AI transcript
0:00:05 The content here is for informational purposes only, should not be taken as legal business
0:00:10 tax or investment advice or be used to evaluate any investment or security and is not directed
0:00:15 at any investors or potential investors in any A16Z fund. For more details, please see
0:00:21 a16z.com/disclosures. Hi everyone, welcome to the A6Z podcast. I’m
0:00:26 Sonal. Today we have another one of our podcast on the road episodes with guests from New
0:00:33 York City on the topic of crypto, but more broadly on crypto networks as emerging economies.
0:00:38 This conversation goes into the super interesting nuances of structuring these networks to avoid
0:00:43 some of the failings we’ve seen in the monetary and fiscal policies of traditional economies,
0:00:49 including debating how to empower users when it comes to risk, but also how to better distribute
0:00:54 access in terms of who captures value from networks. We then also discovered different
0:00:59 mindsets for the governance of these networks, which are really crypto economic systems,
0:01:04 especially as they evolve and grow more mainstream over time. Joining us to have this conversation,
0:01:09 we have two guests, our friends at Placeholder VC. Chris Berniske, who formerly led ARC Invest
0:01:13 Crypto Efforts, has written a lot about financial modeling influence frameworks for analyzing
0:01:18 crypto and co-wrote a book on crypto assets, and Joel Monegro, who before starting Placeholder
0:01:23 with Chris was an analyst at USV, where he helped develop their early blockchain theses
0:01:28 prior to that, he managed the Dominican Republic’s government office in charge of developing
0:01:32 the country’s national and digital economy technology agenda. I share all that as key
0:01:36 context for the conversation that follows. And last but not least, we have two of our
0:01:41 partners from A6 and Z Crypto, Jesse Walden and Dennis Nazarov, formerly co-founders
0:01:45 of MediaChain, which was acquired by Spotify, Jesse and Dennis interview our guests and
0:01:50 also add their perspectives in the discussion and debate. On that note, the content here
0:01:57 is for informational purposes only and should not be taken as legal business tax or investment
0:02:03 advice or be used to evaluate any investment or security. It is not directed at any investors
0:02:10 or potential investors in any fund. For more details, please also see a6nzcrypto.com/disclosures.
0:02:15 Before the discussion goes into what it takes to design such crypto economic systems at
0:02:20 scale from value capture to risk to governance, they first quickly begin with the fundamental
0:02:26 concept of layers in a stack of protocols and decentralized applications. The first
0:02:31 voice you’ll hear is Joel followed by Chris’s and then Jesse and Dennis joins in later.
0:02:35 You can think about it from an engineering point of view and how different kinds of
0:02:40 software are layered on top of each other. You can think about it also from a more social
0:02:46 point of view. Layer one is more machine work and layer two is more human work. And as you
0:02:51 transition from layer one to layer two, then you end up with lighter weight models because
0:02:55 you don’t have the capital cost of the machines to actually do the work, to store the files,
0:03:00 to mine the transactions. What we see at layer two are more abstract units of work that require
0:03:06 human judgment. And there the cost is harder to model because it’s harder to quantify what
0:03:10 is the value that goes into performing some unit of work. And that unit of work can be
0:03:16 anything from curating content to making a governance decision. All of those things are
0:03:21 very difficult to put in a spreadsheet model, but we have the aid of the invisible hand
0:03:26 in a way and that’s helping us figure out what human work is worth. I think the infatuation
0:03:31 with layer one comes from it being much easier to understand the cost and value relationship
0:03:35 between providing a service and consuming a service. It gets harder as you move up the
0:03:40 layers. Once you get into the realm of human work is when you start to really imagine that
0:03:44 there are different ways in which crypto can really change the way we do things.
0:03:48 I think as we go up higher in these layers we’re going to see different incentivization
0:03:54 and therefore value capture mechanisms. Layer one, the priority is security because that’s
0:03:59 basically our clearing and settlement layer. And so we’ve really seen Bitcoin prioritize
0:04:05 security or Ethereum. And because if we build all these layers on top of an insecure layer
0:04:11 one then we’re screwed, right? And then as we move up the stack it’s less about that
0:04:18 machine security say and more about how do you incentivize the economic actors to perform
0:04:23 the service that you’ve promised to provide. And the only way that that ends up being a
0:04:28 service that the end user uses is either if it’s cheaper than existing services that
0:04:32 you can get from the centralized model but on par in terms of user experience or it’s
0:04:38 a fundamentally new experience or service and this is the only place I can get it there’s
0:04:43 the access tokens where basically there’s demand of what I find interesting about an
0:04:47 access token is historically we’ve thought of tokens as needing to connect the supply
0:04:52 side and demand side. An access token really just focuses on the supply side and it can
0:04:56 have a fixed supply and there can be scarcity because basically if the supply side needs
0:05:01 that token to perform the service and performing the service is a profitable activity for them
0:05:06 then there will be a clamoring to get a hold of that token and that drives its own scarcity
0:05:11 and that’s slightly easier to model you can actually use discounted cash flow model to
0:05:17 approximate the value of that token and the demand side can pay in fiat if they want and
0:05:21 I think we’ll increasingly see this where the demand side is going to just pay in whatever
0:05:26 asset they want they don’t need to interface with crypto assets from a day to day perspective
0:05:31 but you can still have value in a work token that organizes the supply side and induces
0:05:34 a competition around being able to provide that service.
0:05:39 So in the model you described Chris we call it the taxi medallion model what’s interesting
0:05:44 about it is there’s one token that is the right to do the work and the other token which
0:05:49 is the payment token and so as you said it’s you can do sort of a cash flow analysis on
0:05:54 what the work token is going to earn and this differs from the base layer where you know
0:06:00 today most of the layer one blockchains use one token for both rewarding the supply side
0:06:05 and for the demand side to consume the service and I’m curious what do you guys think the
0:06:13 implications of moving to work token model are is there any sort of implications for
0:06:17 users and suppliers not being aligned around the same token.
0:06:23 Well the thing that’s really scary about this trend to create dual token systems where one
0:06:27 token gives you access to the supply side or a right to participate in the supply side
0:06:31 and another one into being the payment token whether it’s another token that it’s created
0:06:36 by the crypto network or something like ETH or any other one is that you were doing the
0:06:42 same thing that we did with the world economy which is that we separated currency and capital
0:06:47 the moment that we moved into a fiat currency model in modern capitalism.
0:06:53 We have two major kind of asset types we have capital and we have that and currencies are
0:06:57 really a form of debt at the end of the day and backtracking a little bit the reason we
0:07:01 separated currency from capital is because the transaction velocity of capital is very
0:07:08 low the transaction velocity of a dollar is very high and so as the economy grows exchanging
0:07:12 gold or land or just a barter system is not going to work and so we needed currencies
0:07:19 to accelerate economic growth so far so good the problem is that capital and currencies
0:07:24 respond very differently to economic growth capital appreciates together with economic
0:07:28 growth and currencies actually depreciate as an economy grows.
0:07:34 Inflation is commonly thought of as the printing of new money but really a more traditional
0:07:40 definition of inflation is increases in prices over time as a result of economic growth and
0:07:45 capital as an asset type appreciates as the economy grows because it is more scarce than
0:07:50 currency currency we print more of it to keep up with inflation to keep prices stable and
0:07:53 that’s how they end up devaluing over time because we’re creating more and more and more
0:07:58 what happens over time then is that actually capital becomes more and more concentrated
0:08:02 because its transaction velocity is so low and the problem with that is that we end up
0:08:07 with a lot of people living their lives in in currency and very few people living their
0:08:08 lives in capital.
0:08:13 What part of the promise of crypto networks at least to me is that we are able to combine
0:08:18 currency and capital into a single asset so that then we don’t get the same kind of income
0:08:24 inequality or wealth inequality being created as any individual crypto network grows and
0:08:29 the risk of separating the access token or the work token from the currency token is
0:08:34 that the people who accumulated the access tokens early on that group becomes increasingly
0:08:39 concentrated over time as the economy grows or as the crypto network grows the value of
0:08:44 combining the two. If you have a single token that is both a supply site token and a payment
0:08:50 token in order for the supply site to provide its service it has to take payment in that
0:08:53 token so the token has to be in the user’s hands in order for them to actually consume
0:08:58 the service and so that creates a pressure to sell the work token or sell the capital
0:09:02 token as the network grows because otherwise you’re not going to get any customers. Everyone
0:09:06 in a crypto network can participate from the value created as opposed to just one segment.
0:09:12 I definitely agree there’s a risk to backtracking a little bit with the ethos of crypto separating
0:09:17 the work or the capital and currency. I think one thing even if we end up in a work token
0:09:23 world or taxi medallion world where we’ve separated capital and currency again at least
0:09:29 within those networks the one reassuring thing is that you can’t be a passive accumulator
0:09:35 of capital. You have to be more active like you stake the work token and then you have
0:09:40 to continue to provide work for the network to continue to collect cash flows.
0:09:43 So I would argue that that’s not entirely true and that’s because in these proof of
0:09:49 stake systems you often have the ability to delegate stake and so what happens there is
0:09:53 a marketplace emerges where there are people sitting on capital and they just point that
0:09:58 capital at a worker so it’s very much like taxi medallions work in New York City. They’re
0:10:02 mostly bought up by hedge funds and the like and then they hire drivers to go and drive
0:10:06 the cars and earn passive income on those medallions. And so I think that does speak
0:10:11 to Jule’s point that the separation of these two things does result in a concentration
0:10:17 of capital but I would argue that the flip side is that the users of the service don’t
0:10:22 have to take any risk. So when I get into a taxicab I don’t have to think about whether
0:10:28 Uber or Lyft are going to have a real big impact on the value of my medallion and the
0:10:33 future utility I’ll get out of it. So humans tend to think in one unit of account because
0:10:37 it’s just easier to reason about and you don’t want to be taking risk necessarily when you’re
0:10:42 buying a coffee or a pizza and that ends up going on to be worth millions of dollars.
0:10:49 And so there is this sort of simplicity in the tax now in versus currency model that
0:10:54 I think it’s hard to get away from just because of human nature.
0:10:59 I argue that risk is good because you can’t create value without creating risk. And again
0:11:04 it’s that same kind of thinking that led to the world where we are today. It’s much simpler
0:11:09 to have everyone use dollars because no one has to think about how the markets are moving
0:11:12 and how your value is changing over time. Rather you trust the government. You trust
0:11:18 that they’re going to maintain a certain monetary policy such that you hope that your
0:11:22 hundred thousand dollars today is going to maintain a certain degree of purchasing power.
0:11:28 The problem with that is that by not allowing people to take risks in a way then we’ve cheated
0:11:33 them away from capturing some of the upside of the value. And I think it’s time to rethink
0:11:39 how we think about risk for people more broadly. If we prevent people or the science systems
0:11:44 that make it harder for people to take those risks and participate in the value then we’re
0:11:48 going to end up in the same world where we are today where the values concentrated amongst
0:11:52 those who took the greatest risks. Now obviously it can go really badly if you have a whole
0:11:55 bunch of risk spread a whole whole bunch of people and then everything comes crashing
0:12:00 down then you have a real problem. So it’s not that there isn’t value instability and
0:12:05 value in currencies that make it easier for consumers to go about their daily lives. But
0:12:09 I also don’t think we’re heading to a world where you buy your coffee with Bitcoin. I
0:12:14 also think that the overall argument of well we need to create these systems because otherwise
0:12:18 it’s too risky and then people are not going to use it. I think it’s a little not patronizing
0:12:23 but it underestimates people’s ability to make those decisions for themselves.
