A flippening is coming — a point where the the human experience is dominated by digital. The advancement of the digital experience has been anything but linear — we see step function advancements in new domains (Web, mobile, cloud, AI, AR/VR), and within those domains, logarithmic advancements.
The compound impact of this is the birth of a new economy — the digital economy — where the physical world serves as a means to maintain our physical existence but the we experience everything in the digital world. Yes, that is a little esoteric, but the seeds of the Metaverse have been sowed.
Outside of the basic necessities of life (food, shelter, water), everything else in the human experience could be wholly digital. Although today our anatomical existence is not confined to a series of pods in the matrix, and I am not Morpheus here to offer a red pill, we’re closer to the matrix than we think. Outside of the past decade, the majority of human experiences were entirely physical in nature. Today, we go to our jobs where we meet virtually to produce digital goods and services, only to go home to socialize and consumer entertainment entirely online — often concurrently. This has a compounding effect:
Digital is unlocking a new cohort of creators. The smartphone is the new means of production in the information age and 80% of the US owns one. Hundreds of millions of people, all empowered to be the source of value in peer-to-per networks. Digital services are emerging as their own self-sustaining economies with their users generating highly leveraged economic value. I think it’s time we recognize that digital production is not a cog in the existing paradigm that is the global economy, digital is emerging as its own economy.
Today, we are generating immense value in digital economies. The gaming industry, for example, would itself be the 59th largest economy by GDP this year at ~$140B. Facebook, a single firm, would slot in at 89 based on its 2017 reported earnings — just ahead of Serbia, and still comfortably in the top half of global economies. It is hard to argue that Facebook is not its own economy — its users (citizens) generate value (although not explicitly paid), they pay taxes (data, not dollars), and they consume goods and services. The Facebook identity system even serves as a pseudo passport in the digital world with FB Connect. The problem is that Facebook is encroaching on these fundamental primitives to establish itself as the de facto centralized authority for our existence in the digital world. And for everything else, there’s Google Sign-in.
In the physical world, distribution is a function of proximity and infrastructure (transacting with my neighbour requires little infrastructure; the further the counter-party, the more requisite infrastructure). Physical infrastructure manufactures choke points for centralized authorities to censor trade relationships, often in the name of political posturing. The net is a false promise of globalization. In reality it is highly selective global trade, sometimes.
The introduction of the PC presented the first personal gateway to a more interconnected global economy, giving rise to a new asset class: information. In 1981, IBM blew past their (modest) projections projections of 50k units sold per year, selling 40k in the first day. This preceded TCP/IP by a year, and the world-wide-web by almost a decade, uncovering the appetite humans have for connection and information. Pre web-era, hardware dominated early innovation. This created well defined moats for those manufacturers. Hardware manufacturers like IBM originally required redundancy in component manufacturers to maintain optionality and early applications came from different firms in the interest of fair competition; however, these soon morphed to monopolies. Intel started manufacturing exclusive hardware and Microsoft, controlling the dominant operating system, made it complex to build applications that worked on their OS — positioning themselves as the sole-supplier.
Web 2.0 presented an opportunity to upend these monopolies, and for a brief period it did, giving birth to a new breed of firms built out of the browser. But, history has repeated itself, regressing to a monopolistic environment of centralized entities inserting themselves as the access points. These services provide a positive benefit to end users by bringing the world closer together, organizing the world’s information and helping them find anything they want to buy. Three very important components of functioning in the digital economy, possibly the only necessary components. If these are the most important things, it feels wrong to have a centralized authority able to exert power and act as the gatekeeper. At present, our identities are inextricably tied to these access points, our participation contingent on a few monoliths.
Not only is there a cost to the innovators who get squeezed out by monopolies, there is a double-weighted cost to society as well:
First, there’s a deadweight loss in innovation by making it difficult for anyone outside The Four to bring scalable products to market. Monopolistic economies reach a point of equilibrium where, without economic viability, a lot of potential development gets left on the table. This leaves a barren wasteland of ‘what ifs’ because, as we’ve seen over and over, the biggest advancements come from the curiosity of people building on the fringes. Eric Raymond’s seminal essay The Cathedral and the Bazaar juxtaposes open and closed source development, highlighting the benefits of decentralized iteration in the former as the catalyst for advancement. We can see examples of this in evolutionary biology as well; even a collection of monkeys can rewrite classic Shakespeare given the opportunity to iterate on each other’s work.
