers to incentivize development on any of its technology platforms.
Potentially use the coins for in-game purchases of virtual items. For example, how we give tips to our favorite Twitch (Amazon owned) streamers.
AmazonCoin could be used for how Prime functions, giving us a monthly “allowance” of them which customers could use to do different things within the value ecosystem.
Reward customers with more digital tokens if they purchase regularly from the Amazon online store; offer lightning deals for Prime Day and holiday deals with some purchases available via AmazonCoin.
Reward usage of Alexa Skills with small amounts of AmazonCoin that could be used for purchases and other customer-centric interactions, such as same-day delivery or drone delivery.
…but don’t fiat currencies already perform these tasks adequately in today’s status quo!?
So, again, what is the carrot and the stick motivating Big Tech companies to launch their own cryptocurrencies? What’s the incremental benefit for Amazon or Facebook? What’s in it for consumers, producers, suppliers, developers, et al?
These are important questions for entrepreneurs to answer — were they to apply blockchain technology toward productive enterprises. Blockchain is a hammer, but not everything is a nail…
You can’t beat incumbents at their own game
Big Tech’s markets all trend toward monopoly, because they operate multi-sided networks with zero barriers-to-entry. Thus, network liquidity is the basis of competition for many of them: Who has the most buyers and sellers; the most producers and consumers; the most supply and demand; etc. That liquidity sets-off the virtuous cycle of network effects, wherein scale improves user experience improves scale and so on.
If you add software’s zero marginal costs to that virtuous cycle, you get Aggregation Theory:
Aggregation Theory states that by developing a differentiated experience an aggregator can secure a critical mass of consumers that gives them power over suppliers; suppliers are then incentivized to deliver their product to the aggregator’s specifications which improves the overall experience, allowing the aggregator to further increase their consumer base, which further strengthens their bargaining position relative to suppliers. To be fair, this is another way of describing a two-sided market, but what makes aggregators unique is the zero marginal distribution costs enabled by the Internet and the zero marginal transaction costs enabled by computers, which means such companies can scale to basically the entire world.
New entrants cannot compete against those incumbents on that battlefield, because the Amazons and Facebooks of the world are entrenched by their unassailable network effects — as described in “A Crossroads Where Platform Meets Proprietary Ambitions”:
[Network effects are] one of the most implacable forces in modern business.
During the Cambridge Analytica mess earlier this year, it became even more clear that Google and Facebook’s dominance is predicated by their superior user experiences, not their superior data. Their user experiences — not their data — start the virtuous cycle of network effects that attract users (demand), webpages (supply), and advertisers (payors). Data is just one of the byproducts spun-off from those information transactions.
As seen with Google open-sourcing datasets or Facebook trading data with 3rd parties, competitors can’t rival the duopoly even were they given equal data assets, because Google and Facebook already have an insurmountable scale advantage that makes the opportunity costs of any constituent switching to rival platforms too large — whether that be users, websites, or advertisers seeking alternatives. So, even if everyone were to have the same data for targeting — perfect competition on that plane — social media’s incumbents would still have more attention.
New entrants can only sustain were they to aim for “new market disruption” in which they occupy incumbents’ blindspots — completely new vectors where incumbents can’t squash upstarts for fear of cannibalizing their own, preexisting cash cows. Think in terms of Google disrupting Microsoft by organizing the chaotic web (“new market disruption”), as opposed to Firefox just building a better browser than Microsoft’s Internet Explorer (merely “sustaining innovation”). Don’t build a better mouse-trap; build a waterwheel the mouse can spin to produce hydroelectricity.
In contrast, a plucky “crypto-Amazon” startup does not present Amazon-proper with any such Innovator’s Dilemma: Adding a cryptocurrency atop an an ecommerce platform, for example, does nothing to improve any constituent’s lot; crypto-Amazon would provide no significant, sustainable, extrinsic, or intrinsic incentive to wrestle producers or consumers from preexisting, fully-scaled marketplaces; and Amazon itself would still have a relative advantage due to its network effects. That presents no cause for FOMO; no motivation to prey on millennial hype; no reason to spurn the preexisting infrastructure accompanying fully-scaled fiat currencies.
Classic economies of scale
This returns us to the question of carrots and sticks, for which Filecoin ($FIL) and the Interplanetary File System (IPFS) are particularly instructive examples: Decentralization in-and-of-itself may be a carrot for some users, but there’s no stick to encourage the mass market adoption needed by Filecoin to drive down costs (and increase performance) such that it can rival the Amazon Web Services of the world.
To establish a moat amidst these entrenched incumbents, upstarts have to improve the user experience by an order of magnitude large enough that they can persuade the mass market to switch from incumbent products when it comes time to cross-the-transom from early adopters.
