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Blockchain Revolution (updated)

Page 12

by Don Tapscott


  Entrepreneur Erik Voorhees called for common sense: “With a reputation-based system, people who are more likely to be able to afford a house should be able to purchase one more easily. Those who are less likely should have a harder time getting a loan.” To him, this method “will drive down costs for good actors and drive up costs for our bad actors, which is the proper incentive.”77 In reputation systems, your creditworthiness is derived not from a FICO score, but from an amalgamation of attributes that form your identity and inform your ability to repay a loan. Credit ratings for companies will also change to reflect new information and insight made possible by blockchain. Imagine tools that can aggregate reputation and track different reputational aspects, such as financial trustworthiness, vocational competence, and social consciousness. Imagine getting credit based on shared values, where the people loaning you money appreciate your role in the community and your goals.

  THE BLOCKCHAIN IPO

  The week of August 17, 2015, was an ugly one: The Chinese stock market crashed, the S&P 500 had its worst performance in four years, and financial pundits everywhere were talking about another global economic slowdown and possible crisis. Traditional IPOs were pulled from the market, mergers were stalled, and Silicon Valley was getting antsy about the overinflated valuation of its cherished unicorns, private companies valued at more than $1 billion.

  Amid the carnage, an enterprise called Augur launched one of the most successful crowdfunding campaigns in history. In the first week, more than 3,500 people from the United States, China, Japan, France, Germany, Spain, the United Kingdom, Korea, Brazil, South Africa, Kenya, and Uganda contributed a total of $4 million. There was no brokerage, no investment bank, no stock exchange, no mandatory filings, no regulator, and no lawyers. There wasn’t even a Kickstarter or Indiegogo. Ladies and gentlemen, welcome to the blockchain IPO.

  Matching investors with entrepreneurs is one of the eight functions of the financial services industry most likely to be disrupted. The process of raising equity capital—through private placements, initial public offerings, secondary offerings, and private investments in public equities (PIPEs)—has not changed significantly since the 1930s.78

  Thanks to new crowdfunding platforms, small companies can access capital using the Internet. The Oculus Rift and the Pebble Watch were early successes of this model. Still, participants couldn’t buy equity directly. Today, the U.S. Jumpstart Our Business Startups Act allows small investors to make direct investments in crowdfunding campaigns, but investors and entrepreneurs still need intermediaries such as Kickstarter or Indiegogo, and a conventional payment method, typically credit cards and PayPal, to participate. The intermediary is the ultimate arbiter of everything, including who owns what.

  The blockchain IPO takes the concept further. Now, companies can raise funds “on the blockchain” by issuing tokens, or cryptosecurities, of some value in the company. They can represent equity, bonds, or, in the case of Augur, market-maker seats on the platform, granting owners the right to decide which prediction markets the company will open. Ethereum was an even greater success than Augur, funding the development of a whole new blockchain through a crowd sale of its native token, ether. Today Ethereum is the second-longest and fastest-growing public blockchain. The average investment in the Augur crowdfunding was $750, but one can easily imagine minimum subscriptions of a dollar or even ten cents. Anyone in the world—even the poorest and most remote people—could become stock market investors.

  Overstock, the e-retailer, is launching perhaps the most ambitious cryptosecurity initiative yet. Overstock’s forward-thinking founder, Patrick Byrne, believes blockchain “can do for the capital markets what the Internet has done for consumers.” The project, dubbed Medici, enables companies to issue securities on the blockchain and recently received the support of the Securities and Exchange Commission.79 The company began issuing its first blockchain-based securities, such as the $5 million cryptobond for an affiliate of FNY Capital, in 2015.80 Overstock claims many financial services firms and other companies are lining up to use the platform. Surely, the tacit approval of the SEC will give Overstock a head start on what is sure to be a long journey.

  Should blockchain IPOs continue to gain traction, they will ultimately disrupt many of the roles in the global financial system—brokers, investment bankers, and securities lawyers—and change the nature of investment. By integrating blockchain IPOs with new platforms for value exchange such as Circle, Coinbase (the most well-funded bitcoin exchange start-up), Smartwallet (a global asset exchange for all forms of value), and other emerging companies, we expect a distributed virtual exchange to emerge. The old guard is taking notice. The NYSE invested in Coinbase and NASDAQ is integrating blockchain technology into its private market. Bob Greifeld, CEO of NASDAQ, is starting small, using blockchain to “streamline financial record keeping while making it cheaper and more accurate,”81 but evidently NASDAQ and other incumbents have bigger plans.

  THE MARKET FOR PREDICTION MARKETS

  Augur is building a decentralized prediction market platform that rewards users for correctly predicting future events—sporting events, election results, new product launches, the genders of celebrity babies. How does it work? Augur users can purchase or sell shares in the outcome of a future event, the value of which is an estimate of the probability of an event happening. So if there are even odds (i.e., 50/50), the cost of buying a share would be fifty cents.