0:12:29 I remember asking you about three four years ago whether it’s actually a good idea to make
0:12:35 your users investors because there’s a cognitive overhead that is associated with that. You’re
0:12:42 asking your users to be sophisticated about the underlying infrastructure powering their
0:12:48 daily experience and I think increasingly in in crypto we’re seeing that at least when
0:12:53 you have some skin in the game participants in these networks are willing to go in a little
0:12:58 bit deeper and the types of communities that emerge are on these projects are just fundamentally
0:13:02 different like people have a different relationship with the network. Ethereum participants own
0:13:08 the token and therefore have an emotional connection to the values of the infrastructure
0:13:13 and its goals and what it achieves. Sometimes. Yeah, to a fault sometimes and I think the
0:13:20 question is how scalable is this? Can we scale this model to the entire world or is it limited
0:13:26 to a subset of users who are sophisticated enough and want to take on that risk and so
0:13:31 just to push back a little bit on the idea that we will be able to scale this model sort
0:13:35 of all the way up. I think the idea of having this work token currency model it doesn’t
0:13:41 preclude power users from participating in the network and then through delegation the
0:13:45 owner of that token does not need to necessarily provide the work. So a power user can invest
0:13:51 in the success of the network that they’re using but it’s a choice and so I think there’s
0:13:56 flexibility both ways. On one side the assumption is that we should give risk to everyone and
0:14:00 that’s that optimal in the other side is we should let people choose. You can argue both
0:14:05 sides of the table and so what that tells me is let the people make the choice but then
0:14:09 that becomes a question of what’s the default. So you know we’ve all gone through a sign-up
0:14:14 form where the checkboxes are checked by default or not that opt you into certain things and
0:14:19 we’ve learned that people tend to stick with the default and so I would rather see a world
0:14:23 where the default is we’re all participating in the value. Yeah, any citizen can go and
0:14:27 open a brokerage account and buy stocks and participate in the market but most people
0:14:32 don’t because that’s not the default. So I think one thing that we can do here is actually
0:14:37 create a model and train another generation of users to think as users who are staked
0:14:41 in the network in a way that we really couldn’t before and the generational aspect I think
0:14:46 is very important because the other thing that’s going on here is that the way these
0:14:51 assets accrue value is very different to the way that other previous kinds of assets accrue
0:14:57 value. Previously in a more traditional world when we had companies go public it was a lot
0:15:02 of the same philosophy of you, you’re a customer of Walmart, Walmart goes public, you can buy
0:15:06 stock in Walmart and then every time that you go to Walmart and you’re paying with your
0:15:12 dollars you know there is some value accruing back to you as a shareholder of the company.
0:15:15 But in order to properly analyze an equity you have to go to business school and learn
0:15:19 how to do this kind of cash flows and how to figure out you know how to analyze whether
0:15:23 management is doing things correctly and so on. What’s different here is that we’re dealing
0:15:28 with these decentralized networks where if they’re properly constructed the value doesn’t
0:15:32 really necessarily depend on the actions of a management team but rather on the overall
0:15:33 network.
0:15:39 Yes, we were talking about the consumer perspective and them being a shareholder and that’s one
0:15:43 side of the argument, the other is from the developer and people who are actually building
0:15:44 these protocols.
0:15:49 So I want to take a step back because we’ve been saying user network participant those
0:15:57 kinds of things and I think that it really depends on which network participant we’re
0:15:58 referring to.
0:16:03 So early on in a network where it’s mostly the supply side right because the supply side
0:16:08 has to come on board to actually provision the asset and presumably the supply side is
0:16:15 going to be a much more sophisticated person at least in their understanding of the network
0:16:16 than the demand side.
0:16:20 At least as we scale out over the long term I think that’s an assumption we can make.
0:16:24 And so that supply side can tolerate that earlier risk because presumably they’re more
0:16:27 sophisticated and so that all makes sense.
0:16:32 Where I think we start to encounter more problems especially if crypto goes mainstream we will
0:16:38 have you know hundreds of millions billions of end users on the demand side and I think
0:16:43 it’s a stretch to ask the demand side to be an expert in the network.
0:16:46 The supply side this is different from our current equity environment.
0:16:52 If you set aside stock based comp traditionally an employee at a company doesn’t necessarily
0:16:54 have exposure to the upside of that company.
0:16:59 Stock based comp has changed that a lot but that employee mostly gets paid in fiat currency
0:17:03 which goes back to Joel’s point of you know they don’t get to participate in the capital
0:17:08 appreciation as much as the management and the concentrated owners of capital.
0:17:11 So for me that’s a big improvement.
0:17:18 Early on demand-siders they’ll be early adopters but I think as this space grows we will abstract
0:17:22 a lot of that complexity away from them and the demand side will just pay in whatever
0:17:27 they want to pay it be they in Kenya be they in the US be they in Korea you pay for the
0:17:32 service with whatever currency you want that ends up getting converted and the supply side
0:17:37 will get paid in the native asset of the network through whatever it may be.
0:17:41 But the key is that the supply side gets access to that risk and that capital appreciation
0:17:42 for me for me.
0:17:47 So I think an interesting sort of avenue to go down here is to again come back to this
0:17:51 idea of the different layers in the stack and how it may be different at each of them.
0:17:56 So at the base layer it makes a lot of sense for there to be sort of one currency or you
0:18:01 know because because you do really want to align the incentives of the supply side and
0:18:07 the users because it’s this very general substrate upon which you know like all all kinds of
0:18:11 more complex applications can be built but this because it’s very general you want there
0:18:17 to be this sort of network effect that everyone is everyone converges on the values and the
0:18:22 goal of this general substrate as you get further up the stack and you build more complex
0:18:28 applications something like a stable coin for example requires sort of more specialization
0:18:32 in terms of the type of work that’s being done and this is to Joel’s point earlier that
0:18:39 it’s it’s more human work and more specialization generally means more expertise.
0:18:45 And so once you get into those types of applications I think it becomes a little bit harder for everyday
0:18:49 users to be sophisticated about the work that’s going on behind the scenes.
0:18:54 People probably don’t need to understand how Ethereum computers you know determine consensus
0:18:59 but I think the difference is that in order for a stable coin to work it’s a much more
0:19:03 you know complicated system and it has parameters that need to be tuned and they probably need
0:19:08 to be tuned by experts whereas computation is deterministic it’s sort of a binary outcome
0:19:11 right or wrong and it can be verified by computers.
0:19:16 And so I would argue that the base layer of the system being more general lends itself
0:19:20 to this sort of single token model a little bit better but as you move further up the
0:19:24 stack I think you do want this separation between sort of the management and the users
0:19:27 because it requires expertise.
0:19:29 And that brings us to governance.
0:19:30 Right.
0:19:34 And maybe an analogy is the base layer sort of like a country it’s like you’re a citizen
0:19:40 of America you get to vote and participate in you know elections and to decide kind of
0:19:41 policy.
0:19:46 Taxation policy is the substrate for all economic activity built on top of America and then
0:19:51 there’s more specific corporations inside of America and they have their own governance
0:19:56 practices they have their own equity and then participating in them is much more specialized
0:20:01 but you have this broad substrate that everyone else builds on top of with different governance
0:20:02 parameters.
0:20:07 So I like to think of or we like to think of crypto networks as emerging economies and
0:20:13 what’s interesting about that is that if you compare crypto network to a country you start
0:20:18 to see a number of similarities there’s a currency that’s exchanged between buyers and
0:20:23 sellers there’s if you think of the executive team or the executive branch is the core development
0:20:28 team and you think of the blockchain as the court or the legislative system where you
0:20:32 know all the rules go there and then you have the supply side which are the miners or the
0:20:36 producers and you have the demand side which are the users who are consuming the service
0:20:39 that starts to look a lot like a small economy.
0:20:44 And then what’s cool about that is that you can use this model to think through whether
0:20:47 a crypto network is properly constructed or not.
0:20:52 So for example things that we’ve learned over time that we like to see in physical economies
0:20:58 like low degrees of corruption and sound monetary policies and fiscal policies and a rich supply
0:21:03 side and an active demand side it ends up getting us into the topic of governance because
0:21:08 one of the things that can determine the success of a national economy or not is how that economy
0:21:09 is governed.
0:21:14 There’s a broader conversation about where is the value of governance in crypto networks
0:21:18 and governance is a difficult topic because it is so broad but I’ll bring it even further
0:21:24 back to the history of information technology in the 50s and 60s.
0:21:27 That era was based around the hardware how quickly you could iterate on hardware and
0:21:31 how quickly could you get computers in the market and IBM won that war because they were
0:21:36 able to design custom computers for custom use cases faster than than anybody else.
0:21:40 That business started breaking down in the 70s and 80s following the introduction of
0:21:45 the microprocessor which consolidated a whole bunch of those circuits into a single part
0:21:49 that was widely available and that created two things.
0:21:53 It first it unbundled the hardware industry and we went from effectively one computer
0:21:58 manufacturer to dozens of PC manufacturers and so on.
0:22:01 But then what happened is that value moved one layer up to the software layer and so
0:22:05 we have Microsoft and the PC software boom of the 70s and 80s.
0:22:09 We saw that get built on top of the microprocessor standard or platform.
0:22:15 Fast forward to the end of the 80s and into the 90s and we went from having dozens of
0:22:22 independent software ventures to having Microsoft consolidating that entire ecosystem and building
0:22:27 its business on the basis of proprietary software and proprietary distribution of that software.
0:22:30 What happened in the 90s is we got two things.
0:22:35 We got the internet and we got Linux which was free software and free distribution and
0:22:38 so that directly challenged Microsoft.
0:22:43 And so we got into the web era where the value moved again one layer up to data which is
0:22:44 where we live today.
0:22:50 We have the big tech companies of today Google, Apple, Facebook, Amazon and so on.
0:22:54 Their main asset their main capital asset is all the data that they’ve been able to
0:22:56 accrue over time as people have used their service.
0:23:01 So we’ve been in this stage for about 20 years now and right on schedule we get the
0:23:07 arrival of a new open technology which are blockchains that directly challenge the proprietary
0:23:11 data business model just as the internet and Linux challenged the proprietary software
0:23:12 and distribution business model.
0:23:16 It gets into a question of okay if we see this pattern of value moving one layer up,
0:23:20 one layer up, one layer up and we’ve gone from hardware to software and from software
0:23:22 to data and now data is free.
0:23:23 What’s above data?
0:23:29 The layer that exists at a higher level and to us that’s governance because it becomes
0:23:33 a question of how do we manage, how do we control, how do we manipulate the data and
0:23:38 how do we agree on a single source of truth which is the whole thinking behind designing
0:23:40 these consensus systems.
