Lower the Drawbridge: Pooling Market Liquidity to Benefit Businesses and Customers Alike
Why and how blockchain will break open data silos
Since its inception, the web has promised a free and open exchange of information promoted by anyone. Today’s tech giants have built their empires on the back of that promise, resolving to “organize the world’s information and make it universally accessible and useful” (Google) and “give people the power to build community and bring the world closer together” (Facebook).
Not only have these big corporations failed to deliver on their promise, they’ve actively built the opposite: walled gardens of data that they keep locked away in their massive centralized databases. Google has failed to make data accessible, and Facebook has failed to bring people closer together or give people power. While Google has indeed indexed the world’s information for anyone to search, it has packaged those search patterns and internet usage history to sell without the user’s active consent or say in the matter. Facebook has enabled its users to remain in touch with their friends and form groups to organize online, but it has used their social behavior data to actively manipulate them and influence their ideology.
Due to the consolidation of data to the top few players, barriers to entry for a small startup make it almost impossible to compete. For example, in the ad industry, the Google/Facebook duopoly accounted for 61% of the $250 billion online ads business in 2017. It’s not just limited to tech either — incumbents across industries have a vise-grip on user bases, their data, and even the intelligence on that data.
Incumbents across industries have a vise-grip on user bases, their data, and even the intelligence on that data.
Efforts to decentralize industries have been well intentioned, but poorly executed, falling short in key areas such as incentive design, usability, and practicality. Many blockchain protocols have focused on completely decentralized computing where every transaction is recorded on a ledger as it happens. This goal of complete decentralization is unrealistic: Most end users do not have the resources, the interest, nor the capability to successfully participate in compute-intensive networks. No one has invented an effective scaling solution to offload data to blockchains. Most crucially, the value of tokens represented by these networks often is not properly tied to the value and growth of the network itself, disincentivizing participation even from those with the means to be a network keeper.
As foreshadowed by existing infrastructure (e.g., Ethereum or Bitcoin), the active work that needs to be done to curate transactional data will fall onto the shoulders of a few players. The costs of decentralized data — replicated compute, latency times to reach consensus, etc. — don’t make it conducive for a large number of direct participants. Workers with access to resources at scale who can specialize in actions like staking as a service will be the network keepers. In the long run, the average person will not be able to scale their resources fast enough, so businesses will naturally assume this role.
Despite business entities still being the primary keepers that operate on networks, the premise of decentralized networks will still have significant impact on end users who interact with those businesses, whether or not they even know that blockchain is involved. Even though businesses will be the ones running nodes, no single organization will silo an entire marketplace’s data. Data will flow freely across the network and be owned by end users or the network itself. Service providers will offer “data liquidity” to those who contribute to it.
For example, if Uber and Lyft pooled market liquidity, the network effects from a larger base of drivers and riders would create better matching with more efficient pricing because the data is richer than it would be in silos. Unlike the current system where trying to maintain a competitive advantage yields insurmountable barriers to entry such as exorbitant infrastructure and user acquisition costs, these networks will accrue value as more businesses within a given industry join, which will allow for collaboration, pooled infrastructure, and elimination of redundancies.
For this large of a paradigm shift to succeed, we need interoperability between networks and network participants to have skin in the game. Blockchain-based networks are already trending in that direction as more projects use Proof-of-Stake mechanisms and as protocols like Cosmos and Polkadot provide shared security and transactability across chains.
A small or mid-sized company acting alone might not be able to make up the ground it’s lost to the user data duopolists (or the big winners in the several other industries whose market share distribution follows the power law curve). But if several of the next largest players team up to get the ball rolling, the long tail could ultimately create more value than the top names, and the corporate Goliaths would have serious competition.
Although creating such an alliance would have inherent difficulties (addressed below), a marketplace built on shared resources using unified standards not only saves immediate costs, it also leads to network effects that smaller players often struggle to achieve. A linear growth in users results in the value of the network increasing as a square of the number of users. Once a network reaches critical mass where the cost of linear growth is outpaced by the benefits of network effects, those who have invested in it will reap the rewards. If access to the network requires staking right-to-work tokens, the token value should reflect the network’s value. Assuming a network is designed with the incentives aligned from the beginning and enforced throughout the network with token mechanics, all actors staked on the network can capture that value according to the work they contribute to it.