  Augur relies on “the wisdom of the crowd,” the scientific principle that a large group of people can often predict the outcome of a future event with far greater accuracy than one or more experts.82 In other words, Augur brings the spirit of the market to bear on the accuracy of predictions. There have been a few attempts at centralized prediction markets, such as the Hollywood Stock Exchange, Intrade, and HedgeStreet (now Nadex), but most have been shut down or failed to launch over regulatory and legal concerns. Think assassination contracts and terrorism futures.

  Using blockchain technology makes the system more resilient to failure, more accurate, and more resistant to crackdowns, error, coercion, liquidity concerns, and what the Augur team calls euphemistically “dated jurisdictional regulation.” The arbiters on the Augur platform are known as referees and their legitimacy derives from their reputation points. For doing the right thing—that is, correctly stating that an event happened, who won a sporting match, or who won an election—they receive more reputation points. Maintaining the integrity of the system has other monetary benefits: the more reputation points you have, the more markets you can make, and thus the more fees you can charge. In Augur’s words, “our prediction markets eliminate counterparty risks, centralized servers, and create a global market by employing cryptocurrencies including bitcoin, ether, and stable cryptocurrencies. All funds are stored in smart contracts, and no one can steal the money.”83 Augur resolves the issue of unethical contracts by having a zero-tolerance policy for crime.

  To Augur’s leadership team, human imagination is the only practical limit to the utility of prediction markets. On Augur, anyone can post a clearly defined prediction about anything with a clear end date—from the trivial, “Will Brad Pitt and Angelina Jolie divorce?” to the vital, “Will the European Union dissolve by June 1, 2017?” The implications for the financial services industry, for investors, economic actors, and entire markets, are huge. Consider the farmer in Nicaragua or Kenya who has no robust tools to hedge against currency risk, political risk, or changes to the weather and climate. Accessing prediction markets would allow that person to mitigate the risk of drought or disaster. For example, he could buy a prediction contract that pays out if a crop yield is below a certain level, or if the country gets less than a predetermined amount of rain.

  Prediction markets are useful for investors who want to place bets on the outcome of specific events such as “Will IBM beat its earnings by at least ten cents this quarter?” Today the reported “estimate” for corporate earnings is nothing more than the mean
or median of a few so-called expert analysts. By harnessing the wisdom of the crowds, we can form more realistic predictions of the future, leading to more efficient markets. Prediction markets can serve as a hedge against global uncertainty and “black swan” events: “Will Greece’s economy shrink by more than 15 percent this year?”84 Today, we rely on a few talking heads to sound the alarms; a prediction market would act more impartially as an early warning system for investors globally.

  Prediction markets could complement and ultimately transform many aspects of the financial system. Consider prediction markets on the outcomes of corporate actions—earnings reports, mergers, acquisitions, and changes in management. Prediction markets would inform the insurance of value and the hedging of risk, potentially even displacing esoteric financial instruments like options, interest rate swaps and credit default swaps.

  Of course, not everything needs a prediction market. Enough people need to care to make it liquid enough to attract attention. Still, the potential is vast, the opportunity significant, and access available to all.

  ROAD MAP FOR THE GOLDEN EIGHT

  Blockchain technologies will impact every form and function of the financial services industry—from retail banking and capital markets to accounting and regulation. They will also force us to rethink the role of banks and financial institutions in society. “Bitcoin cannot have bail-ins, bank holidays, currency controls, balance freezes, withdrawal limits, banking hours,”85 said Andreas Antonopoulos.

  Whereas the old world was hierarchical, slow-moving, reluctant to change, closed and opaque, and controlled by powerful intermediaries, the new order will be flatter, offering a peer-to-peer solution; more private and secure; transparent, inclusive, and innovative. To be sure, there will be dislocation and disruption, but there is also a remarkable opportunity for the industry’s leaders to do something about it today. The financial services industry will both shrink and grow over the coming years; fewer intermediaries will be able to offer more products and services at a much lower cost to a much larger population. That’s a good thing. Whether permissioned and closed blockchains will find a place in a decentralized world is up for debate. Barry Silbert, who founded SecondMarket and is now CEO of the Digital Currency Group, said, “I have a very cynical view of the objectivities put forward by large financial incumbents. When all you have is a hammer, everything looks like a nail.”86 We believe that the unstoppable force of blockchain technology is barreling down on the entrenched, regulated, and ossified infrastructure of modern finance.87 Their collision will reshape the landscape of finance for decades to come. We would like it to finally transform from an industrial age money machine into a prosperity platform.

  CHAPTER 4

  RE-ARCHITECTING THE FIRM:

  THE CORE AND THE EDGES

  BUILDING CONSENSYS

  July 30, 2015, was a big day for a global group of coders, investors, entrepreneurs, and corporate strategists who think that Ethereum is the next big thing—not just for business, but possibly for civilization. Ethereum, the blockchain platform eighteen months in the making, went live.

  We witnessed the launch firsthand in the Brooklyn office of Consensus Systems (ConsenSys), one of the first Ethereum software development companies. Around 11:45 a.m., there were high fives all around as the Ethereum network created its “genesis block,” after which a frenzy of miners raced to win the first block of ether, Ethereum’s currency. The day was eerily suspenseful. A massive thunderstorm broke over the East River, triggering loud and random emergency flood warnings on everyone’s smart phones.

