Building Blockchains  – Ripe Model for Principal-Agent Problem – Business and Finance tips and Advice

Building Blockchains  – Ripe Model for Principal-Agent Problem

Administration principle, in broad phrases, offers with the connection between managers and enterprise entities. Inherent on this relationship is the principal-agent downside. This downside arises as a result of the pursuits of a supervisor (agent) can — and infrequently do — diverge from the pursuits of the homeowners of the enterprise (principal) that she or he is managing.

Basic administration incentivization: the carrot and the stick

Enterprise organizations mitigate the principal-agent downside by use of incentive video games that higher align supervisor and enterprise proprietor pursuits.

Instance 1 (Reward-Based mostly Recreation): A supervisor is incentivized to generate revenues for a enterprise as a result of it is a efficiency metric that may affect his or her compensation. Revenues additionally profit the enterprise and its homeowners by rising an organization’s fairness worth (benefiting shareholders), enabling the corporate to pay down debt (benefiting collectors), permitting workers to be paid on time, and so forth.

Instance 2 (Deterrent-Based mostly Recreation): A supervisor is deterred from performing in a way that incurs extreme danger and legal responsibility for the enterprise homeowners. A method that is achieved is thru authorized mechanisms equivalent to vicarious legal responsibility or ‘piercing the company veil.’ The previous could permit a supervisor to be held straight responsible for the damage, or unlawful conduct, of his or her worker; the latter could permit a supervisor to be held personally and solely liable within the context of fraud, and so forth.

I might hazard that the fashionable ‘enterprise group stack’ is constructed upon a whole bunch of various reward and deterrent incentive video games, every enjoying a component in collectively establishing a Nash equilibrium between the ‘gamers’ inside a enterprise (i.e., managers and homeowners). These video games are prevalent in any respect layers of the stack — e.g., compensation constructions, human sources insurance policies, governance insurance policies, legal guidelines and laws, and so forth. — and every recreation offers ‘checks and balances’ to the principal-agent downside which are basic to the viability of the group.

Enter the ‘Cryptoeconomic Enterprise Mannequin’

With the appearance of Blockchain-based belongings — and the exponential inflow of capital into the Blockchain business over the previous few years — we have now witnessed the beginning of a novel enterprise mannequin. This mannequin permits corporations to generate income in new methods via the creation of open-source protocols and code (a useful service for which we as soon as relied upon the altruism, somewhat than revenue motive, of builders to offer).

I seek advice from this because the cryptoeconomic enterprise mannequin. This may be outlined as any enterprise mannequin predicated on making revenue by constructing a cryptoeconomic system, i.e., a peer-to-peer cryptographic community which capabilities on offering incentive funds to (assumed) adversarial nodes. Just about all public/permissionless Blockchains at this time are ‘cryptoeconomic programs’ by this definition.

The cryptoeconomic enterprise mannequin upsets the traditional principal-agent equilibrium that’s usually achieved by utilizing reward and deterrent incentive video games. That is executed by introducing a wholly new class of stakeholder into the ecosystem — the Keepers of a Blockchain community (e.g. tokenholders and different individuals who present a type of ‘paid labor’ into the community, equivalent to validators, miners, and so forth.)

If the standard enterprise has two lessons of gamers (managers and homeowners), the cryptoeconomic enterprise has three (managers, homeowners and Keepers).

These new entrants complicate the sport principle mannequin as a result of, now, as a substitute of the performing solely on behalf of homeowners, there are two units of stakeholders (homeowners and Keepers) whose pursuits rely upon the efforts of a supervisor. What occurs when the pursuits of those completely different units of stakeholders diverge? In whose pursuits would (or ought to) an agent be motivated to behave?

Business model

Token providing occasions & the chance of divergence/dilution

Worth creation in a conventional enterprise mannequin is completely different than worth creation in a cryptoeconomic enterprise mannequin.

In a conventional enterprise, the ultimate milestone of success is attaining profitability. Managers are incentivized to realize profitability, after which to perpetually improve profitability, as a result of the fruits of this labor accrue 100 % to the enterprise entity benefiting each homeowners and managers. Easy sufficient.

This isn’t precisely the case for a cryptoeconomic enterprise mannequin. Early within the cryptoeconomic enterprise life cycle, every milestone advantages managers and homeowners collectively — however upon an organization’s token providing occasion milestone (word: as a result of the time period ‘ICO’ is a fake pas) there’s a basic shift.

Worth creation now not accrues to the enterprise entity, however on to the product/output of that enterprise (i.e., the cryptoeconomic system)

In a cryptoeconomic enterprise mannequin, the ultimate milestone just isn’t profitability per se, however within the worth of the Blockchain community/token, which current scholarship suggests could also be measured as a token’s present utility worth (“CUV”) and discounted anticipated utility worth (“DEUV”). CUV/DEUV come into play instantly following the token providing occasion milestone, concurrently with the introduction of Keepers into the stakeholder set.

This level is illustrated under:


So how does this impression our pondering on managerial incentives?

