This is chapter 4 in The Blockchain Economy serialised book. For the index please go here.
TL:DR. Governance matters and Blockchain changes the rules on governance.
Some people were drawn to Bitcoin and Blockchain because they sensed that the current system was broken and they hoped that what Satoshi Nakamoto released in the dark days of the Global Financial Crisis would help fix it.
Since then we have had nearly a decade of money printing and debt creation. Has that fixed the problem that we all saw so visibly during the Global Financial Crisis or has it simply made the next crisis worse?
Now that headlines are consumed by the surging Bitcoin price and images of conspicuous consumption that is your’s for the taking if you buy Bitcoin, those early thoughts of fixing the system have been forgotten. We have replaced “get rich quick by buying and flipping property” with “get rich quick by buying and flipping Bitcoin”.
There Is No Alternative (TINA)
Capitalism may be in crisis, but the alternative (communism) is worse, so Queen TINA rules.
When Capitalism lost it’s natural enemy, after the collapse of the Soviet Union, Capitalism started a long move towards the crisis that hit us in 2008. This crisis of Capitalism is a problem because the alternative of Communism is clearly a failed system/ideology.
During the Cold War, the West had to convince people in both the developed and developing world that capitalism was better for the people by spreading wealth broadly. After the Berlin Wall collapsed, when the people no longer needed to be convinced because there was no competing ideology, wealth went to a smaller and smaller group of people through the process of Financialization. Without a stake in the capitalist system, people moved to populism of both the left and the right and this came to a head in 2016 with Brexit and then the resurgence of the left wing of the Labor Party in the UK and the election of Donald Trump in America. Populism of left and right could destroy capitalism, which will be a disaster because the alternative (communism) has already been proven to fail.
Introducing Digital Cooperatives
The best hope for a revised and sustainable version of Capitalism comes from the concept of digital cooperatives where workers, customers and owners are aligned. The Equity Token model is ideally suited as the funding and governance mechanism for Digital Cooperatives.
This post explore three types of Digital Cooperatives;
- Customer Cooperatives
- Worker Cooperatives
- Hybrid Customer + Worker Cooperatives.
Successful governance models need to look after both customers and workers, so the hybrid model is likely to win. Shareholder primacy has been the mantra of the Financialization Economy, sometimes at the expense of either customers or workers or both. This will change during the Blockchain Economy when ownership will be shared more equally among customers and workers, benefiting the few passive investors along for the ride.
When customers and workers are shareholders you only have two interests to look after, making governance a lot easier.
Shareholder returns are then a byproduct of happy customers and happy workers. If either customers or workers become unhappy, eventually shareholders lose.
In the Analog era, happy workers did not matter and customers only cared about price
If you are in the extraction business – getting something like oil or gold or other commodities out of the earth – you don’t need to worry at all about how happy your workers or customers are. Customers only care about price and your price can be low if you pay low wages to workers (who are fungible and easily replaced and have no impact on the quality of the product).
That became slightly less true in the manufacturing economy. Henry Ford famously wanted workers paid enough so that they could afford his cars. Sadly in most cases it is a tragedy of the commons. Companies want somebody else to ensure that people have enough money to buy their products, so manufacturing workers are unhappy and, apart from a few people, customers don’t care enough to vote with their wallet against companies that treat workers badly.
In the services and knowledge economy, the happiness of the worker matters.
For example, if you engage a consultant or investment banker on a critical job, it matters if that person thinks their job sucks and they don’t like their employer. The knowledge economy is really the knowledge workers economy.
The same is true if you walk into a coffee shop or any other services operation where your experience matters to you. Miserable workers, grinning inanely because the company policy tells them they will be fired if they do not act happy, does not make for a good experience.
The services economy is really the “experience economy”.
Digitisation enables new experiences at low prices. The Digital Economy intersects with the knowledge and services economy but have not connected properly due to a governance mismatch. That governance mismatch can be fixed in the Blockchain Economy.
There is a critical and privileged role for the seed investor in the Blockchain Economy. Do you want to be invested in the past – the extraction and manufacturing economy – or the future of the knowledge and services economy? Investors will need to change their attitude to risk by investing earlier based on fundamental analysis.
The idea of Cooperatives is not new. Before looking into the future of Digital Cooperatives, we will look at some successful and not so successful Cooperative models from the past.
One example of a Customer Cooperative is Vanguard. The customer in this case is a shareholder of the funds. There are no outside investors. This structure allows Vanguard to win by charging very low fees (see this post for more). This Customer Cooperative structure makes Vanguard the real disrupter in the Wealthtech segment of Fintech. When they started in 1975, their average expense ratio was 0.89%. By 2014 this had dropped to 0.18%. Given their scale, network effects and customer ownership structure, nobody can undercut Vanguard on price and in a commodity such as a passive index fund, price is the deciding factor. Vanguard’s growth numbers tell the story:
32 years to reach $1 trillion in assets
8 years to get to $2 trillion
3 years to get to $3 trillion.