0:23:44 The crypto networks at the end of the day are systems that we designed to arrive at a shared
0:23:49 understanding of what is the right data to observe in a world where all the data is open.
0:23:51 And ultimately that is a governance system.
0:23:57 With that model do you think the base layer, the computational substrate, does that become
0:23:58 a commodity?
0:24:02 How do you think about the value of the base layer and how governance of the base layer
0:24:05 relates to the governance of the applications on top of it?
0:24:11 I think we need to be careful of thinking of it statically because just as Joel just
0:24:15 went through there’s this evolution of value capture that we saw with information technology
0:24:22 and I think we will see an evolution of value capture within crypto where value will start
0:24:24 to move up the protocol stack.
0:24:29 Right now we’re focused a lot on developer protocols because we believe it’s the developer
0:24:35 era of crypto and those are the most valuable people and developer attention is the most
0:24:38 valuable resource I would argue within crypto right now.
0:24:44 And we may have this period of value accrual and developer facing networks which then may
0:24:48 become commoditized and shift up to more consumer facing protocols.
0:24:50 But it’s more that there’s this evolution.
0:24:53 So how do you justify that more concretely?
0:24:58 For example, two transactions can use the same amount of gas, they could use the same
0:25:04 amount of the computational resource of Ethereum, but their economic value can be drastically
0:25:05 different.
0:25:09 I mean that brings a question of there’s sort of this tragedy of the commons problem that
0:25:14 one user of the protocol derives way more value from this underlying substrate than
0:25:15 another.
0:25:19 We can compare the foundational layer of a blockchain smart contract platform and decentralized
0:25:23 applications being built on top of it to general cloud computing infrastructure such
0:25:30 as Azure or Google Cloud or Amazon AWS and all the super valuable kind of union or applications
0:25:31 built on top of it.
0:25:37 They all utilize this commodity layer and kind of pay for computation at the level of
0:25:42 the resource, but the value they derive from the cloud platform is immensely higher, hence
0:25:46 their market caps combined are much higher than the cloud platforms underneath them.
0:25:50 So I don’t think every layer one protocol will capture a ton of value.
0:25:53 I think most of them will get commoditized and the ones that don’t will be the ones that
0:25:59 become these stores of value for these really important settlement protocols within the
0:26:00 space.
0:26:05 But I think that as we move up past that, we could see these middleware protocols actually
0:26:09 have more scale than the underlying smart contract protocols.
0:26:13 Start now with the developer in the future with the consumer, but still largely in the
0:26:14 protocol layer.
0:26:18 And I mean, we’re talking about a multi-decadal evolution here, but an evolution nonetheless.
0:26:23 I have a different way of thinking about value, which is through the lens of cost.
0:26:27 And this goes back to Econ 101, one of the first things they teach you is marginal benefit
0:26:30 equals marginal cost at equilibrium.
0:26:36 And bringing that into the discussion of where does value accrue, then you can then extend
0:26:40 that and okay, value will accrue to where there is the highest cost.
0:26:42 And it doesn’t really matter where in the layer that is.
0:26:46 It matters more what is the kind of service that’s being provided and what is the cost
0:26:47 of that service.
0:26:49 And then the other dimension is scale.
0:26:54 I think people sometimes confuse commodity with value less.
0:26:58 You can have something that is a complete commodity like milk and still get enormous amounts of
0:27:03 scale that permit value to accrue at that layer regardless.
0:27:08 As you move up the different layers or you start thinking about where does value accrue
0:27:14 in different places, just bringing back the whole governance umbrella, making a decision.
0:27:15 What’s the value of a decision?
0:27:19 Well, it might be in precisely where they’re implementing it in the governance over the
0:27:24 standard and over the protocol over time, where perhaps over time as the protocol becomes
0:27:30 more important and the standard becomes more widespread, then the value or the cost of
0:27:33 making a protocol decision increases over time because it affects a greater number of
0:27:35 people.
0:27:39 And so that’s one way in which you can kind of use the lens of cost to kind of chase down
0:27:44 where value might accrue in different services or across an ecosystem.
0:27:51 I think one helpful analogy with the governance space and value accrue from the perspective
0:27:57 of cost, if you look at, for example, United States, the United States has a fixed supply
0:28:05 of one president, but the cost of being that president has grown over time as the network
0:28:08 of the United States has also grown over time.
0:28:12 And this is actually where I think fixed supply works in a governance token setting.
0:28:16 If you have a fixed supply of that asset, but the cost and value of governing that network
0:28:21 is going up, then so too should the cost per token of that asset.
0:28:23 And so that’s a useful analogy for thinking through it.
0:28:28 And just thinking about America being a substrate for businesses built on top of it, the incentives
0:28:35 there is that corporations that exist within America are taxed to fund that substrate.
0:28:38 Better infrastructure, all kinds of services.
0:28:42 And to my earlier point, that there is no kind of economic relationship in the same
0:28:46 way that there is in America between Ethereum, for example, and the applications built on
0:28:52 top of it, you could imagine that there is some way in protocol to say it’s an upgrade
0:29:00 to ERC 20 standard, that 10% of the tokens every quarter, it’s a tax that goes to fund
0:29:01 the base chain.
0:29:08 And maybe this is a way to solve the problem of how do we fund innovation of the base chain.
0:29:09 I’m curious what you think of that.
0:29:16 I think traditionally taxation is one of the mechanisms through which a currency can boot
0:29:17 strap value.
0:29:22 And this goes back to, for example, the shardless theory that the government has to spend the
0:29:25 currency first and get it into circulation and then collect taxation.
0:29:28 And so that kick starts the economic flywheel.
0:29:32 People are experimenting with different forms of taxation in the space.
0:29:35 And really a transaction fee is a form of tax.
0:29:43 But we haven’t seen direct taxation to fund core developers beyond the inflationary model.
0:29:47 And that’s really kind of taxation through senior age or dilution.
0:29:52 For example, there’s Zcash or Decred or some of these networks that are working with this
0:29:57 idea of, okay, part of the monetary policy, we’re going to mint out over time and Decred
0:30:03 allocates 10% of each Coinbase reward to the developer pool, which will be allocated through
0:30:05 governance and the community’s decision to write it.
0:30:07 That’s effectively a 10% tax.
0:30:10 And same with Zcash, it’s a 20, 30% tax.
0:30:14 And because it’s of the income, right, if you think of every time a new block is produced,
0:30:15 that’s income that’s going to the miners.
0:30:18 But 10% of that is coming back to development.
0:30:22 It’s an implicit as opposed to an explicit tax that then funds the network.
0:30:27 You know, if you start thinking about governance first through the lens of this idea of taxation,
0:30:31 you can think of your kind of analogy of we have a fixed supply of one precedent and then
0:30:35 we can figure out how much it’s cost to run for precedent over time and figure out, you
0:30:38 know, what’s the cost of that governance model.
0:30:41 But there’s something that we can observe more concretely, which is just a tax rate
0:30:43 over time in world economies.
0:30:49 And we have seen tax rates as a proportion of GDP increase over time, as GDP increases
0:30:54 because the cost of governing the economy grows together with the growth of the economy.
0:30:59 And so how we can translate that into crypto networks is thinking through what is the cost
0:31:04 of governing a crypto network and the cost of maintaining an economic system over time.
0:31:08 And how does that change as that network grows or contracts over time?
0:31:13 So again, we keep coming back to this conversation around different layers in the stack and we
0:31:17 did a whole podcast on this about how the emergence of base layer crypto networks are
0:31:24 like cities in that there’s a bunch of people that have a vested interest in the infrastructure
0:31:27 upon which they’re building and they’re pulling it in different directions.
0:31:30 But there’s actually at the birth of a lot of cities, there’s not this like formal process
0:31:35 for coordinating that it just consensus emerges to this very rough process.
0:31:39 A lot of these ideas around rough consensus and running code are from Venkatesh Rao’s
0:31:43 post on Breaking Smart, which we’ve referenced a number of times on the podcast and we keep
0:31:44 coming back to.
0:31:50 We also talked about the emergence of internet standards and specifically the internet engineering
0:31:55 task force was this loose group of academics and engineers that were working on base layer
0:32:00 internet protocols and they had this very formal policy to not have voting, but instead
0:32:05 sort of weekly coordinated consensus mechanism whereby people argued their points with strong
0:32:06 opinions.
0:32:10 It was sort of a robust and sort of scientific approach and the best ideas were converged
0:32:11 upon.
0:32:17 So it’s this idea that a rough consensus emerges from one strong opinions weekly held to running
0:32:20 code in order to form those opinions.
0:32:24 And that’s very much the governance model of Bitcoin and Ethereum today.
0:32:27 Other projects are taking a different approach with formal on chain governance.
0:32:32 I think our view is that the more general the network, in terms of the service that it’s
0:32:37 providing, the more it lends itself to this process of rough consensus.
0:32:43 If you go all the way down the stack down to IP protocol, it’s this very general protocol.
0:32:48 It’s completely un-opinionated about the packets that it’s moving from A to B and the rough
0:32:53 consensus process or work there, it’s very lightweight and easy to integrate.
0:32:59 I would make the argument that general computation platform would lend itself to that same process
0:33:04 because you want it to do this very general thing and a thing that is very deterministic.
0:33:07 It doesn’t require human subjectivity to validate.
0:33:11 Then as you go further up the stack, there are applications built on top of the substrate
0:33:17 and as Dennis made earlier, it’s like the businesses built on top of America.
0:33:19 Each of them are providing different services.
0:33:23 They require different expertise in order to provide those services.
0:33:27 I would make the argument that at that layer in the stack, governance does become important.
0:33:32 The expertise requires specialization and these applications need to be more dynamic and responsive
0:33:38 to their users versus general computation, which over time should hopefully remain fairly
0:33:43 consistent such that these applications can build on top without the rules changing on
0:33:44 them.
0:33:51 There are many factors that go into governance decision processes that are informal.
0:33:55 One factor is the original roadmap of the project.
0:34:01 Does this change fit within the original vision outlined by both the founders and the community?
0:34:04 In Bitcoin, there is a promise of 21 million Bitcoins.
0:34:05 That is very important to it.
0:34:09 Also, there’s figureheads, Vitalik, for example, has very strong opinions.
0:34:13 While people trust him, he is one of many voices in the community.
0:34:15 I think it’s not dictatorial.
0:34:19 He proposes changes and there’s a debate and a conversation.
0:34:25 The base layer today in a platform like Ethereum is both the medium of exchange and the reward
0:34:28 for the supply side of the network.
0:34:31 Importantly, the governance process is this process of rough consensus where there is
0:34:35 no default setting for upgrading the network.
0:34:41 This is an important connection to draw because the users of the network have an active interest
0:34:44 in how the network evolves.
0:34:47 They are incentivized to participate in this process of rough consensus.
0:34:52 Whereas an application built on top of Ethereum, that layer in the stack, the expertise required
0:34:57 may necessitate that the management of this organization, whether it’s a central company
0:35:02 or a loosely affiliated group of people all over the world, that those stakeholders have
0:35:04 that expertise in order to make those decisions.
