Manufacturing Consensus
Thanks to Vitalik Buterin, Tarun Chitra, Sreeram Kannan, Arthaud Mesnard, Maxwell Tabarrok, and Robert Drost for feedback
Dryden Brown

October 11, 2023

Manufacturing Consensus

Thanks to Vitalik Buterin, Tarun Chitra, Sreeram Kannan, Arthaud Mesnard, Maxwell Tabarrok, and Robert Drost for feedback


TLDR.

Crypto is threatened by decentralization. Decentralization is the transfer of power from Direct Leaders to Opinion Leaders; Opinion Leaders inform the voting preferences of Token Holders. There are fewer Opinion Leaders than Direct Leaders, as Opinion Leaders have cross-project influence. As such, when projects decentralize governance, they centralize power across the industry. This makes crypto more vulnerable to capture and attack, because a smaller number of people need to be captured, and their distribution can be boosted or constrained by the owners of the social platforms they use. We can mitigate the risks of decentralization if we understand them. Finally, we should develop a regulatory environment that promotes the longevity and growth of the industry.

Why Decentralize?

Crypto projects always start with centralized governance. Projects begin with a vision and an attempt at realizing this vision, carried out by an individual or team led by a Direct Leader. The Direct Leader makes decisions about strategy and resource allocation.

Often an element of the strategy or product design involves issuing a token. A token is usually a liquid, tradable claim on a share of the value created by a project. Decentralization is the process by which the Direct Leader transfers the right to make decisions (power) from themselves to the holders of their token. Token Holders vote on what the project should do: strategy and resource allocation.

Why do Direct Leaders decentralize when they issue a token? Decentralization imposes costs on an organization — decisions are made more slowly by lower context people who are not held accountable for bad decisions — this is why companies don’t operate this way. These costs are being felt across the industry. Kevin Owocki, who left as Direct Leader of Gitcoin to later return, described a broader trend of “founders boomeranging” back into leadership to solve the organizational dysfunction caused by decentralization. As the impetus for governance changes, Rune Christensen wrote of MakerDAO in 2022, “The governance processes and political dynamics… fundamentally aren’t compatible with the reality of effectively processing complicated real-world financial deals.”

Projects decentralize because this is usually a regulatory requirement to issue tokens, implicitly mandated by the Howey Test. Howey deems (most) tokens that claim value from a project led by a “common enterprise” (Direct Leader and team) securities. If a token is judged a security, it imposes a massive regulatory headache and expense on the Direct Leader and team. Beyond the functional product possibilities unlocked by tokens, the following benefits inform the calculus around decentralization:

  1. Liquidity for early stakeholders; less market and regulatory scrutiny than equities markets; cheaper than IPOing
  2. Increased financing availability and project value by unlocking new demand for ownership via liquid capital markets; less market and regulatory scrutiny than tradfi equities markets; cheaper than IPOing
  3. Stakeholder alignment — give tokens to customers, vendors, etc.; tokens as a CAC/retention lever for users and teams building on top of the protocol; cheaper than IPOing; fewer restrictions
  4. Retirement – stop working, reap the benefits

These benefits are material. The industry is not totally cynical about this, because a final rationale for decentralization blinds them: Cargo culting Bitcoin leads to brand value accrual that cashes out in legitimacy. Ceding power is perceived as noble; actually, it is often a pretense for an economically-motivated abdication of responsibility. Leadership is noble.

Projects decentralize because there is a powerful economic incentive to do so in light of US regulations, and because it conveys upon them legitimacy; but they do so at the project-level cost of decreased organizational effectiveness, and at the industry-level cost of the centralization of power.

Manufacturing Consensus.

When projects decentralize, Direct Leaders are nominally ceding power to the Token Holders — but is this actually the case? No – decentralization is the transfer of power from Direct Leaders to Opinion Leaders.

Voting fails to express the preferences of the voters because in democratic systems, voters prefer to delegate power to Opinion Leaders. Opinion Leaders are people who inform voters’ views on a project, because they are perceived as being higher context than them, perhaps wiser, and certainly more legitimate. Opinion Leaders are often a former Direct Leader, but sometimes they are the former or current Direct Leader of another project. Using the power bestowed upon them as a function of Token Holders’ trust, Opinion Leaders come to control the information flows that inform the preferences of voters. By controlling information, Opinion Leaders dictate voting outcomes; sometimes Opinion Leaders have explicit power via a formal delegate system. Often L1s like Ethereum have robust off-chain governance systems (e.g. EIP) that precede votes, but votes formally decide the fate of a proposed change.

This dynamic was most famously described in Chomsky and Herman’s Manufacturing Consent. They argue that mass media is the propaganda arm of the US government – mass media controls the flow of information, so it dictates voting outcomes. Today, there is a broader network of independent Opinion Leaders who come to prominence on social media, but still they feel the weight of the power of politics. Further, independent Opinion Leaders are subject to the whims of the Direct Leaders who control the social media platforms they use to disseminate their ideas. If social media platforms were to decentralize, this problem would be compounded further. Elon demonstrates the potential of Direct Leadership, as someone capable of breaking with Opinion Leader influence.