Amazon has strategically foreclosed on such opportunities: Not only do its network effects ensure its superior user experience, but Amazon simply doesn’t leave enough margin in its unit economics to provide competitors an opportunity to make a meaningful improvement on cost as well.
I’m sure you’re ready to interject with: “But token incentives…”
To which I’d volley back: “What about them?”
AWS has such massive scale and Amazon proper such razor-thin margins that there’s no room for token holders — the fragmented providers of storage space and computing power — to extract a material profit from any rival service they might provide. Hypothetically, were each decentralized Filecoin node to net 1 penny’s worth of income per unit of service provided, it would be such an insignificant reward that it wouldn’t be worth the trouble for any one individual. In contrast, a net income of 1 penny per unit is certainly worth-it for AWS at-large, since Amazon multiplies that across a whole lot of volume.
Such traditional economies of scale are a sustainable moat for a lot of centralized tech businesses.
Incumbents are structurally entrenched in centralization
But, let’s set-aside the value propositions and product roadmaps as they pertain to new entrants. Instead, let’s talk more about the specific incumbents you summoned, Amazon and Facebook, were they to pivot down these avenues. Long-story-short, these companies structurally cannot decentralize because their businesses fundamentally require centralization.
Like all businesses, Big Tech monetizes constituents’ access to some sort of scarcity. From “Spotify and Ek’s Parlay”:
Businesses are built around access to some sort of scarcity. Super-simplistically, Facebook monetizes access to finite attention; Facebook users grant it their finite attention due to its superior user experience — specifically its network effects.
Big Tech’s gameplan is centralization, in which they are increasingly concentrating the open web in their respective walled-gardens. I personally say it’s not entirely conscious or nefarious; rather, it’s often easily explained as inertial and altruistic. After all, benevolent dictatorship — however fallible — is the optimal approach to competing against the corporate bureaucracies that this epoch’s Bezoses and Zuckerbergs supplanted: End-to-end, technocratic control of a product such that it continually evolves toward that requisite more-perfect user experience — an invisible asymptote demanded by divinely discontent stakeholders.
Regardless of intent, there are obviously negative consequences to this trend toward centralization. A particularly well-publicized one is “platform risk”, which comes in many flavors, like this from “Antitrust and Tech’s Endgame”:
That’s a misincentive inherent in most 3rd party platforms who also peddle proprietary products [like Amazon Fulfillment Services and Amazon Basics]. Digital platforms like Amazon are even worse, since the data they’re privy to redoubles their propensity toward vertical foreclosure. (AWS compounds that yet again for Amazon.) At very least, there should be a Chinese Wall within such organizations.
While Big Tech structurally cannot (and will not) decentralize, incremental decentralization is obviously desirable for both the supply-side and the demand-side of tech’s various marketplaces. Decentralization is theoretically the vector for new market disruption — that aforementioned “blindspot… where incumbents can’t squash upstarts for fear of cannibalizing their own, preexisting cash cows.” (The pendulum will swing back toward decentralization eventually, but we’re a few years away — and billions of dollars in R&D/capex away — from decentralization being competitive.)
Yet, the problem remains that decentralization is merely a carrot without a stick. Again, I know your reflex is to say “But token incentives…”, however I’ve already demonstrated that nobody can compete against Amazon on the basis of cost or scale. Without achieving parity on either cost or scale, a crypto-Amazon new entrant would never be able to cross-the-transom from evangelist early adopters to utilitarian mass market constituents, and thus it would fail to reach sustainable competition.
As such, crypto-Amazon’s token would at worst be a pyramid scheme — promising early adopters that they’ll be able to realize gains by selling to some greater fools who’d ultimately hold-the-bag. (At best, it would be a security, which bears its own set of mitigating tradeoffs.)
The logical response to that is: “What’s wrong with succeeding in a small niche, like early adopters, and just stopping there?”
To which I’d answer: “Nothing, great idea!”
More precisely, that would be/is great for Filecoin. Although their token value would plateau at a relatively lower altitude (thanks to a smaller TAM), maybe Filecoin will get some unforeseen opportunity to cross-the-transom one day. But, you’re not talking about an upstart; you’re taking about big ole Amazon going down this crypto path to re-summit a mountain it’s already sitting atop. Amazon has already won the mass market; it’s not going to eschew that marketshare or write-down all of those proprietary capital assets for no upside.
But, never mind the indeterminate spoils for Amazon itself; Bezos’ Amazon-gone-crypto would present users with the opposite problem faced by those of an upstart crypto-Amazon: Instead of a carrot-without-a-stick, this pivot would be a stick-without-a-carrot. In other words, the alleged extrinsic incentive (token appreciation) that would otherwise be used as a vehicle to push users unto a more perfect disposition (decentralization) is missing that “more perfect disposition”, because the end-result of Amazon-gone-crypto is an unaltered state of centralization within Amazon’s platform. Running furiously but ultimately standing-still.
An example of a carrot and a stick…
