Capturing value in crypto through network effects and mechanism design
Week three of a16z’s Crypto Startup School focuses on understanding how to capture value and design proper incentives within the decentralized framework. We learn how familiar ideas like network effects and mechanism design can hold unique power for crypto networks.
In the first presentation, Andreessen Horowitz crypto partner Ali Yahya discusses “Crypto Business Models.” Yahya explains that the consensus mechanisms of blockchains create trust among independent participants in decentralized networks.
At first glance, this may seem at odds with the idea of capturing value, since none of the factors that allow companies to build moats in traditional industries — trade secrets, intellectual property, or control of a scarce resource — apply in crypto.
This leads to the “value-capture paradox” — how can easy-to-replicate, open-source code be defensible in a competitive landscape?
The answer is that network effects are just as powerful, if not more so, in crypto than in traditional industries. This is due to the economic flywheel enabled by tokens, which incentivize participants and coordinate all economic activities in crypto networks. Combined with the ability of developers to build on each others’ networks using autonomously executing smart contracts, this should result in winner-take-all dynamics, contrary to what might seem intuitive in open source, Yahya says.
In the next lecture, Sam Williams, founder and CEO of decentralized storage system Arweave, gives an overview of “Mechanism Design,” a field of study that has become newly relevant with the development of Bitcoin and subsequent blockchains that require carefully designed incentives for network participants.
Williams uses examples to show that economic incentives, when designed properly, can persuade self-interested people to exhibit useful behaviors at fair market value with minimal central planning. This provides a new tool to bootstrap decentralized networks.
He cautions, however, that poorly conceived incentive systems can overpower moral frameworks in ways that can be dangerous. This could be harmful, he says, in decentralized protocols, since self-executing code may not be easily altered to curtail unintended consequences.
Williams closes with a case study of his company, Arweave, and the way it created an endowment-style financial incentive system to build a platform where data can be secured forever. This kind of model opens the door to new kinds of community-owned networks that can’t be manipulated by central owners.