As a cool market warms, a reprieve for one of blockchain’s most foundational concepts
Section 1: Dreams Of Decentralization
It has been pointed out by some intrepid observers that Satoshi’s original Bitcoin white paper doesn’t use the word “decentralization” even once.
This is true. Yet it is also true that the foundational premise of the document is that any trust-based model for financial transactions creates an inevitable reliance on intermediaries. These intermediaries may solve for the inherent weaknesses of the system, but they do so at a meaningful cost, which includes eliminating the viability of entire categories of transactions.
Bitcoin represented an approach to digital money and exchange that eliminated the need for those trusted intermediaries. It accomplished this by leveraging a public ledger of transactions, validated by a decentralized network of nodes.
For the few years after the whitepaper launched, the Bitcoin community of miners, validators and enthusiasts grew. As that happened, others started asking whether a similar approach of a public ledger validated by decentralized nodes could create new and different opportunities as well.
Ethereum added the concept of a smart contracts, by which the digital assets tracked on a public ledger could be moved automatically according to predetermined rules.
The first Ethereum explanatory meme - that of the network as a “world computer” for running a host of decentralized applications - was born. Whereas Bitcoin had focused the idea of decentralization and disintermediation on a digital money, the implications of Ethereum to some seemed even wider.
Ethereum launched a little more than a decade after the rise of social media and Web 2.0 platforms. In scale and usage, these platforms dwarfed, any previous computer applications. Because of their integral role in the way we communicate and interact professionally and personally, they also created stronger lock-in network effects and higher exit costs for users than previous tools.
The problem, as some noticed, was that these platforms unending need for commercial growth put them on an inevitable collision course with their own users. As Chris Dixon wrote in “Why Decentralization Matters,” they either had or would inevitably reach a point where they could no longer grow in terms of pure numbers of users and instead have to focus on extracting more capital (or in the case of advertising-based models, data) from those users they already had. Already having certain natural monopoly properties because of the power of their network effects, this scenario would be a disaster for competitive markets and long term consumer choice.
Entrepreneurs flocked to the Ethereum community with dreams of creating decentralized alternatives to those increasingly monopolistic services. Social networks that couldn’t deplatform people and which weren’t subject to the tyranny of gameable algorithms. Commerce platforms that allowed for true peer-to-peer commerce without a grabby invisible hand sitting next to the cash register, taking a growing cut of everything. Content platforms where creators actually got paid for the value they created.
This was what decentralization meant and why it mattered. Tokenization would eliminate the distinction between network owners and network participants. Anyone who participated would, in effect, be an owner. With that distinction gone, the imperative to extract value would go with it, and networks could develop new business models organized around benefitting the parties engaging with one another rather than the platform allowing them to connect.
The problem was that tokens weren’t just good for transforming and re-aligning the economics of networks. They were the most powerful fundraising and capital formation tool the world had ever seen.
Section 2: “Tokenize The World!”
The active principle driving decentralized applications was that tokens could represent the value that was exchanged through the activity of the network of people using the application. Tokens would allow people access to the network’s benefits; to perform work on behalf of the network (and in turn be rewarded for that work); or to participate in the decision making for the network.
An early limited time token sale would jump start that network activity by allowing tokens to be distributed beyond the team initiating the project, while having the positive side effect of creating a treasury to help the team focused fully on the project to build.
At least, that was the idea. As we all know, what came to be known as Initial Coin Offerings or ICOs took on a life of their own that was almost wholly and entirely separate from just providing a nice way to bootstrap the network.
By the end of the ICO boom, that idea had been replaced with a mechanized, systematic process colorfully known as the “Shitcoin Waterfall.” In this process, privileged rounds of professional investors were offered steep discounts in order to validate the project and able to make their money back immediately upon ICO or exchange listing.
This process yielded a capital formation flywheel the likes of which the world had almost never seen. All told, more than $14 billion dollars were raised by ICOs in 2017 and 2018
In truth, the ICO phase was a perfect storm of conditions to create a massive speculative bubble.
First, as a fundraising mechanism, tokens provide the most seamless, friction free experience possible. Anyone, anywhere could, in theory, purchase tokens and have them delivered almost instantaneously. This massive reduction of the barrier to entry made participation much more widely possible.
Second, for investors, tokens function more like public stocks than like private startup equity. Because of the emergence of a huge array of exchanges, even retail investors could trade and make bets in the market. These exchanges created liquidity incomparable to previous risk assets like startup equity. Even better than stocks, investors could in many cases trade fractions of tokens, which means that no one was priced out of assets.
