The Slow Death of the Firm

Most people think of Bitcoin as a digital asset, but it can be thought of as something more general than that: a decentralized organization. Years from now, Satoshi’s creation may be looked at as a catalyst for the slow death of the firm.

The slow death of the firm may already be underway

Why do firms exist?

Economists typically suggest that firms exist for two main reasons: to minimize transaction costs and to aggregate capital and people. Ronald Coase wrote about the firm’s ability to minimize transaction costs in 1937 in his famous essay “The Nature of the Firm.” Seventy five years later, Nicholas Vitalari and Haydn Shaughnessy wrote about the firm’s ability to aggregate capital and people in the Elastic Enterprise. In addition to the economic arguments, some argue that firms provide people with structure and stability (i.e. job security), which risk-averse humans inherently seek.

Firms have played an important role in society for decades for these reasons (and likely a variety of others). Despite their prominence, most people dislike them.

Bitcoin thrives with no firm

In January of 2009, Satoshi released software that combined cryptography and incentives to offer users a digital service (a ledger to store and transfer value) that persists over time without any central party behind it. There is no firm behind Bitcoin; there’s simply code (rules for organization) and incentives (the BTC token) that brings together many different participants who are all incentivized to contribute their time and resources to maintain the service.

Bitcoin relies on proof-of-work consensus to secure the network and align the workers in the network. There are three types of workers in the network: miners, developers, and users. The miners work is measured objectively and that work gets compensated directly from the protocol: hash power contributed to the network earns BTC. To be a miner, you just need electricity and an Internet connection and you can earn BTC. Miners are the only group of workers that get paid directly from the protocol and the other two groups (developers and users) work indirectly for the protocol if they own BTC. If developers and users add value through coding, holding, or marketing, they add value to BTC and the BTC they own appreciates.

This new organizational structure has resulted in close to $100B worth of value creation (today the total market value of Bitcoin is now larger than the market capitalization of Goldman Sachs).

So what?

Bitcoin is the first example of an organizational structure that has the beneficial characteristics of the firm (minimizing transaction costs, aggregating capital and mindshare, and providing job security for contributors) combined with some new characteristics:

• Ownership isn’t controlled by an exclusive group of founders, employees, and investors
• Data isn’t controlled by any one entity
• Decision making power is not controlled by one person or group and there are checks and balances from a broad variety of market participants

These things don’t seem important to most people today. But I think they will ultimately allow decentralized organizations to impact billions of people by:

• Offering new earning opportunities to people around the world who otherwise would not have them (without favoring people in any particular jurisdiction). The internet is global but the economy is still not truly global. Blockchain-based organizations that aren’t bound to a physical location offer new earning opportunities to billions, as the elimination of a legal entity reduces the need for legal contracts and friction and opens up new short-term, global labor opportunities. 1protocol and 21.co are two examples of platforms that have the potential to open up new labor opportunities for billions.

A microtasks marketplace is one of many blockchain-native services offering new earning opportunities globally

• Creating clear incentive alignment between users, employees, and founders. In traditional firms, the incentives between users, employees, and owners are often not clearly aligned. When a token on a global blockchain is the business model, incentives are no longer muddled by legal entities, jurisdictions, and business models that conflict with the best interest of the users. I see a future world where users have ownership of the products they use.
• Creating new products that weren’t possible with firms. Bitcoin is the best example of this to date — p2p cash had been attempted before but was always thwarted by regulators. Bitcoin came along and the decentralized nature made it resistant to being thwarted by regulators. It turns out that traditional firms fundamentally cannot build some products that people want and need.

So if Bitcoin has demonstrated the positive characteristics of a firm along with all of the added benefits of a decentralized org, why isn’t the death of the firm obvious?

There are clear hurdles holding back decentralized organizations from broader adoption

The main challenges that come with this new organizational structure are:

• Decentralized decision making is hard. To date there are no clear best practices around governance and there is still a lot of learning to be done. Bitcoin has a truly decentralized governance structure (there’s no founder that the community looks to and its very hard to make any changes to the protocol) which works OK if you’re trying to be a protocol that serves as a store of value and doesn’t need to iterate much, but does not work well for most early stage technology projects that need to iterate often and quickly. My view is that some centralization of decision making is generally necessary in the early days of a project. The best projects will likely be designed to be decentralized across all facets of the org for the long-term, but not necessarily right from the beginning.
• It is difficult to accurately measure contributions in most types of work today. Bitcoin works well because labor contributed to the system can be measured objectively and is very difficult to game. Most labor still requires some centralized human judgement to effectively allocate resources. There are some interesting efforts in the works around proof-of-stake and other systems that may enable the decentralization of resource allocation across a wide variety of labor types in the future.
• Decentralization means a lot of different things to a lot of people and often gets abused. Some people are religious about decentralization and view anything that is not Bitcoin to be centralized. Others abuse the term and masquerade their centralized “ICOs” as decentralized organizations. Right now it’s difficult to differentiate the good approaches to building a decentralized org from the bad, and not many people are thinking about quantifying decentralization. This is a step in the right direction, but there’s a long way to go (and there will be lots of blow ups along the way).

Where do we go from here?

Digital assets are now worth over $200B in aggregate and penetrating the mainstream, but we’re still in the very early days of high functioning decentralized organizations at scale.

I think there are two ways that we’ll ultimately get to a world of far more decentralized organizations and far fewer firms:

• New decentralized organizations will emerge. Bitcoin is just the first decentralized organization to offer a digital service that people want and need. Ethereum (smart contracts) and Sia (file storage) are others and I think we’re just scratching the surface in seeing innovative approaches to governance, token distribution, and collaboration. Lots of experimentation in these areas is needed.
• Traditional firms will transition to decentralized organizations. We’re already seeing this happen slowly. Brave and Kik are two early examples of firms that have tokenized and Dust and YouNow are two firms that are in the process of tokenizing. Tokenization is an important first step, but after tokenization it’s equally important that these projects put in place systems that persist over time with good incentive structures and govern themselves without central decision makers. This is easier said than done. Many more traditional companies will follow in this transformation (2018 mayeven be the year of bankcoins), most traditional firms will fail, but there will be diamonds in the rough.

Additional reading:

• The Blockchain Man describes the practical differences between a world of firms to a world of blockchain-based decentralized organizations
• Vitalik’s The Meaning of Decentralization discusses what decentralization means from a software perspective
• Balaji’s Quantifying Decentralization proposes a framework for measuring decentralization

About the author: Nick runs 1confirmation, an early stage crypto fund. Sign up for the newsletter and check out the next Token Summit in SF on December 5th.