How Business Models Change for Service Providers
Pooling resources and collaborating with natural competitors may seem counterintuitive, particularly with the emphasis businesses today place on protecting proprietary IP. Startups must not only defend their economic “moats” — which, not surprisingly, tend to be data moats — but also attack established ones. That said, companies in most industries could benefit from network effects enabled by high market liquidity, user traction, and shared infrastructure, and thus stand to gain from opening the castle up for business. Joining a network, if participant incentives are aligned correctly, would supplement, not cannibalize, an existing company’s central business.
A great existing example of this is decentralized exchanges. In 0x protocol’s relayer network, service operators run order books with “networked liquidity,” meaning they can fulfill orders from other nodes, leading to a more market efficient order book. Assuming the supplier surplus would otherwise go unused, the pooled market liquidity benefits both relayers (and traders) by providing a higher transaction volume than any one operator would see as a centralized exchange.
Most tech companies today face the following problems:
- compute costs
- server hosting
- data custody
- authentication
- user session management
- transactions
In the future, network participants will specialize in
- private key management
- client optimizations
- state commits
- blockchain network layer abstraction for the end user
For example, such a business model could include abstracting away gas fees as a service cost via a transaction fee (in the manner of Uber, Airbnb, Stubhub, and crypto exchanges), a subscription fee (Amazon, Spotify), or a loss leader in exchange for having the user in the ecosystem (Gmail, Instagram, Soundcloud). The core product and feature offerings stay the same, but businesses become service providers. Just like you’re able to call anyone in the world regardless of their mobile company, you should be able to call a ride, order food, and even revoke access to your data without having to worry about who is orchestrating the transaction.
Having shared standards and protocols alone isn’t worth anything; shared infrastructure and market liquidity are what drives network effects. With the growing use of open source, cloud, and SaaS, companies are already reusing infrastructure components. Doing so on a decentralized network, however, allows for much more seamless integration, lower startup costs, pooled security, and aligned incentives for all network participants. Let’s look at a few examples.
GDPR
After the EU’S General Data Protection Regulation (GDPR) was passed into law last year, thousands of companies scrambled to make sure every inch of their online business was compliant by the deadline. An inordinate amount of engineering resources at each company was dedicated to allowing users to access, update, and delete all of their data from databases. In many cases, the required code refactoring looked remarkably similar. The International Association of Privacy estimated that Fortune 500 companies would spend $7.8 billion to ensure they are compliant.
Disregarding for a moment that GDPR would not be necessary if an effective data ownership solution became prevalent, companies on a shared network could make a set of common features available to every participant with a certain amount of stake in the network. This work, which could be originally sponsored by a grant, not only saves time and money for each company, but also comes with the positive externality of token appreciation because as more companies join the network to take advantage of the solution, their staking will be compulsory, driving the demand for tokens.
Platform Economies
Another use case is platform economies with matching algorithms. Since consortium networks can allocate resources more efficiently than a single platform, blockchain could optimize platforms from home sharing to freelance labor. For the sake of example, consider the ridesharing economy: Uber, Lyft, and other apps all provide essentially the same services. Rather than having separate matching systems with separate pools of drivers, a network could function as an exchange between riders and drivers that pools “ridesharing liquidity” to find efficient pricing.
Instead of competing for users, companies could design products that specialize on a specific niche or segment of the market. Lyft, for example, could offer a product where different riders can share the same car to save money and receive a more social experience, targeting the younger, college-aged market. Uber, on the other hand, could offer a white-glove service that guarantees a certain quality of car and enforces standards that make it more suitable to established professionals. An additional benefit is that UI elements — maps, search, requesting a ride, payment, etc. — could be templatized and reused to make it easier for new entrants to launch products and services for the network.
These new business models have numerous inherent benefits. Shared infrastructure reduces startup costs because businesses can rent services only when they need them, and economies of scale kick in given the lower overhead costs from using replicated components. When incentives are aligned across businesses, rather than mimicking features and trying to steal each other’s users, companies can redirect their energy toward finding innovative market niches and providing the best services. In these models, each new user contributes to the overall value of the network, regardless of which service they use. Companies have the ability to make a profit even if they operate at cost. The fact that staking tokens on the network is necessary to access its marketplace liquidity means demand for tokens increases as the network grows, resulting in the appreciation of token value and profits for all participants who staked sufficiently.
