6 min read

Cartoon monkeys are rediscovering fire

Information goods have always been difficult to price as they represent products of pure utility in the neoclassical sense, but with 0 marginal cost of production. The key innovation of cryptocurrencies is  the ability to assign mathematically verifiable scarcity to little blocks of organized information. This has sparked a furious trend of financialization of pure information goods. In turn, as people are rediscovering real-world utilities under this new paradigm, they are also rediscovering some core precepts of corporate finance and shareholder capitalism.
I didn’t study engineering at university because I had a particular passion for electrical power grids. It was more like a proof-of-work for the ability to study something difficult, with a central entity verifying the proof of completion, namely a degree. Although I retained very little, given that I never ended up actually working in power grids, some bits of knowledge reluctantly ended up stuck to the side of my skull. One of my favorite courses was MGT-431 Information: Strategy and Economics, an introduction to information economics. Information goods, like an idea or a MP3, are characterized by three main factors:

  1. Non-rivalrous: If you buy a house, only you can live in it. If you buy a MP3 (remember the days?) it doesn’t stop someone else from listening to the same MP3. Information goods are easily replicable.
  2. Non-excludable: You can’t unring the bell. You can’t make someone forget listening to a song. If you see a nice picture of a cartoon monkey, someone cannot confiscate your enjoyment. Artificial barriers can be set up of course—you cannot log in to Xbox Live unless you pay a fee for example.
  3. Intransparency: In the market for tangible goods, purchasers know upfront what they want and what they are buying. However, purchasing a suite of Office software is intransparent, in that the buyer needs to purchase the product first before understanding whether the need is suitable for them. The act of purchase only marks a down payment towards an economic relationship, rather than a transfer of title rights.

Information goods not being excludable doesn’t necessarily make monetization impossible in information markets. For instance, truly free access to the airwaves defined the era of broadcast television. Rather than rely on contributions to keep running, producers realized they could instead monetize people’s attention—a derivative information good with a much higher degree of rivalry and excludability, hence the birth of broadcast advertising.
Public-key cryptography, in the context of information goods, recreates mathematically sound rivalry and excludability for bits and bytes like emails or ERC-20 tokens. A PGP signed email is impossible to replicate. Signing an email with a recipient’s public key excludes everyone apart from the holder of the private key from consuming it. That email is therefore a new type of information good that has more characteristics of a physical art piece on a canvas than of a public good like air.
Cryptocurrencies and tokens extend this concept to a general case, where any piece of information can be encrypted. Information can therefore earn the property of excludability—only the holder of a wallet’s private keys can truly be said to ‘own’ these particular bits and bytes. Non-fungible tokens relax the non-rivalrous constraint, and tokens can become 1/1s.
The really wild frontier is the use of these cryptographic pieces of property to encode interest in a pure information business model like a web3 bank. Imagine a piece of code that accepts deposits and issues credits. This code charges a yield on its credits and pays out interest on its deposits. People receive or purchase governance tokens if they are interested in directing this piece of code. They are essentially the regulatory arbitrage version of shares in a company, where the legal constraints on who can buy them or what they might represent are totally relaxed. This allows for incredible innovation in the development of business models that are purely in the information realm. Having governance tokens that bear a relation to the value accrued by a crypto flywheel opens a new chapter of shareholder capitalism for the information age.
In this new paradigm, banks that have no headquarters and are really difficult to sue can create interest-yielding assets. The business models are objectively creating millions of dollars in profits, with income statements and balance sheets marked to market every single block. People are spending full-time working hours maintaining codebases, marketing products and shitposting on social media to grow these businesses. Token holders are agitating for various initiatives they’d like to see implemented and taking governance personally. A crucial difference is that pure financialization means anyone can buy into a project they believe in at any stage and with any decimal fraction of capital. In meatspace, they would have to wait for the government to let them in (or not) to the club to generate outsize returns.
The accumulation of serious wealth in some of these projects is the catalyst for the emergence of a new set of token-holder rules. They’re emerging from meatspace funds and random individuals interested in the value of their cryptographically verifiable governance claims on the functioning of a decentralized business model. They tend to subscribe to a canonical form of shareholder capitalism, interpreted for the token era. Hasu, for instance, describes principles for managing protocol treasuries:

  1. The goal of a DAO is to maximise long-term token holder value
  2. Each dollar should be allocated to its most profitable use
  3. Saving money in treasury
  4. Investing in growth
  5. Paying out through buybacks or dividends
  6. A DAO becomes an acyclical trader of its own token—if overvalued, sell the token and build equity reserves. If undervalued, buyback and distribute value to token holders
  7. Discount native tokens (treasury stock) to 0
  8. DAOs need treasuries to survive 2-4 years of thin liquidity and revenue
  9. Understand application-specific liabilities and hedge them

Nobody wrote down these principles in the code for Ethereum. They are being rediscovered out of the primordial mass of chaotic early transactions in the markets for pure information. When this chaos interacts with human organizations, new challenges emerge. DAOs face principal-agent problems just like in meatspace capitalism, and are rediscovering the same solutions to fix them. Human beings who work for these protocols may interpret greater value accrued from short-term salary payments than from long-term token value accrual. They would then be incentivized to plunder as much short-term value as they can for themselves, before other agents do. The risk is for DAOs to degenerate into socialist collectives run for the benefit of the employees but without shareholder pressure to try to stop it. Principals, or token holders, are usually too diffuse to present any form of resistance. There are too many principals, and in many DAOs there is often no one agent who speaks for most of the agents as a whole. Some DAOs have imploded or become fully dysfunctional amid this Lord of the Flies backdrop.
As modern capitalism regresses from incentivized shareholder capitalism, with its power to unambiguously do both good and evil by doing well, it is slowly sliding back into the morass of ill-defined goals and unclear incentives of early token-holder chaos. Good intentions can often create bad outcomes. Is the real issue short-termism vs long-termism, or is it activism on political issues? If a company has to look out for stakeholders, does it have to look out for all of them or only a subset? What if stakeholder interests are not aligned? Who wins? Are employees more important than local communities? Should Amazon stop opening warehouses to prevent small shops from going out of business? Who decides which shop should survive and which one should be crushed by a new fulfillment center?
Does it even make a difference what you call it, if in the end it’s shareholder capitalism all the way down? If a company underpays its employees for short-term profit, and the employees go on Twitter to complain, does the stock drop 35% because people are annoyed at being underpaid or because unmotivated employees will not generate as much future value to shareholders? Imagine people are angry that Amazon forced a local bookstore to go out of business and stop buying from Amazon. Does the stock drop because a bookstore owner went out of business, or because revealed preferences showed that the demand curve for books depends on what store sells them? What if people don’t stop buying from Amazon? What should the agents that work at Amazon do then? What should its principals demand? Under stakeholder capitalism, as opposed to shareholder capitalism, it’s impossible to tell.
On the other side of the mirror, token-holder capitalism is emerging from the primordial mud into the moral clarity of active token management and token-holder interest. The incentives are much more transparently aligned and much quicker to mark to market than in meatspace. You can after all see the daily P&L of these businesses. You can see who transacted with them. You can peek into the wallet of a whale worth thousands of ETH and what money says when money talks.
Perhaps one day the two will merge when they meet in the middle. Paper stock certificates on the way into the mud, and digital cartoon monkeys on the way out of it.