0:35:06 I think this is a really critical difference.
0:35:08 The base layer is very general.
0:35:13 Users wanted to do this one thing and do it well, compute things in a deterministic way,
0:35:17 but as you get further up the stack, it becomes a lot harder to reason about those mechanics.
0:35:22 I’ve started to use the term power tokens instead of governance tokens to refer to tokens
0:35:28 that represent the power to change the rules or change the makeup of a crypto network or
0:35:32 at least one vote to change the rules of the crypto network.
0:35:36 One way that I like to describe it is that crypt economics are the rules of the game
0:35:41 and governance is the power to change the rules of the game.
0:35:46 My belief is that as the game becomes more valuable, then the power to change the rules
0:35:48 becomes more valuable as well.
0:35:52 That’s the umbrella that I like to use to think through what’s the value of power, what’s
0:35:54 the value of changing the rules of the game.
0:36:00 If power tokens were the only means of making decisions, it’s sort of a very heavy-handed
0:36:06 specific tool that if manipulated incorrectly, it will lead to negative outcomes.
0:36:13 This more informal process through hard forks, you also, in addition, have checks and balances
0:36:17 where, as you mentioned earlier, there are different classes of participants, the miners,
0:36:22 the developers, the users, different bodies of the government that developers proposed
0:36:23 the code.
0:36:28 It has to be agreed upon by the miners to implement it, so it’s a more multifaceted multi-stakeholder
0:36:33 operation as opposed to who owns the tokens gets to, and the other problem is it creates
0:36:34 a default.
0:36:41 If the network automatically upgrades into some specific version of the code, the catastrophic
0:36:45 scenarios are much worse because everyone opts into a default, whereas in this more
0:36:49 weak consensus model, everyone has to agree in a broader way.
0:36:53 I have a twist on rough consensus and running code, which is crypt economic consensus and
0:36:59 running code, and my take on it is rough consensus works well when you’re small, and when the
0:37:03 number of stakeholders is fairly small, when the IETF was working through these protocol
0:37:09 iterations, you didn’t have to find consensus amongst a very large group of people in terms
0:37:11 of who is really affected by these decisions.
0:37:15 Today, it’s a completely different kind of dynamic where the underlying protocols have
0:37:20 remained fairly stagnant, and all of the innovation in terms of use cases has happened above,
0:37:24 where governance is a lot more fluid in the sense that each individual application can
0:37:28 construct its environment or its system in the way they prefer.
0:37:34 But bringing these ideas back to crypto, there’s another model that I like to think about which
0:37:37 is on-chain governance, off-chain diplomacy.
0:37:42 So by off-chain diplomacy, I mean every time that a core developer team meets with each
0:37:47 other to make a decision, or a user or an application of that protocol wants to lobby
0:37:48 for a change.
0:37:54 The human process by which we arrive at proposals and ultimately decisions, you still have meetings
0:38:00 between people debating and arriving at decisions and proposing different ideas.
0:38:01 All sorts of issues can emerge, right?
0:38:06 You can have concentration in the power token that enables a small group of people to really
0:38:10 control the network, but you can have the same kind of dynamic today with rough consensus.
0:38:14 If you don’t have a formal process that allows everyone that they can participate in that
0:38:18 process, you can end up with a clique that effectively governs the network through their
0:38:21 own rough consensus and cuts out everyone else.
0:38:26 Let’s make sure everyone in the network has a fundamental right to participate in that
0:38:27 governance process.
0:38:32 And let’s have mechanisms for people to get together and have sophisticated discussions
0:38:33 about how decisions were made.
0:38:37 But let’s make them convince the community and convince the network that that is the
0:38:38 right thing to do.
0:38:44 I think also, if you don’t have formal governance mechanisms and clarity around it, you devolve
0:38:47 into governance by defection.
0:38:48 And we saw that with Bitcoin.
0:38:51 We’re not necessarily arguing for complicated governance.
0:38:59 We’re arguing for rules and transparency such that the network participants all understand
0:39:02 not only what the rules are, but how the rules are changed.
0:39:07 Yeah, I guess where we might diverge a bit is that we are arguing that the more general
0:39:11 the service of a crypto network, the more it should be ossified.
0:39:17 So again, coming back to this IP is ossified, Bitcoin has ossified, maybe a general computation
0:39:23 substrate is better ossified because it lends itself to the trust that the developers building
0:39:27 on top need in order to feel comfortable building there.
0:39:31 However, those applications that developers build because they’re complex and dynamic
0:39:35 and interfacing with end users need to be able to change.
0:39:41 And in order for them to do so, a formal governance process is probably necessary.
0:39:45 The default is to take whatever the coin holders vote upon and upgrade the system.
0:39:50 And so I think one of the assumptions is that the token holders participating in the vote
0:39:56 and prior to that participating in the diplomacy are experts and have the best interests of
0:39:58 their users in mind.
0:40:01 Their interests are hopefully aligned with their end users.
0:40:03 And they pay for it if they mess up through dilution.
0:40:04 Right.
0:40:05 That’s right.
0:40:09 And so the incentives are tightly coupled so that the experts make decisions for the
0:40:12 benefit of their users and for the benefit of themselves.
0:40:15 And you end up with this very dynamic system where the end users don’t necessarily need
0:40:19 to think about the complexity of the underlying mechanic of the thing.
0:40:24 And importantly, there’s explicit enforceability over one canonical group of contracts that
0:40:26 control the system.
0:40:32 And so the output of the governance process doesn’t require, for example, end users or
0:40:36 other participants in the network to download new software and run it.
0:40:41 The analogy of a blockchain is we’re traveling down a highway.
0:40:47 And then we decide that we want to take a turn, one of two turns into two different futures.
0:40:52 And that will be upgrading– miners upgrade their software to a new fork version.
0:40:57 What forks are in protocols is different than forks are on base layers.
0:41:02 You can’t fork in the case of a stable coin because it has all this collateral.
0:41:06 You can’t fork the collateral because your DAP doesn’t control that.
0:41:09 You are using the existing platforms collateral.
0:41:10 So the upgrade process has to be different.
0:41:14 In the governance debate, there’s nuance in what it means to upgrade a DAP that’s running
0:41:16 on top of ProCo and the protocol itself.
0:41:19 You brought up the example of a computation network.
0:41:22 It’s a very well-defined kind of service.
0:41:24 A computer runs the code, and the code has an output.
0:41:28 If you focus on something more controversial, like how value is distributed, then all of
0:41:30 a sudden you find that the governance is really important.
0:41:37 And I’d also argue that power token voting excludes the needs of miners and the needs
0:41:38 of users.
0:41:39 That depends on how you design it.
0:41:43 If you think of power as a source of value, then you want to make sure that that power
0:41:46 is evenly distributed amongst the participants of the network.
0:41:49 Otherwise, you end up, again, where we are in the modern economy today with very few
0:41:53 people with a lot of power, and most people with not that much power.
0:41:58 So just one thing I wanted to add is that one of the problems with thinking about on-chain
0:42:03 governance as a way for users to actively participate in the evolution of a network
0:42:07 is that in practice, if we look at the real world and how governance systems work, there’s
0:42:09 actually very low participation.
0:42:16 This is because as an individual user, an individual voter, my one vote, my little say doesn’t
0:42:19 have all that much influence on its own.
0:42:22 And so there’s this apathy about participation.
0:42:28 And so a assumption is that when we talk about users affecting or risking together and participating
0:42:33 in governance, is that they have some sort of emotional stake in the outcome of governance
0:42:34 processes.
0:42:41 And that may be the case in very niche applications where users feel a strong affinity to the application
0:42:42 they’re using.
0:42:46 If I don’t have a strong connection to participating in voting, maybe I’d be more likely to sell
0:42:48 my vote to someone who does.
0:42:53 And the result of that is the same risk that Joel described earlier, where the capital
0:42:57 and the currency become disaggregated.
0:42:59 And this could undermine on-chain governance processes.
0:43:03 It’s important to note that on-chain governance is really hard for a number of reasons.
0:43:07 In the context of blockchains, it’s very difficult to know who the participants are.
0:43:12 You can be hundreds of people just by generating multiple keys.
0:43:17 And so when you have this system that is synonymous, it’s difficult to enforce behavior patterns
0:43:22 that lead to good governance, say, in shareholder governance where shareholders are bound by
0:43:23 fiduciary law.
0:43:28 There’s a great post by a researcher at Cornell who we recently had on the podcast named
0:43:32 Phil Diane, and he went deep down the rabbit hole into different attacks that you could
0:43:33 launch.
0:43:34 The rise of dark doubts?
0:43:39 Yeah, the post dives in deep and our podcast does as well on different sort of attacks
0:43:43 that you can launch to bride participants in on-chain governance schemes.
0:43:49 I think a lot of arguments against on-chain governance are kind of primitive in their
0:43:52 thinking around how is that governance applied.
0:43:57 One common element of a lot of the counterarguments is the assumption that governance power is
0:44:02 linear and one token equals one vote, whereas in crypto networks, we have the opportunity
0:44:05 to design much more intricate systems with much more intricate rules.
0:44:09 And so, yes, you can replicate yourself across a thousand different addresses, while you
0:44:15 can make it such that your governance power is amplified if you have all your tokens
0:44:20 in one wallet and so you can make it actually more powerful to basically voluntarily disclose
0:44:24 still within the pseudonymous system how much of the token you have because you get more
0:44:30 power by aggregating your assets together and you can kind of change how the shape of
0:44:35 that curve, depending on the context, you can also do things like look at the age of
0:44:36 an address.
0:44:40 One thing that we learned actually from a non-crypto company that was in the online
0:44:44 community abuse space is that the length an account has been open is the greatest determinant
0:44:45 of whether it’s a troll or not.
0:44:50 And so you can use things like the life span of an account or of a wallet or the tokens
0:44:51 that it received.
0:44:55 And you can even make distinctions around whether the tokens in that wallet were purchased
0:44:58 from an exchange or were received directly through mining.
0:45:02 And you can factor all of those things into how you design, let’s call it your governance
0:45:03 curve.
0:45:07 Maybe those are all examples of on-chain reputation that’s sort of native to the system.
0:45:08 Exactly.
0:45:10 So yeah, thank you guys very much for coming on.
0:45:14 It’s been awesome sort of recapping the space and how it’s evolved over the last few years
0:45:20 and super excited to see how our theses play out over the years going forward.
0:45:21 Well thanks for having us.
0:00:10 tax or investment advice or be used to evaluate any investment or security and is not directed
0:00:15 at any investors or potential investors in any A16Z fund. For more details, please see
0:00:21 a16z.com/disclosures. Hi everyone, welcome to the A6Z podcast. I’m
0:00:26 Sonal. Today we have another one of our podcast on the road episodes with guests from New
0:00:33 York City on the topic of crypto, but more broadly on crypto networks as emerging economies.
