Decentralisation and the wisdom (or madness) of crowds
Speaking to a journalist in 2016, Vitalik Buterin reflected on his motivations when inventing Ethereum — in particular his binary view of the forces of good and evil. Attributing the latter to centralised societal powers, Buterin set about developing decentralised use cases for blockchain beyond Bitcoin. This dualist mindset is mirrored elsewhere in emerging innovations. One example is the war of words over the definition and scope of the metaverse, including dichotomies such as open-versus-closed, decentralised-versus-centralised, low-versus-high fidelity, and a number of others which we addressed in our recent paper Unreal Estate — Metaverse, extended reality and the future of our physical world.
The wisdom of crowds
One potential benefit of decentralisation is the wisdom of crowds, whereby aggregated actions or opinions from a group are regarded as a viable alternative to expert opinion. This perspective could serve to validate the decentralised autonomous organisation (DAO), an ‘internet-native business that is collectively owned and managed by its members… decisions are governed by proposals and voting to ensure everyone in the organisation has a voice’. However, voting power within DAOs on virtual platforms is not necessarily equally distributed, meaning a ‘democratised’ virtual platform could easily become a plutocracy favouring wealthier tokenholders, rendering obsolete any crowd’s purported wisdom. In cases where virtual worlds are centralised (and therefore not governed by DAOs), there is usually a clearly stated reason. In one instance, a centralised metaverse platform made the case that ‘…a project of our size and vision needs to be curated and decisions have to be made quickly towards our vision…’
Freedom from choice
The wisdom of crowds’ antithesis would be the madness of crowds — popularised in the 19th century Charles Mackay book on the topic including examples such as the South Sea bubble, tulip bulb mania and witch mania. A parallel to Mackay’s thesis of irrational group behaviour is political economy 101's teaching that the ‘benevolent dictator’ is the most efficient form of governance, which seems akin to the attitude familiar technology heavyweights toward consumer influence such as Henry Ford (T Model Ford available in any colour, as long as it’s black); Steve Jobs (control of the entire user experience); and Mark Zuckerberg (lack of profile customisation).
Decentralisation or delusion..?
More recently, a criticism of decentralisation, or decentralised finance (DeFi) more specifically, is the accusation of it being a misnomer. A 2021 paper by the Bank of International Settlements claimed that ‘full decentralisation in DeFi is an illusion. And indeed, platforms have groups of stakeholders that take and implement decisions, exercising managerial or ownership benefits’. As discussed earlier this year, a recent NBER paper also weighed in on the plights of DeFi, claiming in their analysis that Bitcoin holdings are more unequally distributed than wealth within the US population. One might infer that rather than creating a more equitable society, DeFi has simply served as a new speculative asset class for the financial elite. Can the same be said for decentralised innovations in real estate? A related conundrum I have debated with numerous academic and industry colleagues over recent years is the comparative merits of centralised (institutional) and decentralised (retail) residential real estate investment.
Institutional versus retail landlords
Where I came from, property investment was seen as a vehicle for social mobility. In fact, it’s what got me into the asset class to begin with. I’d therefore have to acknowledge a bias of mine in favour of the retail (aka. decentralised, amateur or mum-and-pop) landlord, most of whom hold a single asset aside from their own residence. However, in recent years, and particularly in the aftermath of COVID-19, we have seen a growing institutional appetite for investment in housing. Consider the £600m deal between Moorfield and Bricklane, Legal & General’s £4.5 billion pledge on build-to-rent and affordable housing, as well as retailer John Lewis’ foray into the build-to-rent sector. Back in 2019, Bricklane CEO Simon Heawood was quoted by Letting Agent Today: ‘[t]he unfortunate reality is that the amateur buy-to-let market has shown itself incapable of providing a service to tenants that is fit for purpose’. Begrudgingly, I can’t help but agree with Simon on this point. Consider the point we made about UK social housing last year: 23% of the private rented sector stock failed to meet the Decent Homes Standard in 2019, compared to 12% for social housing and 16% for owner occupiers. Although retail landlords may be able to hide among the masses in relative anonymity, it would be difficult for an institutional landlord to do the same if it was found that one in four of their assets were barely habitable or ‘non-decent’.
Finding a healthy medium
If decentralised investments offer equitable opportunities but face the challenge of mismanagement, and centralised investments offer something approximating the opposite, is there a way of combining the virtues of both (and discarding the downsides)? So far it seems the closest approximation to this has been fractionalisation — where retail investors are able to pool their resources into otherwise-unattainable investments (a benefit of decentralisation) and engage the services of an accountable, professional manager (a benefit of centralisation). Although there has been a growing prevalence of fractionalisation innovations within real estate and other sectors (see fine art, for example), they too haven’t been free of challenges. Principal of these challenges appears to be the ability to raise the requisite funds to manage a large enough asset base to warrant their existence. Think of it this way: an investment broker might only have to make a single sale in order to trade a £500,000 home or £300 million office block, but a fractionalisation platform may need to make anywhere from two to 10,000 (or beyond) sales in order to trade the same volume of assets. For many would-be fractionalisation platforms, it’s simply easier to deploy their technology on behalf of institutional investors, and that’s what they’ve done.
These paradoxes fuel our interest in innovative approaches to fractionalisation, so if you’re aware of one (or more), please get in touch via investment@pilabs.vc
