Labor Economics in web3

Published in

Sporos DAO

8 min readAug 30, 2022

Introduction

All startups must attract, retain and compensate for labor in order to incentivise work and the production of a good or service. This simple fact is so rooted in the foundation of economics that the methods for managing labor can often be overlooked.

Web3 provides a new economic framework for producing goods and services which builds upon the technological primitives of blockchains, smart contracts and tokens.

This article aims to explore the problem of attracting, retaining and compensating labor in early stage web3 businesses.

Abstract

To understand the problem of managing labor in early stage web3 businesses we will first assert that labor is a good which is allocated through a market. Markets are the dominant form of social organization in a modern economy, and labor is a good with a market value like any other.

We then consider the labor economics behind web3 software development. We believe web3 businesses will account for a significant share of modern economies output in the coming decade, so understanding the nature of labor economics behind web3 is vitally important.

Whilst a simple exchange of wages for labor is the most common method for incentivising work, we will argue that in the bootstrapping stages of a web3 business’ life this method is often either not an option or not desirable. If we do not incentivise cooperation through wages, the question arises as to how to incentivise that cooperation in the context of a decentralized team working on building software. Our answer is ownership awarded through equity tokens.

We will frame early stage startup formation as a repeated prisoner’s dilemma, where most players opt to defect rather than cooperate. Defect in this context means talent decides not to contribute, and cooperation means they do.

We will use the tit-for-tat strategy popularized in Robert Axelrods ‘The Evolution of Cooperation’ to argue how cooperation can be a dominant strategy when it comes to early stage startups building software. The tit-for-tat strategy deems a person more successful if they cooperate with others. Implementing this strategy occurs when one person cooperates with another in the very first interaction and then mimics their subsequent moves.

The dominance of this strategy is strengthened by the presence of tokens and blockchains as is the case in web3. Why? Because of transparency and immutability.

Labor Economics in Web3 Software Production

Web3 Definition

Web3 is a catch-all term for an internet that is decentralized, deployed on blockchains and built, operated and owned by its users. Instead of the internet controlled by a few large entities (e.g Google and Meta) web3 embraces ownership that is distributed amongst builders and users.

Why Work in Web3

Ownership of financial assets is a well documented route to building wealth. In a traditional corporation, profits are distributed to shareholders and if the market valuation of the company increases it is shareholders who stand to benefit.

This structure works by incentivising participants to work hard at improving the company’s prospects thus earning more profit.

The corporate structure begins to weaken when power and control concentrates into relatively few hands and the motives of shareholders (owners) diverges from the people actually running the company (workers) or using the products (users) as evidenced by the high turnover rate of tech employees — most tech workers leave their jobs in under two years.

Web3 lowers the barrier to entry for directly owning the value you create online. Through tokens and blockchains ownership can be awarded transparently and cheaply. Tokenomic design can incentivise individuals to contribute value without relying on a central party to administer.

There are other reasons for working in web3 including censorship resistance and owning your own single identity across platforms. In this essay we focus on ownership as the killer feature of web3.

Why Not Just Pay Wages?

Insufficient Capital

For many early stage businesses paying contributors wages is simply not an option. Young startups are fragile entities centered around the vision and energy of a founding team. They don’t have cash, they don’t have a clear roadmap and they certainly do not have a revenue generating product. More often than not all they have to begin with is an idea for solving a problem in the market.

Once a team has gained some traction they may be able to attract private financing. But until that point, contributors work for the project because they believe in the idea, and they are drawn to the upside potential of owning a stake in the businesses success.

Suboptimal Incentives

Even if the founding team could pay its contributors a wage, this is arguably not the ideal method for incentivising work in the bootstrapping phase. Everyone at an early stage startup needs to think and act like an owner. An owner is driven to do what is best for their business. They don’t wait for instructions, they are comfortable with uncertainty and they work above and beyond for the long-term goals of the project. Crucially, an owner is not in it for the salary. Owners are entitled to a share of any surplus profit generated by a business and its this potential monetary upside which motivates owners to work.

A startup therefore needs to attract contributors who are willing to think and act like owners. Not paying wages but incentivising through ownership stakes is one way of attracting the right people with the right mindset.