  According to its Web site, Ethereum is a platform that runs decentralized applications, namely smart contracts, “exactly as programmed without any possibility of downtime, censorship, fraud, or third party interference.” Ethereum is like bitcoin in that its ether motivates a network of peers to validate transactions, secure the network, and achieve consensus about what exists and what has occurred. But unlike bitcoin it contains some powerful tools to help developers and others create software services ranging from decentralized games to stock exchanges.

  Ethereum was conceived in 2013 by then-nineteen-year-old Vitalik Buterin, a Canadian of Russian descent. He had argued to the bitcoin core developers that the platform needed a more robust scripting language for developing applications. When they rejected him, he decided to craft his own platform. ConsenSys was first off the block, so to speak, launched to create Ethereum-based apps. Flash-forward a couple of years and the analogy is clear: Linus Torvalds is to Linux what Vitalik Buterin is to Ethereum.

  When discussing the rise of blockchain and Ethereum technology, Joseph Lubin, ConsenSys’s cofounder, said, “It became clear to me that instead of people wasting their time walking down the street with posters on sticks, we could all work together to just build the new solutions to this broken economy and society.”1 Don’t occupy Wall Street. Invent our own street.

  Like many entrepreneurs, Lubin has a bold mission, not just to build a great company but to solve important problems in the world. He deadpans that the company is a “blockchain venture production studio, building decentralized applications, mostly on Ethereum.” Pretty low-key. But, if implemented, the applications that ConsenSys is building would shake the windows and rattle the walls of a dozen industries. Projects include a distributed triple-entry accounting system; a decentralized version of the massively popular Reddit discussion forum, plagued of late by controversy over its centralized control; a document formation and management system for self-enforcing contracts (aka smart contracts); prediction markets for business, sports, and entertainment; an open energy market; a distributed music model to compete with Apple and Spotify, though those two firms could use it too;2 and a suite of business tools for mass collaboration, mass creation, and mass management of a management-less company.

  Our story of ConsenSys is not so much about its ambitious blockchain-based products or services. It’s about its efforts to cultivate a company of its own, pioneering important new ground in management science along the lines of holacracy, a collaborative rather than hierarchical process for defining and aligning the work to be done. “While I don’t want us to implement holacracy as is—it feels way too rigid and structured to me—we are working to incorporate many of its philosophies in our structure and processes,” said Lubin. Among those holacratic tenets are “dynamic roles rather than traditional job descriptions; distributed, not delegated authority; transparent rules rather than office politics; and rapid reiterations rather than big reorganizations,” all of which describe how blockchain technologies work. How ConsenSys is structured, how it creates value, and how it manages itself differs not only from the industrial corporation but also from the typical dot-com.

  Joe Lubin is not an ideologue, and certainly not an anarchist or libertarian as some in the cryptocurrency movement are. But he does think that we need to change capitalism if we want it to survive, specifically to move away from the command-and-control hierarchies inappropriate for a networked world. He notes that today, even though vast networks enmesh the world and enable us all to communicate inexpensively, richly, and immediately, hierarchies prevail. Blockchain technology is the countervalence: “Global human society can now agree on the truth and make decisions in ten minutes, or ten seconds. This surely creates an opportunity to have a more enfranchised society,” he said. The greater the engagement, the greater the prosperity.

  The End of Managers. Long Live Management

  ConsenSys operates according to a plan that all employees (“members”) developed, modified, voted on, and adopted. Joe Lubin describes its structure as a “hub” rather than a hierarchy, and each of its projects is a “spoke” in which major contributors hold equity.

  For the most part, members of ConsenSys choose what they work on. No top-down assignments. Lubin said, “We share as much as possible, including shared software components. We build small agile teams but there is collaboration among them. We have tons of immediate, open, rich comm
unication.” Members choose to work on two to five projects. When someone sees a piece of work that needs to get done, he or she jumps in and pushes it a little or a lot farther in a valuable direction, as appropriate for her role. “We talk about things quite a bit so people are aware of the many things that could be pushed forward,” he said. But these many things can and do change constantly. “Part of being agile means that priorities are dynamic.”

  Lubin is not the boss. His main operational role is advisory: “In many cases, individuals ask me or others what would be good to work on,” he said. Through Slack3 and GitHub,4 he suggests directions they might pursue “to build all the services and platforms that we want to build, and many that we want to build but don’t know it yet.”

  Member ownership explicitly incentivizes this behavior. Everyone owns a piece of every project directly or indirectly: the Ethereum platform issues tokens that members can exchange for ether and then convert into any other currency. “Our goal is to achieve a nice balance between independence and interdependence,” Lubin said. “We view ourselves as a collective of closely collaborating entrepreneurlike agents. At some point, it may prove necessary to suggest that a certain thing really needs to get done and if nobody steps up, to hire someone initially for that role or incentivize internal people to do it,” said Lubin. But, overall, “everyone is a self-managed adult. Did I mention we communicate a lot? Then we all make our own decisions.”

 

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