The second cost to society is even more explicit: censorship. In this information age, where connection and shared experiences dominate the digital experience, gatekeepers repress open connectedness in self-interest. This is human nature — we’ve seen seen this take form in any hierarchical power structure. The printing press enabled mass production of information, but the transmission of that information was heavily censored through government-controlled distribution — this was prolific, so much so that it was addressed in the First Amendment of the US Constitution. Today, we often think of these oppressive restrictions on information and connection as problems faced in authoritarian governments known for censorship (China, N. Korea), but what often gets glossed over is this same censorship exerted in the services we use every day. Ben Thompson does a great job of defining this in his work on Aggregation Theory — (worth the read).
I am not arguing against the services these companies provide — in fact, I’m writing this in Chrome on the keyboard I bought on Amazon — my argument is that these services should serve as an end-point, not an access point.
There are two fundamental properties to exist and participate in an economy: identity and money. In the digital economy there needs to be a digital manifestation of both. There is an opportunity, finally, with the tools available to us in the web 3.0 era to be self sovereign. The design space in digital is unbounded. It only makes sense for participation in the digital economy to be unbounded as well.
Identity in Web 3.0 Era
Our identity should be decoupled from these centralized service providers, instead functioning like DNS on the open internet protocol. The proliferation of asymmetric cryptography unlocked a new axis for us to approach identity in the digital world. Though its prominence in the broader social consciousness has been relatively recent with the rise of Bitcoin; asymmetric, or public key cryptography, is decades old. The complexity is both an enabler and a blocker. The inherent complexity in public-private key pairs offers security, but conversely presents a difficult user experience, often cited as a barrier to broad adoption. The most widely used consumer platforms in the space are centralized entities that take custody of the private key to enable a more simplistic user experience.
These custodians create a low friction experience for the average consumer but we’re reverting right back to the risk of centralized control (not to mention the second derivative centralized authorities that govern custodial services). I believe we’ll start to see more novel implementations of identity that is both effective and usable by the average consumer. The intersection of distributed computing, and asymmetric cryptography creates an interesting design space — think public key fingerprints like those used for authentication in the Signal protocol, meets IPFS.
Money in Web 3.0 Era
What really unlocks the growth of the digital economy is a native currency to the digital world. Common medium-of-exchange currencies date back to ~700 BC. Coins were issued to obfuscate the friction of the double coincidence of wants in a barter system — a currency native to the economy. This unlocked higher frequency of trade. Today we have currencies native to the digital economy in cryptocurrencies — for the first time ever, being able to guarantee the scarcity of a digital asset. But, there is a high degree of friction for the general consumer using a cryptocurrency — in large part because the majority of cryptocurrency holders did not earn that token, they purchased it with currency that’s rooted in the physical world paradigm. So, although the currency itself is native to the digital economy, the means by which it is obtained is rarely a digital native experience. This introduces a two key points of friction (1) the extra step in converting to a new currency and (2) the anchoring of value to the base currency that was converted.
The value of a currency is a function of relativity. As long as the relative value within the economy is stable, purchasing power remains stable and we should expect stable spending behaviour. However, when someone buys into the economy they are now anchored to the relative value of the new asset to its value in the base currency. Think of this as the difference of someone converting their USD earnings to the Yen for a 2 week vacation in Japan; that person will view all things through the lens of USD — doing quick conversion calculations. Now contrast that with a native of Japan who has spent their whole life exclusively earning and spending the Yen, with no plans to ever visit the US — the USD:Yen conversion isn’t even a consideration.
The former scenario produces a high cognitive burden because it is no longer just a question of purchasing power in the new economy but also the opportunity cost in purchasing power of the base currency. This is what almost almost all cryptocurrency holders face today.
If a user earns the new currency directly, the anchoring effect of relativity to the base currency is broken — because there is no “base”. Of course, the same opportunity cost still exists given these cryptocurrencies have gateways back to fiat currencies, but just like the average citizen does not actively monitor FX rates in other countries, my hypothesis is that many users will follow the same behaviour in earned cryptocurrencies once the digital economy reaches a state of recursive user behaviour. The counter-argument to that would be that the FX analogy carries little water because it’s of little impact to an average consumer who does not participate in another country’s economy. My argument is that the digital economy is producing enough value that the average person will soon straddle two worlds: physical and digital. Hayek would suggest, per The Decentralization of Money, that individual economies should develop individual currencies that compete, eventually consolidating to a few universally used currencies.
Vitalik wrote a good post on medium-of-exchange tokens — here — that unpacks the friction of a currency specific to digital experiences, as he refers to as appcoins. The assertion is that there is a having a digital good or service only unlocked through a currency native to that network introduces (i) user friction and (ii) volatility risk in purchasing power by switching between preferred, day-to-day currency and the appcoin. I agree with these arguments, however, I am bullish on medium-of-exchange tokens for digital ecosystems; because, I fundamentally believe that these will become our day-to-day currencies.
Today we take physical dollars and port it into the digital world for the fringe spending we do there. Tomorrow, the fringe spending will be in the physical world and we will adapt physical spending to the digital native currency and the majority of “GDP” we generate is in digital economies.