A downside for businesses is that the cost of switching becomes essentially zero. While this aspect would be beneficial for users, one would expect this nearly frictionless switching to hurt a business. However, framing it in the traditional view of “switching” misses the entire point. In many of these networks, like in the ridesharing example, users might not necessarily even know they are using one service or another because all the optimizations happen under the hood. Despite users switching between Verizon and Sprint, for example, they are still locked into a telecommunications network as a whole, which reduces the overall risk for the industry. If customer retention is a core part of your business, you can always mix in components of traditional business models such as service contracts, rewards, or building your brand reputation.
How the User Experience Improves
This new, more democratic ecosystem affords an all-around better experience for users. The product ecosystem is more diverse and can address customer needs better because businesses can now afford to build specific features for specific customers that used to be too expensive to be feasible. Power users could pay subscription fees or stake for access to more functionality and bonuses. All users have low to no switching costs between providers on the same network.
Customers are already used to interacting with a service provider which abstracts the marketplace or network away from them. In merchandising, there are wholesale and retail businesses. Retail stores interact with the wholesale distribution network and offer the storefronts (dApps) that customers (users) walk into to buy the product. Since T-Mobile and AT&T both use the GSM standard, for example, T-Mobile buys usage from AT&T’s cell towers for expanded coverage.
By using dApps, users are essentially buying data liquidity from the network through the startup operating the service. The goal of the startup, in this case a service provider, is to commit network-wide actions on behalf of the user (e.g., establishing an account, making changes to their profile, etc.). Users have a single account system with fine-tuned data management, which saves time, keeps their identity and data secure, and provides greater privacy.
As pooled liquidity attracts companies to blockchain-based business models, users naturally benefit from the transparency, ownership, and trustless transactions that they enable. Indeed, many of the most discussed blockchain use cases ameliorate pain points for the user:
When you go to the doctor, you have more transparency into the handling of your medical history and get rewarded for taking preventative health measures. When you need a loan, your verifiable credit history gives you instant approval. When you want to rent an apartment, your immutable rental record can be seamlessly shared with management companies so they don’t need to run a formal credit check that hurts your score. When you purchase produce or medicine, the entire supply chain history can be available for your peace of mind. If you stake in a network with your favorite social media site, you can have direct say in the shape of the product (no more unfavorable UI updates!). When you allow service providers to sell your data to advertisers, you choose exactly what is shared and get compensated appropriately — and hopefully get served better ads.
Token models designed with the end user in mind redefine customer-business relationships. Customers now have bargaining power with their services because moving to another competitive business on the network means more than just losing business: in Delegated Proof-of-Stake models, users would unbond their tokens to the business and reduce its power on the network.
Chris Dixon of Andreessen Horowitz theorizes, “The question of whether decentralized or centralized systems will win the next era of the internet reduces to who will build the most compelling products.” Because the value proposition of decentralized systems attracts the best developers and entrepreneurs, he says, the best products will be built on blockchain-based networks.
Conclusion: Not a Zero-Sum Game
Industries won’t just move toward decentralization naturally. Migration will depend on robust mechanism design, cross-business devops coordination, and effective network health monitoring. In a future post, we will lay out a path for this vision to come to fruition.
Industry incumbents are pulling the ladders up from behind them. But since startups that pool liquidity can reach global scale more quickly through blockchain networks, the long tail could be more valuable than even their industry’s monopolists or duopolists.
Venture capital firms are already starting to see the value in “the compounded benefits of collaborating communities,” as Fabric Ventures puts it, over traditional “zero-sum game capitalism.” These compounded benefits mean early movers have tremendous upside. The more value an entity adds at the beginning, the more it can capture long term through foundation grants and incentives for seeding, building, and growing the network.
Pioneers in industries will lower their drawbridges and take the risk of truly being more open and connected to their customers, business partners, and comparators. If the movement of those bold enough to act first proves fruitful, others will be forced to make a choice: disrupt or get disrupted.
Thank you to Kevin Xu, Max Einhorn, the entire Fraktal team, and Noah Golub for their ideas and input.
To learn more, visit fraktalgroup.com, email us at contact@fraktalgroup.com, and follow us on Twitter.
Note: This article makes several assumptions that might fall completely flat. Pooling market liquidity might be best solved through a non-blockchain solution. The economics of shared infrastructure might not work out anything like described. Centralized companies might stop stealing your data. We might shift our collective consciousness and decide selling user data is not stealing at all.
I would like to make the same suggestion that Matt Stephenson of Planck did in his inspiring essay, that you mentally add “according to some, it might be possible that” to all assumptions made in this article, in order that any tired debates on the existential threats to crypto can be set aside in favor of more productive discussions.