0:00:38 This conversation goes into the super interesting nuances of structuring these networks to avoid
0:00:43 some of the failings we’ve seen in the monetary and fiscal policies of traditional economies,
0:00:49 including debating how to empower users when it comes to risk, but also how to better distribute
0:00:54 access in terms of who captures value from networks. We then also discovered different
0:00:59 mindsets for the governance of these networks, which are really crypto economic systems,
0:01:04 especially as they evolve and grow more mainstream over time. Joining us to have this conversation,
0:01:09 we have two guests, our friends at Placeholder VC. Chris Berniske, who formerly led ARC Invest
0:01:13 Crypto Efforts, has written a lot about financial modeling influence frameworks for analyzing
0:01:18 crypto and co-wrote a book on crypto assets, and Joel Monegro, who before starting Placeholder
0:01:23 with Chris was an analyst at USV, where he helped develop their early blockchain theses
0:01:28 prior to that, he managed the Dominican Republic’s government office in charge of developing
0:01:32 the country’s national and digital economy technology agenda. I share all that as key
0:01:36 context for the conversation that follows. And last but not least, we have two of our
0:01:41 partners from A6 and Z Crypto, Jesse Walden and Dennis Nazarov, formerly co-founders
0:01:45 of MediaChain, which was acquired by Spotify, Jesse and Dennis interview our guests and
0:01:50 also add their perspectives in the discussion and debate. On that note, the content here
0:01:57 is for informational purposes only and should not be taken as legal business tax or investment
0:02:03 advice or be used to evaluate any investment or security. It is not directed at any investors
0:02:10 or potential investors in any fund. For more details, please also see a6nzcrypto.com/disclosures.
0:02:15 Before the discussion goes into what it takes to design such crypto economic systems at
0:02:20 scale from value capture to risk to governance, they first quickly begin with the fundamental
0:02:26 concept of layers in a stack of protocols and decentralized applications. The first
0:02:31 voice you’ll hear is Joel followed by Chris’s and then Jesse and Dennis joins in later.
0:02:35 You can think about it from an engineering point of view and how different kinds of
0:02:40 software are layered on top of each other. You can think about it also from a more social
0:02:46 point of view. Layer one is more machine work and layer two is more human work. And as you
0:02:51 transition from layer one to layer two, then you end up with lighter weight models because
0:02:55 you don’t have the capital cost of the machines to actually do the work, to store the files,
0:03:00 to mine the transactions. What we see at layer two are more abstract units of work that require
0:03:06 human judgment. And there the cost is harder to model because it’s harder to quantify what
0:03:10 is the value that goes into performing some unit of work. And that unit of work can be
0:03:16 anything from curating content to making a governance decision. All of those things are
0:03:21 very difficult to put in a spreadsheet model, but we have the aid of the invisible hand
0:03:26 in a way and that’s helping us figure out what human work is worth. I think the infatuation
0:03:31 with layer one comes from it being much easier to understand the cost and value relationship
0:03:35 between providing a service and consuming a service. It gets harder as you move up the
0:03:40 layers. Once you get into the realm of human work is when you start to really imagine that
0:03:44 there are different ways in which crypto can really change the way we do things.
0:03:48 I think as we go up higher in these layers we’re going to see different incentivization
0:03:54 and therefore value capture mechanisms. Layer one, the priority is security because that’s
0:03:59 basically our clearing and settlement layer. And so we’ve really seen Bitcoin prioritize
0:04:05 security or Ethereum. And because if we build all these layers on top of an insecure layer
0:04:11 one then we’re screwed, right? And then as we move up the stack it’s less about that
0:04:18 machine security say and more about how do you incentivize the economic actors to perform
0:04:23 the service that you’ve promised to provide. And the only way that that ends up being a
0:04:28 service that the end user uses is either if it’s cheaper than existing services that
0:04:32 you can get from the centralized model but on par in terms of user experience or it’s
0:04:38 a fundamentally new experience or service and this is the only place I can get it there’s
0:04:43 the access tokens where basically there’s demand of what I find interesting about an
0:04:47 access token is historically we’ve thought of tokens as needing to connect the supply
0:04:52 side and demand side. An access token really just focuses on the supply side and it can
0:04:56 have a fixed supply and there can be scarcity because basically if the supply side needs
0:05:01 that token to perform the service and performing the service is a profitable activity for them
0:05:06 then there will be a clamoring to get a hold of that token and that drives its own scarcity
0:05:11 and that’s slightly easier to model you can actually use discounted cash flow model to
0:05:17 approximate the value of that token and the demand side can pay in fiat if they want and
0:05:21 I think we’ll increasingly see this where the demand side is going to just pay in whatever
0:05:26 asset they want they don’t need to interface with crypto assets from a day to day perspective
0:05:31 but you can still have value in a work token that organizes the supply side and induces
0:05:34 a competition around being able to provide that service.
0:05:39 So in the model you described Chris we call it the taxi medallion model what’s interesting
0:05:44 about it is there’s one token that is the right to do the work and the other token which
0:05:49 is the payment token and so as you said it’s you can do sort of a cash flow analysis on
0:05:54 what the work token is going to earn and this differs from the base layer where you know
0:06:00 today most of the layer one blockchains use one token for both rewarding the supply side
0:06:05 and for the demand side to consume the service and I’m curious what do you guys think the
0:06:13 implications of moving to work token model are is there any sort of implications for
0:06:17 users and suppliers not being aligned around the same token.
0:06:23 Well the thing that’s really scary about this trend to create dual token systems where one
0:06:27 token gives you access to the supply side or a right to participate in the supply side
0:06:31 and another one into being the payment token whether it’s another token that it’s created
0:06:36 by the crypto network or something like ETH or any other one is that you were doing the
0:06:42 same thing that we did with the world economy which is that we separated currency and capital
0:06:47 the moment that we moved into a fiat currency model in modern capitalism.
0:06:53 We have two major kind of asset types we have capital and we have that and currencies are
0:06:57 really a form of debt at the end of the day and backtracking a little bit the reason we
0:07:01 separated currency from capital is because the transaction velocity of capital is very
0:07:08 low the transaction velocity of a dollar is very high and so as the economy grows exchanging
0:07:12 gold or land or just a barter system is not going to work and so we needed currencies
0:07:19 to accelerate economic growth so far so good the problem is that capital and currencies
0:07:24 respond very differently to economic growth capital appreciates together with economic
0:07:28 growth and currencies actually depreciate as an economy grows.
0:07:34 Inflation is commonly thought of as the printing of new money but really a more traditional
0:07:40 definition of inflation is increases in prices over time as a result of economic growth and
0:07:45 capital as an asset type appreciates as the economy grows because it is more scarce than
0:07:50 currency currency we print more of it to keep up with inflation to keep prices stable and
0:07:53 that’s how they end up devaluing over time because we’re creating more and more and more
0:07:58 what happens over time then is that actually capital becomes more and more concentrated
0:08:02 because its transaction velocity is so low and the problem with that is that we end up
0:08:07 with a lot of people living their lives in in currency and very few people living their
0:08:08 lives in capital.
0:08:13 What part of the promise of crypto networks at least to me is that we are able to combine
0:08:18 currency and capital into a single asset so that then we don’t get the same kind of income
0:08:24 inequality or wealth inequality being created as any individual crypto network grows and
0:08:29 the risk of separating the access token or the work token from the currency token is
0:08:34 that the people who accumulated the access tokens early on that group becomes increasingly
0:08:39 concentrated over time as the economy grows or as the crypto network grows the value of
0:08:44 combining the two. If you have a single token that is both a supply site token and a payment
0:08:50 token in order for the supply site to provide its service it has to take payment in that
0:08:53 token so the token has to be in the user’s hands in order for them to actually consume
0:08:58 the service and so that creates a pressure to sell the work token or sell the capital
0:09:02 token as the network grows because otherwise you’re not going to get any customers. Everyone
0:09:06 in a crypto network can participate from the value created as opposed to just one segment.
0:09:12 I definitely agree there’s a risk to backtracking a little bit with the ethos of crypto separating
0:09:17 the work or the capital and currency. I think one thing even if we end up in a work token
0:09:23 world or taxi medallion world where we’ve separated capital and currency again at least
0:09:29 within those networks the one reassuring thing is that you can’t be a passive accumulator
0:09:35 of capital. You have to be more active like you stake the work token and then you have
0:09:40 to continue to provide work for the network to continue to collect cash flows.
0:09:43 So I would argue that that’s not entirely true and that’s because in these proof of
0:09:49 stake systems you often have the ability to delegate stake and so what happens there is
0:09:53 a marketplace emerges where there are people sitting on capital and they just point that
0:09:58 capital at a worker so it’s very much like taxi medallions work in New York City. They’re
0:10:02 mostly bought up by hedge funds and the like and then they hire drivers to go and drive
0:10:06 the cars and earn passive income on those medallions. And so I think that does speak
0:10:11 to Jule’s point that the separation of these two things does result in a concentration
0:10:17 of capital but I would argue that the flip side is that the users of the service don’t
0:10:22 have to take any risk. So when I get into a taxicab I don’t have to think about whether
0:10:28 Uber or Lyft are going to have a real big impact on the value of my medallion and the
0:10:33 future utility I’ll get out of it. So humans tend to think in one unit of account because
0:10:37 it’s just easier to reason about and you don’t want to be taking risk necessarily when you’re
0:10:42 buying a coffee or a pizza and that ends up going on to be worth millions of dollars.
0:10:49 And so there is this sort of simplicity in the tax now in versus currency model that
0:10:54 I think it’s hard to get away from just because of human nature.
0:10:59 I argue that risk is good because you can’t create value without creating risk. And again
0:11:04 it’s that same kind of thinking that led to the world where we are today. It’s much simpler
0:11:09 to have everyone use dollars because no one has to think about how the markets are moving
0:11:12 and how your value is changing over time. Rather you trust the government. You trust
0:11:18 that they’re going to maintain a certain monetary policy such that you hope that your
0:11:22 hundred thousand dollars today is going to maintain a certain degree of purchasing power.
0:11:28 The problem with that is that by not allowing people to take risks in a way then we’ve cheated
0:11:33 them away from capturing some of the upside of the value. And I think it’s time to rethink
0:11:39 how we think about risk for people more broadly. If we prevent people or the science systems
0:11:44 that make it harder for people to take those risks and participate in the value then we’re
0:11:48 going to end up in the same world where we are today where the values concentrated amongst
0:11:52 those who took the greatest risks. Now obviously it can go really badly if you have a whole
0:11:55 bunch of risk spread a whole whole bunch of people and then everything comes crashing
0:12:00 down then you have a real problem. So it’s not that there isn’t value instability and
0:12:05 value in currencies that make it easier for consumers to go about their daily lives. But
0:12:09 I also don’t think we’re heading to a world where you buy your coffee with Bitcoin. I
0:12:14 also think that the overall argument of well we need to create these systems because otherwise
0:12:18 it’s too risky and then people are not going to use it. I think it’s a little not patronizing
0:12:23 but it underestimates people’s ability to make those decisions for themselves.