Adversarial actors seeking to harm a project or the industry will be operating outside the bounds of the internal logic of a project (a Byzantine Participant) – they won’t be attempting to steal money, or tokens, but rather to sow discord to create a meta-problem: industry dysfunction and potentially collapse. If crypto is taking zero-sum political power from an actor, this response is rational.

The lesson is: if an adversarial actor (perhaps a hostile government, or other misaligned interest groups) wanted to control crypto, they would:

  1. Incentivize project decentralization (with financial or social capital)
  2. Encourage Opinion Leadership centralization (potentially using social platforms as a lever)
  3. Co-opt Opinion Leaders with the reach to influence the important projects

This would be much easier than co-opting the teams of those projects, because Opinion Leaders have cross-project influence. The result of decentralization is a more fragile industry, with a clear Achilles’ heel.

Dead or Alive.

Ethereum is formally decentralized, but its a Live Player project: it is actively led by a group of high-legitimacy Opinion Leaders including its founder, Vitalik. There is little-to-no cross project influence present, because there is no power vacuum left by a checked-out core developer team. It’s hard to find a single non-Ethereum Opinion Leader that Ethereum people seriously listen to. Within the broader Ethereum ecosystem, L2s are deeply influenced by core Ethereum devs; given that their decentralization largely comes from a tight coupling to the underlying L1, this seems necessary – which highlights a vector of attack for L2s – a Dead Player L1. 

Dead Player projects are projects that have decentralized, and instead of graduating from Direct Leader to Opinion Leader, the founder has meaningfully retired – leaving a power vacuum, opening the project up to external influence.

Dead Player projects are hard to resuscitate, and Opinion Leader led projects are hard to pivot. There’s little incentive to execute on the pivots required to have a major second or third act, because as a new would-be Live Player leader, it’s an uphill battle for social capital within the project, and there is no clear mechanism for attaining an economic incentive i.e. tokens commensurate with CEO-level work. It’s much easier to simply start a new project.

Stunted Growth.

Many projects have a vision for an end state like Bitcoin’s: an autonomous, immutable system running itself on the internet forever. It’s worth taking a moment to appreciate the cyberpunk elegance and historical achievement of such systems. But, it takes leadership to steward a project to a lofty perch – if the history of technology has taught us anything, it is that new projects using new technologies will displace older ones, particularly if there is not a high-legitimacy Direct Leader in place to navigate through Christensensian disruption. Premature decentralization is not the path to immortality – it’s the path to a quicker death.

Opinion Leader-led projects have a limited ability to have strong second or third acts, creating a greater opportunity for new entrants. Imagine if Facebook had decentralized to Facebook Protocol upon achieving PMF (or hitting 1B DAUs): META wouldn’t be a $800B company because Opinion Leaders would not have guided Token Holders to vote for the “overpriced” Instagram acquisition, and certainly not the investment in metaverse technology. Only a Direct Leader with Mark Zuckerberg’s legitimacy can make contrarian calls. In Facebook Protocol world, Instagram would’ve taken eyeballs from the Facebook core product, and Oculus might be doing significant R&D on metaverse tech – building their own empires. And Facebook Protocol would be dying. This is not bad in its own right, but it does suggest that premature decentralization stunts projects’ growth. An unfufilled destiny is a sad sight to behold, but more practically, smaller outcomes means a higher cost of capital for the industry. VCs are willing to underwrite “expensive” deals in spaces with megaoutcomes.

Recruiting is harder for decentralized projects. With less confidence that they can make bold strategic decisions, would-be recruits become founders. Rare are projects with such insane legitimacy that the social capital they convey outweighs the obvious economic incentive to build a new project using new technology. The Ethereum Foundation recruits extremely well – their researchers could make more money launching new L1s a la Avalanche or Solana – but the EF is an exception.

Premature decentralization leads to more projects (which is good), but smaller outcomes and a higher cost of capital for the industry (which is bad).

Conclusion.

Contemplate the costs the decentralization imposes both on your project and to the industry. Vitalik wrote, “small things being centralized is great, extremely large things being centralized is terrifying.” The biggest thing in crypto is the entire industry. We should not shepard crypto to a place where power could potentially be centralized and controlled by adversarial Opinion Leaders, under the pretense of the noble ideals on which the industry was founded.

We need to be able to create tokens without removing Direct Leaders. Great things get built over long periods of time by great leaders with the legitimacy to take bold action. To realize the benefits of tokenization without misguided decentralization, we need to create a regulatory environment that enables this. In doing so, we will enable bigger outcomes, which lowers the cost of capital for crypto, enabling further growth. But more importantly, we will reduce the fragility of the industry, closing off an avenue of attack that we are largely blind to – the potential for malicious actors to leverage decentralization against crypto.

I will explore a new regulatory model for crypto and a token-based implementation approach in a follow-up essay.

References:

  1. The Most Important Scarce Resource is Legitimacy, Vitalik Buterin
  2. Manufacturing Consent, Noam Chomsky and Edward Herman
  3. Rationality is Self-Defeating in Permissionless Systems, Bryan Ford and Rainer Böhme
  4. Live Players versus Dead Player, Samo Burja
  5. What do I think about network states?, Vitalik Buterin
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