Blockchain and the future of companies
They are everywhere. From the moment you wake up, until the last moments before you fall asleep, our senses are bombarded with the proof of their ubiquitous existence. We see their “footprints” everywhere we look and they are so well ingrained in our lives, that we cannot even imagine our lives without them and the products of their work.
I am talking about companies.
As a separate entity from the individual working man, companies started to appear around 400 years ago, in the great Age of Discoveries. Their initial purpose never changed much, although it gained additional attributes and an ever-increasing complexity: to limit the liability of the entrepreneur. Or, in other words, to try to maximize the benefits/risk ratio. Modern-day companies came to be in Britain in 1844 and in 1855 it became explicit that shareholders’ wealth is to be protected from the exploits of the company.
In many ways, companies were the herald of the Industrial Revolution. And in the past 170 years, they set out to conquer the world, ever pushing against the boundaries of their legal charter, until they become the humongous giants they are today, many several bigger than the economies of entire countries.
Yet, in all their victorious stride, there was a limitation they were not able to overcome. At least, until now.
Just like the biggest empires in history, today’s largest companies are not threatened or limited by external enemies, but by their own structure and the fundamental flaws of human nature.
As individuals, we have egoistical interests. We are driven by our own survival, our pleasures and wishes, our psychological drive to succeed, to better our condition, sometimes way beyond what one could call rational needs. And no matter how well defined they are, companies are still groups of individuals, subserved to various degrees to the interests of the group. For smaller companies and start-ups, the common interests and vision are the main driver of their celerity and perseverance, everybody working as one for a common dream. But as the companies grow larger and larger, the systems, processes and structures in place slowly lose their humane touch and become cold, unfeeling and profit-driven.
And at that moment, diverging interests start to create cracks in the fibre of the corporation. This is not a rare case. Actually, it is so common and well-documented that it even has it’s own field of study — Agency Theory (Jensen and Meckling — 1976).
Agency Theory is used to explain the complex relationship between principals (shareholders as owners of the company) and agents (managers as the executive body of the company). Ideally, they should both have the same overarching objective — the thriving of the company. In practice, things look a bit more complex and it all boils down to responsibility, risk-taking and personal rewards. By definition, shareholders delegate the running of the company to (presumably) experienced managers, so they contribute with the capital, but they have little to no say in day-to-day decisions. Managers, on the other hand, have full access to all relevant info, but they have little to no risk attached to their decisions because it is not their wealth on the line.
This creates a split in two key areas: goals and appetite for risk. Typically, managers tend to have long-term goals, while shareholders wish short-term profit. Additionally, managers have lower risk aversion, while shareholders have a higher risk aversion. Not to mention, the asymmetrical flows of information and incentives promote moral hazard, often managers having side-interests, sometimes even contrary to the interests of the shareholders.
There are ways to reduce principal-agent tensions, many revolving around performance-driven management (providing bonuses to the management team for reaching profit targets), controlling the costs of monitoring, trying to minimize informational asymmetry through periodical reporting etc. However, none of the methods is perfect. For example, regarding bonus systems, a frequent critique is that it stimulates CEOs to seek short-term profit, to gain higher bonuses.
However, regardless of what method you chose, they all involve costs with internal and external monitoring, because people don’t trust each other and that puts a brake on the size and scope of corporations.
A little trust goes a long way.
And just in case you haven’t already tipped off by the fact that I mentioned trust, yeah, this is where blockchain can come in the picture and change everything.
Ever since Ethereum launched in 2014, it has become clear that smart contracts and the innate decentralized consensus of a blockchain can create a programmable framework for any given role structure. The tensions associated with the agency theory are not an exception, promising to reduce agency costs by orders of magnitude and drastically increase efficiency.
Now imagine that all the informational asymmetries, all the metrics and scenarios for which shareholders would have had to incur costs with monitoring. They could all be written down in self-executable smart contracts, protected by cryptographic security and an immutable decentralized consensus, so that no agent can breach the integrity of their contractual relationship.
The natural next step — eliminating the agent altogether.
One could say that direct democracy died out in Ancient Greece from the same reason why owners hire managers to run their business — the Polis (or in this case the company), became far to big/complex for direct involvement. Nowadays, it is very hard to challenge the idea that you could run a large corporation without a clearly defined managerial hierarchy — a clear chain of authority and responsibility, stemming from the ownership rights of the shareholders, through the administration board and the top management and down to the latest intern.
But it is this very concept of the top-bottom approach that blockchains can change, by creating a system of trust and responsibility among peers, and immutable binding rules through smart contracts.
And such new acephal entities, born out of common interests and self-binding rules are called DAOs — Distributed Autonomous Organizations — and they might be very well the future of companies.
In a DAO, there are no directors, no managers and no employees. Just shareholders, a set of governance rules (agreed upon by everyone and coded into smart contracts), and a reputation system. These are the basics of any DAO and it may sound simple, but it might change everything we know about the way we collaborate as human beings, just like liquid democracy can change everything we know about the relationship between the individual, state and society.
Going way beyond just the mitigation of principal-agent tensions, the concept of DAO manages to eliminate the need for managers through two key solutions.
First, we know that given a large enough number of individuals given the chance to express an opinion around a problem, the solutions will cover a Gaussian distribution around the best possible solution. This is called the wisdom of the crowd and has been proven to be a real phenomenon in many circumstances, especially for strategic decisions. For day to day decisions where celerity is key and specialized knowledge should be applied, a reputation system should hold the key — all voters have the opportunity to delegate and revoke voting rights to a recognized expert that will represent them.
Of course, a detailed discussion about DAOs could go further into detail, presenting innovative concepts such as holographic consensus or the holonic theory, which could be a topic for a more detailed article.
Since 2016, when the first DAO experiment took place, the phenomenon only got more and more complex, a lot of research being put into how we, humans, interact with each other and how systems of systems can be designed to run without a central authority. Most likely, 10 years from now, when we will look back, we will see that DAOs as we see them now, are still in their infancy. But even with all the uncertainty, their perspective is amazing.
Companies have been a defining feature of civilization in the past 500 years. But they are rooted in the classical limitations of a hierarchical society. Blockchain and his trust-creating features can not only change the way we interact within society. It can also change the way we work together for common goals. And this can help us, as Humanity to finally develop organizations and social structures solid and powerful enough to tackle the challenges of the 21st century.