Incentive Alignment
Crypto was the missing piece to the open-source software movement. We know that iterative development leads to the most accelerated growth in innovation, however, firms are reluctant to engage because the dominant strategy is to fight for market dominance and develop moats. Prisoner’s dilemma for these firms presents too high an opportunity cost in collaborating for the dominant players — that’s why we see examples like Microsoft resisting open platform in the 90’s and more recent examples of Facebook exerting platform dominance and pulling the rug out on firms like Zynga. Crypto upended this paradigm with a simple economic property: scarcity. With a finite supply, everyone is economically aligned to grow demand for the scarce asset — inciting a natural incentive to collaborate.
Users were marginalized in the share of value capture, even though as noted above, they are generating the majority of the value in these network based digital services. In a crypto-economy, the share of value capture is democratized. This has a powerful incentive to bootstrap network effects from the bottom up.
Pre-crypto it was a zero-sum game; everyone is fighting for market share. There was always this fundamental tradeoff of societal benefit v. individual benefit i.e. close the moats and collaborate for the greater good, but for market leaders that came at a cost to potential profits. With crypto though, societal benefit and individual benefit reinforce each other. The more an individual optimizes for the greater good, the more they benefit individually. These were fundamentally at odds with each other, until now. Rationale optimization favours collaboration and iterative development.
Clayton Christensen talks about commoditized components in the value chain forcing businesses to find adjacent opportunities. The best benefit in a crypto-economy is to race to commoditization and then find those adjacent possibilities rather than fend off commoditization.
All that being said, I’m not arguing in opposition of competition — competition is good for innovation. The difference is that the competition is for incremental share of a finite resource — productive growth relies on meritocratic distribution of the finite resource which is a non-trivial governance consideration. The cost of undermining the greater good in self interest must be worth less to an individual than optimizing for collaboration.
What’s an economy without taxes?
Ben Franklin famously stated that nothing can be certain but death and taxes. Although our digital selves don’t face an impending mortality independent of our physical expiration, taxation may not be similarly obfuscated in the digital world — and I think that’s a good thing. A common meme in the commentary on cryptocurrencies is the idea that a majority of the actors use it for nefarious activities or tax evasion — the reality is that likely accounts for a small minority or activity.
Taxes are inherently good, contrary to our feelings when our annual filing rolls around. Taxes pay for public services and infrastructure i.e. roads. Public infrastructure is incredibly important in the digital world too, it just takes a different form i.e. consensus protocols.
Similarly, the method of ‘taxation’ in a crypto-economy can take different forms as well. Some protocols extract fees in the network for services rendered by validators. Some extract a tax for inactive tokens with expiration tied to airdrops — a way to incite higher velocity. The reflexive problem to that is a velocity that is too high, resulting in a DOS threat — implementing fees is a mitigation tactic. An interesting analogue would be to look at the Tobin Tax, originally presented by James Tobin as a way to mitigate market manipulation in high frequency FOREX trading. The use of funds in a Tobin inspired taxation system in a crypto-network could take the form of a sink (destroy the funds), which is essentially a pro-rata distribution to token holders by reducing supply. I like the idea of dedicating the funds to development goals for the network — similar to the UN Development goals. Ethereum is an example of this with the dev goals.
There are ways to obviate fees by operating with a permissioned consensus and authenticating users. I think we will see more implementations like this for mainstream consumer adoption because (1) Permissioned consensus offers higher performance and mainstream users value incremental performance over incremental decentralization; and, (2) most mainstream consumers see authentication as lower friction to fees — we see this in every freemium app.
Absent of fees, there is still an effective form of taxation. It’s often overlooked because it is not explicitly extractive in nature. it’s the dilutive by way of inflationary incentives to network actors. Said another way, rather than extract value from a user in the form of fees, the network increases the supply to pay for network services i.e. the block reward.
Why this is all so exciting
What gets me excited about the expansion of the digital economy is the opportunity to upend the current power dynamics. That’s not to say I have an anarchistic view of the world, but the rate of innovation in digital is outpacing the existing paradigm of governance in the physical world, and the gap is only getting wider. That, to me, is a by-product of our feeble attempts to fit new innovation in existing mental models. We need to recognize that the digital economy is worlds apart and should be approached from first principles. The digital economy should be treated for what it is, its own world.
More than half the world is connected through the internet. The entry points to the global network are becoming more ubiquitous and the tools to create value for each other are increasingly dynamic. For all the division in social, economic and political constructs in the physical world — there’s an opportunity to put those aside and approach the digital world as a blank canvas for collaboration.
The foundation is in place for a new economy, a digital economy — I’m excited to build for it.