0:12:29 I remember asking you about three four years ago whether it’s actually a good idea to make
0:12:35 your users investors because there’s a cognitive overhead that is associated with that. You’re
0:12:42 asking your users to be sophisticated about the underlying infrastructure powering their
0:12:48 daily experience and I think increasingly in in crypto we’re seeing that at least when
0:12:53 you have some skin in the game participants in these networks are willing to go in a little
0:12:58 bit deeper and the types of communities that emerge are on these projects are just fundamentally
0:13:02 different like people have a different relationship with the network. Ethereum participants own
0:13:08 the token and therefore have an emotional connection to the values of the infrastructure
0:13:13 and its goals and what it achieves. Sometimes. Yeah, to a fault sometimes and I think the
0:13:20 question is how scalable is this? Can we scale this model to the entire world or is it limited
0:13:26 to a subset of users who are sophisticated enough and want to take on that risk and so
0:13:31 just to push back a little bit on the idea that we will be able to scale this model sort
0:13:35 of all the way up. I think the idea of having this work token currency model it doesn’t
0:13:41 preclude power users from participating in the network and then through delegation the
0:13:45 owner of that token does not need to necessarily provide the work. So a power user can invest
0:13:51 in the success of the network that they’re using but it’s a choice and so I think there’s
0:13:56 flexibility both ways. On one side the assumption is that we should give risk to everyone and
0:14:00 that’s that optimal in the other side is we should let people choose. You can argue both
0:14:05 sides of the table and so what that tells me is let the people make the choice but then
0:14:09 that becomes a question of what’s the default. So you know we’ve all gone through a sign-up
0:14:14 form where the checkboxes are checked by default or not that opt you into certain things and
0:14:19 we’ve learned that people tend to stick with the default and so I would rather see a world
0:14:23 where the default is we’re all participating in the value. Yeah, any citizen can go and
0:14:27 open a brokerage account and buy stocks and participate in the market but most people
0:14:32 don’t because that’s not the default. So I think one thing that we can do here is actually
0:14:37 create a model and train another generation of users to think as users who are staked
0:14:41 in the network in a way that we really couldn’t before and the generational aspect I think
0:14:46 is very important because the other thing that’s going on here is that the way these
0:14:51 assets accrue value is very different to the way that other previous kinds of assets accrue
0:14:57 value. Previously in a more traditional world when we had companies go public it was a lot
0:15:02 of the same philosophy of you, you’re a customer of Walmart, Walmart goes public, you can buy
0:15:06 stock in Walmart and then every time that you go to Walmart and you’re paying with your
0:15:12 dollars you know there is some value accruing back to you as a shareholder of the company.
0:15:15 But in order to properly analyze an equity you have to go to business school and learn
0:15:19 how to do this kind of cash flows and how to figure out you know how to analyze whether
0:15:23 management is doing things correctly and so on. What’s different here is that we’re dealing
0:15:28 with these decentralized networks where if they’re properly constructed the value doesn’t
0:15:32 really necessarily depend on the actions of a management team but rather on the overall
0:15:33 network.
0:15:39 Yes, we were talking about the consumer perspective and them being a shareholder and that’s one
0:15:43 side of the argument, the other is from the developer and people who are actually building
0:15:44 these protocols.
0:15:49 So I want to take a step back because we’ve been saying user network participant those
0:15:57 kinds of things and I think that it really depends on which network participant we’re
0:15:58 referring to.
0:16:03 So early on in a network where it’s mostly the supply side right because the supply side
0:16:08 has to come on board to actually provision the asset and presumably the supply side is
0:16:15 going to be a much more sophisticated person at least in their understanding of the network
0:16:16 than the demand side.
0:16:20 At least as we scale out over the long term I think that’s an assumption we can make.
0:16:24 And so that supply side can tolerate that earlier risk because presumably they’re more
0:16:27 sophisticated and so that all makes sense.
0:16:32 Where I think we start to encounter more problems especially if crypto goes mainstream we will
0:16:38 have you know hundreds of millions billions of end users on the demand side and I think
0:16:43 it’s a stretch to ask the demand side to be an expert in the network.
0:16:46 The supply side this is different from our current equity environment.
0:16:52 If you set aside stock based comp traditionally an employee at a company doesn’t necessarily
0:16:54 have exposure to the upside of that company.
0:16:59 Stock based comp has changed that a lot but that employee mostly gets paid in fiat currency
0:17:03 which goes back to Joel’s point of you know they don’t get to participate in the capital
0:17:08 appreciation as much as the management and the concentrated owners of capital.
0:17:11 So for me that’s a big improvement.
0:17:18 Early on demand-siders they’ll be early adopters but I think as this space grows we will abstract
0:17:22 a lot of that complexity away from them and the demand side will just pay in whatever
0:17:27 they want to pay it be they in Kenya be they in the US be they in Korea you pay for the
0:17:32 service with whatever currency you want that ends up getting converted and the supply side
0:17:37 will get paid in the native asset of the network through whatever it may be.
0:17:41 But the key is that the supply side gets access to that risk and that capital appreciation
0:17:42 for me for me.
0:17:47 So I think an interesting sort of avenue to go down here is to again come back to this
0:17:51 idea of the different layers in the stack and how it may be different at each of them.
0:17:56 So at the base layer it makes a lot of sense for there to be sort of one currency or you
0:18:01 know because because you do really want to align the incentives of the supply side and
0:18:07 the users because it’s this very general substrate upon which you know like all all kinds of
0:18:11 more complex applications can be built but this because it’s very general you want there
0:18:17 to be this sort of network effect that everyone is everyone converges on the values and the
0:18:22 goal of this general substrate as you get further up the stack and you build more complex
0:18:28 applications something like a stable coin for example requires sort of more specialization
0:18:32 in terms of the type of work that’s being done and this is to Joel’s point earlier that
0:18:39 it’s it’s more human work and more specialization generally means more expertise.
0:18:45 And so once you get into those types of applications I think it becomes a little bit harder for everyday
0:18:49 users to be sophisticated about the work that’s going on behind the scenes.
0:18:54 People probably don’t need to understand how Ethereum computers you know determine consensus
0:18:59 but I think the difference is that in order for a stable coin to work it’s a much more
0:19:03 you know complicated system and it has parameters that need to be tuned and they probably need
0:19:08 to be tuned by experts whereas computation is deterministic it’s sort of a binary outcome
0:19:11 right or wrong and it can be verified by computers.
0:19:16 And so I would argue that the base layer of the system being more general lends itself
0:19:20 to this sort of single token model a little bit better but as you move further up the
0:19:24 stack I think you do want this separation between sort of the management and the users
0:19:27 because it requires expertise.
0:19:29 And that brings us to governance.
0:19:30 Right.
0:19:34 And maybe an analogy is the base layer sort of like a country it’s like you’re a citizen
0:19:40 of America you get to vote and participate in you know elections and to decide kind of
0:19:41 policy.
0:19:46 Taxation policy is the substrate for all economic activity built on top of America and then
0:19:51 there’s more specific corporations inside of America and they have their own governance
0:19:56 practices they have their own equity and then participating in them is much more specialized
0:20:01 but you have this broad substrate that everyone else builds on top of with different governance
0:20:02 parameters.
0:20:07 So I like to think of or we like to think of crypto networks as emerging economies and
0:20:13 what’s interesting about that is that if you compare crypto network to a country you start
0:20:18 to see a number of similarities there’s a currency that’s exchanged between buyers and
0:20:23 sellers there’s if you think of the executive team or the executive branch is the core development
0:20:28 team and you think of the blockchain as the court or the legislative system where you
0:20:32 know all the rules go there and then you have the supply side which are the miners or the
0:20:36 producers and you have the demand side which are the users who are consuming the service
0:20:39 that starts to look a lot like a small economy.
0:20:44 And then what’s cool about that is that you can use this model to think through whether
0:20:47 a crypto network is properly constructed or not.
0:20:52 So for example things that we’ve learned over time that we like to see in physical economies
0:20:58 like low degrees of corruption and sound monetary policies and fiscal policies and a rich supply
0:21:03 side and an active demand side it ends up getting us into the topic of governance because
0:21:08 one of the things that can determine the success of a national economy or not is how that economy
0:21:09 is governed.
0:21:14 There’s a broader conversation about where is the value of governance in crypto networks
0:21:18 and governance is a difficult topic because it is so broad but I’ll bring it even further
0:21:24 back to the history of information technology in the 50s and 60s.
0:21:27 That era was based around the hardware how quickly you could iterate on hardware and
0:21:31 how quickly could you get computers in the market and IBM won that war because they were
0:21:36 able to design custom computers for custom use cases faster than than anybody else.
0:21:40 That business started breaking down in the 70s and 80s following the introduction of
0:21:45 the microprocessor which consolidated a whole bunch of those circuits into a single part
0:21:49 that was widely available and that created two things.
0:21:53 It first it unbundled the hardware industry and we went from effectively one computer
0:21:58 manufacturer to dozens of PC manufacturers and so on.
0:22:01 But then what happened is that value moved one layer up to the software layer and so
0:22:05 we have Microsoft and the PC software boom of the 70s and 80s.
0:22:09 We saw that get built on top of the microprocessor standard or platform.
0:22:15 Fast forward to the end of the 80s and into the 90s and we went from having dozens of
0:22:22 independent software ventures to having Microsoft consolidating that entire ecosystem and building
0:22:27 its business on the basis of proprietary software and proprietary distribution of that software.
0:22:30 What happened in the 90s is we got two things.
0:22:35 We got the internet and we got Linux which was free software and free distribution and
0:22:38 so that directly challenged Microsoft.
0:22:43 And so we got into the web era where the value moved again one layer up to data which is
0:22:44 where we live today.
0:22:50 We have the big tech companies of today Google, Apple, Facebook, Amazon and so on.
0:22:54 Their main asset their main capital asset is all the data that they’ve been able to
0:22:56 accrue over time as people have used their service.
0:23:01 So we’ve been in this stage for about 20 years now and right on schedule we get the
0:23:07 arrival of a new open technology which are blockchains that directly challenge the proprietary
0:23:11 data business model just as the internet and Linux challenged the proprietary software
0:23:12 and distribution business model.
0:23:16 It gets into a question of okay if we see this pattern of value moving one layer up,
0:23:20 one layer up, one layer up and we’ve gone from hardware to software and from software
0:23:22 to data and now data is free.
0:23:23 What’s above data?
0:23:29 The layer that exists at a higher level and to us that’s governance because it becomes
0:23:33 a question of how do we manage, how do we control, how do we manipulate the data and
0:23:38 how do we agree on a single source of truth which is the whole thinking behind designing
0:23:40 these consensus systems.
0:23:44 The crypto networks at the end of the day are systems that we designed to arrive at a shared
0:23:49 understanding of what is the right data to observe in a world where all the data is open.
0:23:51 And ultimately that is a governance system.
0:23:57 With that model do you think the base layer, the computational substrate, does that become
0:23:58 a commodity?
0:24:02 How do you think about the value of the base layer and how governance of the base layer
0:24:05 relates to the governance of the applications on top of it?
0:24:11 I think we need to be careful of thinking of it statically because just as Joel just
0:24:15 went through there’s this evolution of value capture that we saw with information technology
0:24:22 and I think we will see an evolution of value capture within crypto where value will start
0:24:24 to move up the protocol stack.