Third, if the first two factors above reflected the mechanism for market action, it still leaves the question of demand. For a decade or more, investors in the US had been told the stories of the incredible gains of venture capitalists wise enough to bet on upstart visionaries like Mark Zuckerberg, all the while being left out of the action by accredited investor laws. To some, the ability to participate in the disruptive potential of cryptocurrencies and tokenized projects from the ground up was a huge draw.
Fourth, for all of the cynicism that has come to be associated with ICOs after the bubble burst, the reality is that there was a huge amount of sincere excitement about the idea of building a new architecture for open, fair, permissionless and truly peer-to-peer networks. For every scam, there was another project that saw immigrants paying too much for remittances or free speech being threatened by global media censors and wanted to leverage a new technology playing field to build something different.
Taken together, it created the ultimate conditions for amazing demand, and eventually, a cataclysmic fall. Between 2017 and 2018, thousands upon thousands of projects launched ICOs, each promising to decentralize everything and tokenize the world.
Section 3: The Reckoning
So, what happened?
We all know the story of token prices crashing - cratering to less than 95% of their all time high. Any trip to the remnants of crypto trader Twitter shows how many are left holding bags because even if one wanted to take the loss, there is no liquidity and no buyer of last resort.
Just as - if not more - important however is the narrative fallout around the idea of decentralization
The primary issue has to do with expectations around delivery and timing. In traditional venture investing, investors understand that they’re on a very long time-table and that even “breakout” startups can take years to mature.
Public markets don’t have such a long horizon. Public market investors are much more concerned with the now. This pressure is part of why Silicon Valley’s stars try to stay private for as long as possible.
Crypto is a strange hybrid of public and private markets. On the one hand, it is undeniable that crypto projects are akin to early stage startups, in that any investment in them is made on a highly speculative assessment of future potential and the team’s ability to make that real.
Because tokens are traded on exchanges, however, crypto projects are also subject to pressures like that felt in public market equities. Projects that haven’t been able to live up to expectations about how fast they can make progress have led investors to feel disillusioned. Unfortunately, this disillusionment is a narrative force that applies pressure whether it or not projects are actually under-delivering relative to a reasonable time scale.
In addition, there is a friction to value tradeoff. And in most use cases, friction won.
This wasn’t something very many crypto investors considered as the prices of their random ICO coins skyrocketed. When gravity returned, however, and the first of the previously hyped decentralized applications actually saw release, many were stunned by how clunky the experience truly was.
This brought up the important question - in fact the key question for any decentralized application - Is the friction to value tradeoff of decentralization worth it?
The irony is not that investors and the community at large started asking this question. The irony is that this question was only asked after huge amounts of capital had been deployed. In hindsight, the more logical sequence would have been to ask, as a part of due diligence, are the problems decentralization is trying to solve for and enable in this application worth the inevitable tradeoffs in terms of efficiency, speed and experience?
Sadly, this didn’t happen. And as we tried to apply the same sort of “daily active user” metrics of centralized applications, the abysmal usage seemed simply to reinforce that the tradeoffs of decentralized applications weren’t worth it.
Taken together, the result of this was a new, cynical narrative that dismissed outright the entire Web 3.0 movement. Everything that was so fresh and exciting just a year or two earlier became reduced to a reminder of our capacity for scams, speculation, and irrational exuberance.
Section 4: Don’t Throw Out The Baby With The Bathwater - Why Decentralization Still Matters
So why, in the midst of all the cynicism, should we still care about decentralization?
For starters - we are months away from having frictionless dApp experiences. User onboarding, fiat-into-crypto, cost structure of , throughput, and speed are about to change dramatically. Imagine a dapp experience using Ethereum+SKALE+Maker+Bitski.
Additionally, just as the unbound optimism of the ICO boom misrepresented the true opportunity of decentralized networks by wrapping them in hyperbole, the cynicism of our previous bear market masked just how much new decentralized approaches were seeping into the system.
We can start first with decentralized money. This original intended use case for cryptocurrencies remains one of the strongest. In an ecosystem like Bitcoin, decentralization refers to the decentralization of the network of miners who secure the network and to the fact that it is a monetary system completely outside the purview of the state and central banks.
For those of us in parts of the world with relatively stable monetary systems, Bitcoin represents an interesting investment or, perhaps, a hedge against future instability caused by a 10+ year experiment in quantitative easing.
For those living under unstable monetary regimes and strict capital controls, Bitcoin represents a lifeline: a way to keep wealth away from the scourge of hyperinflation, and a way to move money even beyond strict bank controls. Venezuela, while not the panacea of Bitcoin adoption that some narratives would try to suggest, still shows just how transformative this technology can be on an individual level.