It’s a Dilemma

We can think of early stage startup formation as a repeated prisoner’s dilemma defined as,

‘A situation where individual decision-makers always have an incentive to choose in a way that creates a less than optimal outcome for the individuals as a group.’

The prisoner’s dilemma is the most famous game in game theory that shows why two rational individuals might not cooperate, even if it appears in their best interests to do so.

Key components to our model:

Group: The startup as a whole

Individual decision makers: Contributors to the startup

Incentives: Cooperate (work on project without pay) or defect (do not work on the project)

Optimal outcome: All contributors consistently contribute

Suboptimal outcome: Some or all of the contributors stop working totally or partially

This table shows an abstract breakdown of the ‘payoffs’ that each person may get depending on what their colleague does. Defect is the highest payoff which acknowledges the fact that contributors always have a high incentive to defect and not work on the project. However, in a repeated game, defection by one player is likely to be met by defection from all players, leading the startup to the bottom right corner of the table and in the long term: failure.

https://www.investopedia.com/terms/i/iterated-prisoners-dilemma.asp

The lack of a steady wage leaves contributors with a persistent incentive to defect, ultimately leading to most startups falling into the suboptimal outcome and eventually failing. 80% of startups fail in their first year.

Over a repeated game, the top left corner (cooperate, cooperate) leads to the best long-term outcome for a startup.

Startups already employ several tactics to incentivise work, get contributors to cooperate and put themselves as close as possible to the optimal outcome.

Equity: Founders promise early contributors equity in the company should they reach relevant milestones

Vision: Founders inspire people to work for them with a compelling vision

Type of work: Startup work is varied, heavily focused on problem-solving and multi-tasking and this kind of work appeals to certain people

Ways of working: Startup work is normally flexible and self-driven. Again this appeals to certain people

Tit-for-Tat

The tit-for-tat strategy popularized by Robert Axelrod holds that a person is more successful if they cooperate with another person. The strategy combines four properties:

Be nice. Avoid unnecessary conflict by cooperating as long as the other players do.
Be retaliatory. Fight back in the face of a defection by another player.
Be forgiving. Forgive and go back to cooperating after retaliating to a provocation.
Be transparent. Be clear about your behavior so that other players can adapt to your pattern of action.

If someone was to employ the tit-for-tat strategy they would begin by cooperating and then continue to cooperate with the other players assuming they all did the same. If another player stopped cooperating, then we would stop cooperating as well.

This is intuitively a good strategy that people regularly employ in everyday life. The person you want to do business with is the person who defaults to cooperation but isn’t afraid to retaliate if someone isn’t playing nice.

Axelrod proved the strength of this strategy mathematically. You can play around with an interactive version of the game on The Evolution of Trust website.

Sporos Framework Strengthens the Tit-for-tat Strategy

The tit-for-tat strategy is already somewhat applied to early stage businesses. After all, contributors must cooperate in order for the business to get anywhere. The trouble is that most of the rewards for cooperating are deferred to an unknown future date and are inherently uncertain. Contributors don’t see any upside unless the business succeeds. What exactly the contributor will get (in terms of equity) is negotiated ahead of time and is unlikely to be materially affected by the actual work the contributor does.

The Sporos framework resolves this problem by rewarding contributors with equity progressively as the project is built. Contributors know what equity they will get for what work and it is continuously updated on-chain as they earn it in the form of governance tokens. Their equity gives them rights within the business instantly. If you work harder you get more tokens (equity) and can influence the business more as it develops. This progressive increase in ownership is a powerful incentive for contributors to continuously cooperate with their counterparts. Even more so as future allocations of equity are voted upon by existing token holders. If the business succeeds the tokens accrued will gain a market value and the hard work of contributors will translate into a financial reward.

Non-web3 startups incentivise cooperation over the long term with traditional equity structures. This leaves the option of defection as a very viable and attractive strategy for contributors to the detriment of the startup as whole.

Web3 startups that utilize the Sporos product minimize the incentive to defect by continuously and proportionally rewarding contributors with equity. Cooperate. Keep cooperating. And in the end..we are all going to make it.