0:24:29 Right now we’re focused a lot on developer protocols because we believe it’s the developer
0:24:35 era of crypto and those are the most valuable people and developer attention is the most
0:24:38 valuable resource I would argue within crypto right now.
0:24:44 And we may have this period of value accrual and developer facing networks which then may
0:24:48 become commoditized and shift up to more consumer facing protocols.
0:24:50 But it’s more that there’s this evolution.
0:24:53 So how do you justify that more concretely?
0:24:58 For example, two transactions can use the same amount of gas, they could use the same
0:25:04 amount of the computational resource of Ethereum, but their economic value can be drastically
0:25:05 different.
0:25:09 I mean that brings a question of there’s sort of this tragedy of the commons problem that
0:25:14 one user of the protocol derives way more value from this underlying substrate than
0:25:15 another.
0:25:19 We can compare the foundational layer of a blockchain smart contract platform and decentralized
0:25:23 applications being built on top of it to general cloud computing infrastructure such
0:25:30 as Azure or Google Cloud or Amazon AWS and all the super valuable kind of union or applications
0:25:31 built on top of it.
0:25:37 They all utilize this commodity layer and kind of pay for computation at the level of
0:25:42 the resource, but the value they derive from the cloud platform is immensely higher, hence
0:25:46 their market caps combined are much higher than the cloud platforms underneath them.
0:25:50 So I don’t think every layer one protocol will capture a ton of value.
0:25:53 I think most of them will get commoditized and the ones that don’t will be the ones that
0:25:59 become these stores of value for these really important settlement protocols within the
0:26:00 space.
0:26:05 But I think that as we move up past that, we could see these middleware protocols actually
0:26:09 have more scale than the underlying smart contract protocols.
0:26:13 Start now with the developer in the future with the consumer, but still largely in the
0:26:14 protocol layer.
0:26:18 And I mean, we’re talking about a multi-decadal evolution here, but an evolution nonetheless.
0:26:23 I have a different way of thinking about value, which is through the lens of cost.
0:26:27 And this goes back to Econ 101, one of the first things they teach you is marginal benefit
0:26:30 equals marginal cost at equilibrium.
0:26:36 And bringing that into the discussion of where does value accrue, then you can then extend
0:26:40 that and okay, value will accrue to where there is the highest cost.
0:26:42 And it doesn’t really matter where in the layer that is.
0:26:46 It matters more what is the kind of service that’s being provided and what is the cost
0:26:47 of that service.
0:26:49 And then the other dimension is scale.
0:26:54 I think people sometimes confuse commodity with value less.
0:26:58 You can have something that is a complete commodity like milk and still get enormous amounts of
0:27:03 scale that permit value to accrue at that layer regardless.
0:27:08 As you move up the different layers or you start thinking about where does value accrue
0:27:14 in different places, just bringing back the whole governance umbrella, making a decision.
0:27:15 What’s the value of a decision?
0:27:19 Well, it might be in precisely where they’re implementing it in the governance over the
0:27:24 standard and over the protocol over time, where perhaps over time as the protocol becomes
0:27:30 more important and the standard becomes more widespread, then the value or the cost of
0:27:33 making a protocol decision increases over time because it affects a greater number of
0:27:35 people.
0:27:39 And so that’s one way in which you can kind of use the lens of cost to kind of chase down
0:27:44 where value might accrue in different services or across an ecosystem.
0:27:51 I think one helpful analogy with the governance space and value accrue from the perspective
0:27:57 of cost, if you look at, for example, United States, the United States has a fixed supply
0:28:05 of one president, but the cost of being that president has grown over time as the network
0:28:08 of the United States has also grown over time.
0:28:12 And this is actually where I think fixed supply works in a governance token setting.
0:28:16 If you have a fixed supply of that asset, but the cost and value of governing that network
0:28:21 is going up, then so too should the cost per token of that asset.
0:28:23 And so that’s a useful analogy for thinking through it.
0:28:28 And just thinking about America being a substrate for businesses built on top of it, the incentives
0:28:35 there is that corporations that exist within America are taxed to fund that substrate.
0:28:38 Better infrastructure, all kinds of services.
0:28:42 And to my earlier point, that there is no kind of economic relationship in the same
0:28:46 way that there is in America between Ethereum, for example, and the applications built on
0:28:52 top of it, you could imagine that there is some way in protocol to say it’s an upgrade
0:29:00 to ERC 20 standard, that 10% of the tokens every quarter, it’s a tax that goes to fund
0:29:01 the base chain.
0:29:08 And maybe this is a way to solve the problem of how do we fund innovation of the base chain.
0:29:09 I’m curious what you think of that.
0:29:16 I think traditionally taxation is one of the mechanisms through which a currency can boot
0:29:17 strap value.
0:29:22 And this goes back to, for example, the shardless theory that the government has to spend the
0:29:25 currency first and get it into circulation and then collect taxation.
0:29:28 And so that kick starts the economic flywheel.
0:29:32 People are experimenting with different forms of taxation in the space.
0:29:35 And really a transaction fee is a form of tax.
0:29:43 But we haven’t seen direct taxation to fund core developers beyond the inflationary model.
0:29:47 And that’s really kind of taxation through senior age or dilution.
0:29:52 For example, there’s Zcash or Decred or some of these networks that are working with this
0:29:57 idea of, okay, part of the monetary policy, we’re going to mint out over time and Decred
0:30:03 allocates 10% of each Coinbase reward to the developer pool, which will be allocated through
0:30:05 governance and the community’s decision to write it.
0:30:07 That’s effectively a 10% tax.
0:30:10 And same with Zcash, it’s a 20, 30% tax.
0:30:14 And because it’s of the income, right, if you think of every time a new block is produced,
0:30:15 that’s income that’s going to the miners.
0:30:18 But 10% of that is coming back to development.
0:30:22 It’s an implicit as opposed to an explicit tax that then funds the network.
0:30:27 You know, if you start thinking about governance first through the lens of this idea of taxation,
0:30:31 you can think of your kind of analogy of we have a fixed supply of one precedent and then
0:30:35 we can figure out how much it’s cost to run for precedent over time and figure out, you
0:30:38 know, what’s the cost of that governance model.
0:30:41 But there’s something that we can observe more concretely, which is just a tax rate
0:30:43 over time in world economies.
0:30:49 And we have seen tax rates as a proportion of GDP increase over time, as GDP increases
0:30:54 because the cost of governing the economy grows together with the growth of the economy.
0:30:59 And so how we can translate that into crypto networks is thinking through what is the cost
0:31:04 of governing a crypto network and the cost of maintaining an economic system over time.
0:31:08 And how does that change as that network grows or contracts over time?
0:31:13 So again, we keep coming back to this conversation around different layers in the stack and we
0:31:17 did a whole podcast on this about how the emergence of base layer crypto networks are
0:31:24 like cities in that there’s a bunch of people that have a vested interest in the infrastructure
0:31:27 upon which they’re building and they’re pulling it in different directions.
0:31:30 But there’s actually at the birth of a lot of cities, there’s not this like formal process
0:31:35 for coordinating that it just consensus emerges to this very rough process.
0:31:39 A lot of these ideas around rough consensus and running code are from Venkatesh Rao’s
0:31:43 post on Breaking Smart, which we’ve referenced a number of times on the podcast and we keep
0:31:44 coming back to.
0:31:50 We also talked about the emergence of internet standards and specifically the internet engineering
0:31:55 task force was this loose group of academics and engineers that were working on base layer
0:32:00 internet protocols and they had this very formal policy to not have voting, but instead
0:32:05 sort of weekly coordinated consensus mechanism whereby people argued their points with strong
0:32:06 opinions.
0:32:10 It was sort of a robust and sort of scientific approach and the best ideas were converged
0:32:11 upon.
0:32:17 So it’s this idea that a rough consensus emerges from one strong opinions weekly held to running
0:32:20 code in order to form those opinions.
0:32:24 And that’s very much the governance model of Bitcoin and Ethereum today.
0:32:27 Other projects are taking a different approach with formal on chain governance.
0:32:32 I think our view is that the more general the network, in terms of the service that it’s
0:32:37 providing, the more it lends itself to this process of rough consensus.
0:32:43 If you go all the way down the stack down to IP protocol, it’s this very general protocol.
0:32:48 It’s completely un-opinionated about the packets that it’s moving from A to B and the rough
0:32:53 consensus process or work there, it’s very lightweight and easy to integrate.
0:32:59 I would make the argument that general computation platform would lend itself to that same process
0:33:04 because you want it to do this very general thing and a thing that is very deterministic.
0:33:07 It doesn’t require human subjectivity to validate.
0:33:11 Then as you go further up the stack, there are applications built on top of the substrate
0:33:17 and as Dennis made earlier, it’s like the businesses built on top of America.
0:33:19 Each of them are providing different services.
0:33:23 They require different expertise in order to provide those services.
0:33:27 I would make the argument that at that layer in the stack, governance does become important.
0:33:32 The expertise requires specialization and these applications need to be more dynamic and responsive
0:33:38 to their users versus general computation, which over time should hopefully remain fairly
0:33:43 consistent such that these applications can build on top without the rules changing on
0:33:44 them.
0:33:51 There are many factors that go into governance decision processes that are informal.
0:33:55 One factor is the original roadmap of the project.
0:34:01 Does this change fit within the original vision outlined by both the founders and the community?
0:34:04 In Bitcoin, there is a promise of 21 million Bitcoins.
0:34:05 That is very important to it.
0:34:09 Also, there’s figureheads, Vitalik, for example, has very strong opinions.
0:34:13 While people trust him, he is one of many voices in the community.
0:34:15 I think it’s not dictatorial.
0:34:19 He proposes changes and there’s a debate and a conversation.
0:34:25 The base layer today in a platform like Ethereum is both the medium of exchange and the reward
0:34:28 for the supply side of the network.
0:34:31 Importantly, the governance process is this process of rough consensus where there is
0:34:35 no default setting for upgrading the network.
0:34:41 This is an important connection to draw because the users of the network have an active interest
0:34:44 in how the network evolves.
0:34:47 They are incentivized to participate in this process of rough consensus.
0:34:52 Whereas an application built on top of Ethereum, that layer in the stack, the expertise required
0:34:57 may necessitate that the management of this organization, whether it’s a central company
0:35:02 or a loosely affiliated group of people all over the world, that those stakeholders have
0:35:04 that expertise in order to make those decisions.
0:35:06 I think this is a really critical difference.
0:35:08 The base layer is very general.
0:35:13 Users wanted to do this one thing and do it well, compute things in a deterministic way,
0:35:17 but as you get further up the stack, it becomes a lot harder to reason about those mechanics.
0:35:22 I’ve started to use the term power tokens instead of governance tokens to refer to tokens
0:35:28 that represent the power to change the rules or change the makeup of a crypto network or
0:35:32 at least one vote to change the rules of the crypto network.
0:35:36 One way that I like to describe it is that crypt economics are the rules of the game
0:35:41 and governance is the power to change the rules of the game.
0:35:46 My belief is that as the game becomes more valuable, then the power to change the rules
0:35:48 becomes more valuable as well.