Another example is SWIFT. There are two stories around SWIFT:
- 1970s era technology that will get obliterated by new Blockchain based technology.
- An ownership structure that means that the customers aka shareholders are more likely to trust SWIFT to deliver that new Blockchain based technology than any other firm.
The Vanguard and SWIFT stories tells us that ownership matters in the real world. These are not organic farming hippy cooperatives.
There are plenty of other Customer Cooperatives – think of community banks or Coop Grocery stores for example.
Worker Cooperative experiments that failed.
The early Worker Cooperatives that grew out of socialist movements in the 1970s mostly failed due to a simple alignment of interest issue. If employees are owners it is too simple to get employees to vote for a pay increase that will make the business unprofitable; it is a tragedy of the commons. The resurgence of left wing populism is bringing back these ideas, but they are likely to fail for the same reasons.
Digital Worker Cooperatives for the Gig Economy
If the workers are free agents, these micro-entrepreneurs will be much more thoughtful about when and how to raise prices than a salaried employee might.
This is starting to happen in some sectors of the economy. Daily Fintech profiled one example (a Dentist Cooperative). The idea is simply that the ownership of these gig economy networks remains primarily with those who provide the services in those networks. If it works for dentists, why not doctors, drivers….well you name it.
Networks owned by the users
Imagine if Mark Zuckerberg’s next door neighbour at Harvard had the same simple but brilliant idea for a social network and built a good enough product (pretty simple), but decided to offer the first few thousand users a big % of the equity. He or she would be very wealthy (albeit not as wealthy as Mark Zuckerberg) and few thousand people who made it happen would have had their lives changed. Their ownership stake might have given them more incentive to make the network successful rather than a competing network owned by one individual and few investors in Silicon Valley.
In the case of social networks, the User is also the Producer; they produce for free in return for getting a free service. They are also the Product being sold to advertisers. So a User Cooperative is slightly different from a Worker or Customer Cooperative.
Yes But KISS, Blockchain Please
In theory all that sounds good enough, but the Eeyore response to all that Tigger excitement is “the admin issues of thousands of people who combine a role as customers, workers and users makes this an impossible pipe dream”.
That is why we have Smart Contracts and Distributed Autonomous Organisations (DAO). The admin/back office issues are manageable thanks to Blockchain.
A well designed ICO enables a Digital Cooperative. The Ethereum ICO in 2014 is a good example. The early Ethereum investors were also the early workers and the early customers. They understood enough about the technical risk to evaluate that and by building the DAPPS they got to Product Market Fit. Through this simple alignment of interest, Ethereum overcame both technical and market risk.
Tezos for Irony Aficionados
A startup aiming to solve the governance issues around cybercurrencies collapsing into law suits and bankruptcies is pretty delicious for irony aficionados. I never quite understood how Tezos was going to fix the governance issues but clearly they did not eat their own dog food.
The Wolf of Wall Street on LSD
Wall Street is pretty shameless, but the long hot summer of ICO showed us what a totally unregulated alternative looks like and it may be worse. This is a million miles away from what inspired techies and idealists to get involved with an obscure White Paper from an unknown individual on an obscure cryptography site in 2009 and also what got people to put their money and time behind the wild dreams of a decentralised computer from a 19 year old programmer called Vitalik Buterin.
The Critical and Privileged Role of the Seed Investor
Traditional analog and manufacturing businesses are cash capital intensive but low on intellectual capital intensity. Digital businesses are much more cash capital efficient but totally reliant on intellectual capital. You need less cash capital, but you do need some. There is still role for the early investors. If you get in early on a capital efficient business that gets to Product Market Fit, you are golden. The ICO innovation, for all its sketchy characters and craziness, is democratising early stage investing.
During the founding days of VC it had very little to do with fund management and everything to do with innovation. As the VC industry grew to become a huge part of our economy, many VC Funds became more about fund management than innovation. All the incentive in fund management is to grow fund size. That naturally pushes you away from seed investing. Lets say you want a $100m fund (giving you $2m to run the business based on 2% AUM fee). Picking 100 deals at $1m each at Seed stage is too much hard work. You much prefer to do 10 deals at $10m each – and investing $10m at Seed stage is not wise.
So the VC industry deserted the seed stage.
Into that market gap – huge demand at Seed stage not being met by supply – came the ICO innovation in all its messy. sketchy semi-legal glory. A well-designed ICO that reduces both technical risk and market risk because those who can evaluate technical risk and market risk buy the Tokens is a game-changer for investors, workers and customers. Message to regulators – don’t throw out the baby (game-changing innovation) with the bathwater (scammy ICO promoters). Smart regulation that is tech driven not just throwing the lawyers around can be a win for both entrepreneurs and investors.
You can reach out directly to discuss our advisory services by sending an email to julia at dailyfintech dot com
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