Of course, Bitcoin isn’t the only crypto showing the potential of a decentralized money. If Bitcoin represents a decentralized, non-state store of value, the emerging DeFi or open finance ecosystem around Ethereum is the first step in what amounts to a total reimagining of traditional financial products, but offered in a decentralized, permissionless fashion from the ground up.
At the time of writing, more than $544 million equivalent is locked up in decentralized finance products like Maker CDPs. Indeed, even Bitcoin centric products like BlockFi lending could be considered a part of the broader decentralized finance movement, as well.
Finance isn’t the only domain with insurgent decentralized alternatives. Over in the realm of human organization and coordination, some have called 2019 the year of the DAO - or decentralized autonomous organization.
The idea of the DAO, simply put, is that the two ends of the human organizing spectrum - formal businesses or nonprofits on the one end, informal Facebook groups on the other - don’t even come close to recognizing the full spectrum of the way people come together to accomplish goals.
DAOs are creating a new toolset for people to coordinate with one another. Today, we have the beginning of active DAOs like Moloch to develop core protocol infrastructure, but these types of experiments are quickly expanding their scope. By way of example, a group is in the process of forking Moloch to create a private fundraising DAO to support the campaign of Andrew Yang, a candidate focused on the challenge of automation and Universal Basic Income.
Another area where decentralization is not just a theoretical but having an impact today is in the realm of gaming and gambling. There is a reason that these pursuits often show up in the early days of new technologies: they represent some of the most fundamental of human entertainment and pastime.
In the gambling realm, decentralization offers an ability to explore new territory outside the purview of previous regulatory regimes - especially in places where those regimes are highly moralistic.
In the gaming realm, however, the disruptive potential is even greater. A generation of game designers is swarming into the space to reimagine what games could look like on a fundamental level if they were based on true ownership of digital assets and all of the new types of economic relationships and markets between players that this could create.
And then, of course, there are the decentralized social network alternatives. Even those who remain skeptical of the decentralization project can admit that the scale and power of today’s leading communications networks represents a new and challenging force socially, economically, and politically. Not a week goes by that doesn’t have a data breach, and, more and more, politicians are putting data and privacy at the front of the agenda.
The decentralized alternatives emerging to take on these giants have quite a battle in front of them. Network effects are some of the most powerful forces on earth, and most average users today aren’t worried about deplatforming and aren’t particularly concerned with how their data is used.
Still, it is undeniable that consternation with these actors is growing, and a generation of applications is rising to challenge them. Cent is an Ethereum-powered network where users can tip one another on content as well as set bounties to get answers to questions. Mastodon represents a decentralized alternative to Twitter. And just recently, EOS backer Block One announced that they are spending $150m to develop Voice.com as an alternative to giant social networks.
When it comes to why decentralization matters, the point here is not that these network alternatives work yet - or even that they will succeed in the Herculean (or perhaps Sysiphisian) task of dethroning today’s giants.
What matters is that the decentralization movement offers both an ideological and a technological framework to build something different in a new way.
And perhaps this, ultimately, is the point.
Was the narrative of decentralization co-opted, abused, and beaten to death during the ICO boom? Of course it was.
But the reason that it was so ripe for that overuse is that the world is so ready for a different way of thinking, a different way of building, and a different way of acting.
Pundits and watchdogs are welcome to continue to be skeptical. Indeed, that’s their job. But even as that happens, builders are quietly heads down around the world designing an entirely new architecture for business and social engagement. Like the Genie who escapes the bottle, once the intellectual virus of decentralized, permissionless, global peer to peer alternatives is out of the bottle, it is nearly impossible to put back in.
So, what happens next?
Considering the industry is mere months away from having frictionless dApp experiences, the future looks bright. It also has more momentum than ever from a builder perspective. Then combine that with the fact that the problems decentralization was originally trying to solve are getting worse and you have a recipe for something powerful.
For those interested in decentralized money, the global experiment in cheap, easy money continues unabated. For those concerned with the power concentrated in social networks, that power simply grows as they expand to new domains and consolidate their touchpoints in our lives. The abuse from tech monopolies grows with each month and the spotlight shines brighter.
In short, nothing has changed about the problems we came together to solve. Everything still remains in the opportunities for new business models and new ways of human social and professional organization that we came together to try to seize.
We can’t let a market narrative cycle, a classic story of boom and bust, let us take our eye off the prize of those changes.
Bumpy as the path to get there may be, the future bends towards decentralization.