The speedy commentary is that managers and homeowners will solely profit from working to extend a community’s worth to the extent that they keep some quantity of that community’s native tokens. In observe this quantity could be within the ~20–50 % vary for the enterprise entity, which is sizable, however considerably lower than the 100 % worth retention mannequin of a conventional enterprise.

In principle, managers have ‘pores and skin within the recreation’ by advantage of those token holdings and needs to be motivated to drive development within the token’s CUV/DEUV with the expectation of promoting these retained tokens for a revenue at some later date. This consequence can be perfect because it implies an alignment between manager-owner-Keeper pursuits.

However the issue is that the dilution from 100% worth retention (in a conventional enterprise mannequin) to ~20–50 % worth retention (in a cryptoeconomic enterprise mannequin) may dilute a supervisor’s motivation to create long-term worth for the community. With out ample reward/deterrent video games in place, managers are liable to cases of ethical hazard and myopic pondering.

It’s believable, as an illustration, that this may increasingly end in some extent of friction between the revenue motive of managers, which incentivizes a supervisor to retain a good portion of the tokens for the core enterprise and the pursuits of the opposite Keepers/tokenholders who would profit from these tokens being distributed extra broadly thus creating community results that might improve the CUV/DEUV of the token. This may be an instance of misalignment between manager-owner-Keeper pursuits.

Different challenges in managerial motivation post-genesis block

One other problem is because of the truth that income fashions (i.e. ‘rent-seeking’) might not be viable in cryptoeconomic programs. If a supervisor have been to extract revenue/income from a community by coding a centralized payment* right into a protocol or dApp (i.e. any kind of transaction payment that remits worth again to the enterprise), a possible consequence is that the protocol or dApp would both: (i) fail to realize adoption, or (ii) be arduous forked by customers (or duplicated by a competitor) to take away the payment from its code base thus making the community extra cost-efficient.

*Be aware: To make clear my level on centralized charges, sure platforms use sustainable payment fashions as a function of the platform’s cryptoeconomic design (e.g,. Factom and Counter-Celebration, whereby a portion of charges are burned to extend the shortage of the token). Additionally, because the use instances for dApps/protocols proceed to proliferate, centralized charges could show to be an accepted enterprise mannequin for sure functions of Blockchain know-how.

Listed here are just a few of the opposite ramifications of this problem:

  1. Profiting upfront; creating worth later: The creators of cryptoeconomic networks (presently) understand worth for the enterprise entity primarily through two streams: (i) the proceeds of token providing occasions, and (ii) the retention of some quantity of the supplied tokens. Each of those milestones happen comparatively early within the life cycle of a enterprise. Given that almost all of a supervisor’s compensation/revenue is front-loaded, expertise has proven that some managers will decide to easily full a token providing occasion earlier than ‘leaping ship’ to the following venture, somewhat than working to generate worth for his or her present venture.

  1. CUV/DEUV is a foul indicator of managerial competence: We could not but have one of the best instruments to guage managerial efficiency in cryptoeconomic enterprise fashions. CUV/DEUV are inherently completely different metrics than earnings per share, EBITDA, return on fairness, and so forth. (the latter are a few of the instruments used to guage CEO efficiency in a conventional enterprise). CUV/DEUV is pushed by provide and demand; extra becoming for valuing a commodity than fairness. To judge a supervisor’s efficiency on the CUV/DEUV of a token is akin to evaluating a gold firm CEO’s efficiency on the worth of gold.

  1. The dearth of authorized mechanisms to guard Keepers/token-holders: There exists an elaborate physique of company, securities and employment regulation designed to deal with the principal-agent downside between individuals in conventional enterprise constructions (e.g., vicarious legal responsibility, ‘piercing the company veil,’ fiduciary duties owed by administrators to shareholders, and so forth.) These protections don’t (but) exist for the Keepers/token-holders of cryptoeconomic programs. Granted, there may be free market mechanism in play by advantage of the Keepers’ capacity to arduous fork a protocol in retaliation to mismanagement, however this overhaul ought to solely be used as a final resort.

  1. Singular token providing occasions: For conventional start-ups, the method of elevating capital happens in tranches (i.e. Seed, Collection A, Collection B, and so forth.) and every tranche is basically tied to a supervisor’s capacity to display progress in direction of profitability for the reason that earlier tranche. Token choices — alternatively — are principally structured as singular occasions. This construction alleviates the a lot wanted exterior stress on managers to ship on constructing their merchandise on time and on price range. It additionally fails to backstop losses for traders within the occasion supervisor fails to ship.

These are only a few examples of how the principal-agent downside can present itself within the context of recent, cryptoeconomic enterprise fashions— every of which can ultimately be solved by new incentive video games designed for the tripartite (i.e., manager-owner-Keeper) atmosphere.

I think that the examine of administration principle within the context of cryptoeconomic enterprise fashions will proceed to be an evolving subject — and a really related one at that.

Many because of Ryan Zurrer, Lawrence Krimker, Lauren Furman, Marc Pontone and Josh Teichman for his or her contributions to this text. I welcome any feedback or suggestions.

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