0:35:52 That’s the umbrella that I like to use to think through what’s the value of power, what’s
0:35:54 the value of changing the rules of the game.
0:36:00 If power tokens were the only means of making decisions, it’s sort of a very heavy-handed
0:36:06 specific tool that if manipulated incorrectly, it will lead to negative outcomes.
0:36:13 This more informal process through hard forks, you also, in addition, have checks and balances
0:36:17 where, as you mentioned earlier, there are different classes of participants, the miners,
0:36:22 the developers, the users, different bodies of the government that developers proposed
0:36:23 the code.
0:36:28 It has to be agreed upon by the miners to implement it, so it’s a more multifaceted multi-stakeholder
0:36:33 operation as opposed to who owns the tokens gets to, and the other problem is it creates
0:36:34 a default.
0:36:41 If the network automatically upgrades into some specific version of the code, the catastrophic
0:36:45 scenarios are much worse because everyone opts into a default, whereas in this more
0:36:49 weak consensus model, everyone has to agree in a broader way.
0:36:53 I have a twist on rough consensus and running code, which is crypt economic consensus and
0:36:59 running code, and my take on it is rough consensus works well when you’re small, and when the
0:37:03 number of stakeholders is fairly small, when the IETF was working through these protocol
0:37:09 iterations, you didn’t have to find consensus amongst a very large group of people in terms
0:37:11 of who is really affected by these decisions.
0:37:15 Today, it’s a completely different kind of dynamic where the underlying protocols have
0:37:20 remained fairly stagnant, and all of the innovation in terms of use cases has happened above,
0:37:24 where governance is a lot more fluid in the sense that each individual application can
0:37:28 construct its environment or its system in the way they prefer.
0:37:34 But bringing these ideas back to crypto, there’s another model that I like to think about which
0:37:37 is on-chain governance, off-chain diplomacy.
0:37:42 So by off-chain diplomacy, I mean every time that a core developer team meets with each
0:37:47 other to make a decision, or a user or an application of that protocol wants to lobby
0:37:48 for a change.
0:37:54 The human process by which we arrive at proposals and ultimately decisions, you still have meetings
0:38:00 between people debating and arriving at decisions and proposing different ideas.
0:38:01 All sorts of issues can emerge, right?
0:38:06 You can have concentration in the power token that enables a small group of people to really
0:38:10 control the network, but you can have the same kind of dynamic today with rough consensus.
0:38:14 If you don’t have a formal process that allows everyone that they can participate in that
0:38:18 process, you can end up with a clique that effectively governs the network through their
0:38:21 own rough consensus and cuts out everyone else.
0:38:26 Let’s make sure everyone in the network has a fundamental right to participate in that
0:38:27 governance process.
0:38:32 And let’s have mechanisms for people to get together and have sophisticated discussions
0:38:33 about how decisions were made.
0:38:37 But let’s make them convince the community and convince the network that that is the
0:38:38 right thing to do.
0:38:44 I think also, if you don’t have formal governance mechanisms and clarity around it, you devolve
0:38:47 into governance by defection.
0:38:48 And we saw that with Bitcoin.
0:38:51 We’re not necessarily arguing for complicated governance.
0:38:59 We’re arguing for rules and transparency such that the network participants all understand
0:39:02 not only what the rules are, but how the rules are changed.
0:39:07 Yeah, I guess where we might diverge a bit is that we are arguing that the more general
0:39:11 the service of a crypto network, the more it should be ossified.
0:39:17 So again, coming back to this IP is ossified, Bitcoin has ossified, maybe a general computation
0:39:23 substrate is better ossified because it lends itself to the trust that the developers building
0:39:27 on top need in order to feel comfortable building there.
0:39:31 However, those applications that developers build because they’re complex and dynamic
0:39:35 and interfacing with end users need to be able to change.
0:39:41 And in order for them to do so, a formal governance process is probably necessary.
0:39:45 The default is to take whatever the coin holders vote upon and upgrade the system.
0:39:50 And so I think one of the assumptions is that the token holders participating in the vote
0:39:56 and prior to that participating in the diplomacy are experts and have the best interests of
0:39:58 their users in mind.
0:40:01 Their interests are hopefully aligned with their end users.
0:40:03 And they pay for it if they mess up through dilution.
0:40:04 Right.
0:40:05 That’s right.
0:40:09 And so the incentives are tightly coupled so that the experts make decisions for the
0:40:12 benefit of their users and for the benefit of themselves.
0:40:15 And you end up with this very dynamic system where the end users don’t necessarily need
0:40:19 to think about the complexity of the underlying mechanic of the thing.
0:40:24 And importantly, there’s explicit enforceability over one canonical group of contracts that
0:40:26 control the system.
0:40:32 And so the output of the governance process doesn’t require, for example, end users or
0:40:36 other participants in the network to download new software and run it.
0:40:41 The analogy of a blockchain is we’re traveling down a highway.
0:40:47 And then we decide that we want to take a turn, one of two turns into two different futures.
0:40:52 And that will be upgrading– miners upgrade their software to a new fork version.
0:40:57 What forks are in protocols is different than forks are on base layers.
0:41:02 You can’t fork in the case of a stable coin because it has all this collateral.
0:41:06 You can’t fork the collateral because your DAP doesn’t control that.
0:41:09 You are using the existing platforms collateral.
0:41:10 So the upgrade process has to be different.
0:41:14 In the governance debate, there’s nuance in what it means to upgrade a DAP that’s running
0:41:16 on top of ProCo and the protocol itself.
0:41:19 You brought up the example of a computation network.
0:41:22 It’s a very well-defined kind of service.
0:41:24 A computer runs the code, and the code has an output.
0:41:28 If you focus on something more controversial, like how value is distributed, then all of
0:41:30 a sudden you find that the governance is really important.
0:41:37 And I’d also argue that power token voting excludes the needs of miners and the needs
0:41:38 of users.
0:41:39 That depends on how you design it.
0:41:43 If you think of power as a source of value, then you want to make sure that that power
0:41:46 is evenly distributed amongst the participants of the network.
0:41:49 Otherwise, you end up, again, where we are in the modern economy today with very few
0:41:53 people with a lot of power, and most people with not that much power.
0:41:58 So just one thing I wanted to add is that one of the problems with thinking about on-chain
0:42:03 governance as a way for users to actively participate in the evolution of a network
0:42:07 is that in practice, if we look at the real world and how governance systems work, there’s
0:42:09 actually very low participation.
0:42:16 This is because as an individual user, an individual voter, my one vote, my little say doesn’t
0:42:19 have all that much influence on its own.
0:42:22 And so there’s this apathy about participation.
0:42:28 And so a assumption is that when we talk about users affecting or risking together and participating
0:42:33 in governance, is that they have some sort of emotional stake in the outcome of governance
0:42:34 processes.
0:42:41 And that may be the case in very niche applications where users feel a strong affinity to the application
0:42:42 they’re using.
0:42:46 If I don’t have a strong connection to participating in voting, maybe I’d be more likely to sell
0:42:48 my vote to someone who does.
0:42:53 And the result of that is the same risk that Joel described earlier, where the capital
0:42:57 and the currency become disaggregated.
0:42:59 And this could undermine on-chain governance processes.
0:43:03 It’s important to note that on-chain governance is really hard for a number of reasons.
0:43:07 In the context of blockchains, it’s very difficult to know who the participants are.
0:43:12 You can be hundreds of people just by generating multiple keys.
0:43:17 And so when you have this system that is synonymous, it’s difficult to enforce behavior patterns
0:43:22 that lead to good governance, say, in shareholder governance where shareholders are bound by
0:43:23 fiduciary law.
0:43:28 There’s a great post by a researcher at Cornell who we recently had on the podcast named
0:43:32 Phil Diane, and he went deep down the rabbit hole into different attacks that you could
0:43:33 launch.
0:43:34 The rise of dark doubts?
0:43:39 Yeah, the post dives in deep and our podcast does as well on different sort of attacks
0:43:43 that you can launch to bride participants in on-chain governance schemes.
0:43:49 I think a lot of arguments against on-chain governance are kind of primitive in their
0:43:52 thinking around how is that governance applied.
0:43:57 One common element of a lot of the counterarguments is the assumption that governance power is
0:44:02 linear and one token equals one vote, whereas in crypto networks, we have the opportunity
0:44:05 to design much more intricate systems with much more intricate rules.
0:44:09 And so, yes, you can replicate yourself across a thousand different addresses, while you
0:44:15 can make it such that your governance power is amplified if you have all your tokens
0:44:20 in one wallet and so you can make it actually more powerful to basically voluntarily disclose
0:44:24 still within the pseudonymous system how much of the token you have because you get more
0:44:30 power by aggregating your assets together and you can kind of change how the shape of
0:44:35 that curve, depending on the context, you can also do things like look at the age of
0:44:36 an address.
0:44:40 One thing that we learned actually from a non-crypto company that was in the online
0:44:44 community abuse space is that the length an account has been open is the greatest determinant
0:44:45 of whether it’s a troll or not.
0:44:50 And so you can use things like the life span of an account or of a wallet or the tokens
0:44:51 that it received.
0:44:55 And you can even make distinctions around whether the tokens in that wallet were purchased
0:44:58 from an exchange or were received directly through mining.
0:45:02 And you can factor all of those things into how you design, let’s call it your governance
0:45:03 curve.
0:45:07 Maybe those are all examples of on-chain reputation that’s sort of native to the system.
0:45:08 Exactly.
0:45:10 So yeah, thank you guys very much for coming on.
0:45:14 It’s been awesome sort of recapping the space and how it’s evolved over the last few years
0:45:20 and super excited to see how our theses play out over the years going forward.
0:45:21 Well thanks for having us.
with Chris Burniske (@cburniske), Joel Monegro (@jmonegro), Denis Nazarov (@Iiterature), and Jesse Walden (@jessewldn)
When designing cryptonetworks — really, emerging economies — how do we avoid some of the monetary and fiscal policy failings of ”real-world” economies? Like not separating currency and capital, which accelerated and spread economic growth through the former… but also concentrated the latter into the hands of a few? Yet how can we empower users to access capital while also managing risk?
If the promise of cryptonetworks is to better align incentives and value capture, then we can’t make the same mistakes as we did in traditional economies. We also have the chance to do novel things not possible in the physical world, through software. So this episode of the a16z Podcast — featuring voices from Placeholder VC and a16z Crypto — goes deep into the nuances and mechanisms of cryptonetworks, tokens, and decentralized applications at every layer of the ”stack”. Chris Burniske (who has written a lot about financial modeling-influenced frameworks for analyzing crypto) and Joel Monegro (who has written about ”fat protocols”, and once managed the Digital Economy Department at the Ministry of Industry and Commerce of the Dominican Republic) of Placeholder VC discuss and debate all of the above — and more! — with a16z crypto’s Denis Nazarov and Jesse Walden (co-founders of Mediachain, which was acquired by Spotify).
Throughout the history of information technology, we’ve gone from hardware to software, and software to data. So what’s next, what’s the layer above data? The answer is governance — which gives more people a way to participate in decision making around a given network — but the answer for how to implement the best governance isn’t so clear.