Large networks (Youtube, Uber, NASDAQ and traditional finance) earn significant monopoly profits today. Decentralized blockchain networks have the potential to replace these traditional networks and offer the same services without the ability to charge monopolistic prices. As a result, network users will get a bigger piece of the economic pie than they do today (vs equity holders). Founders will still earn over-sized returns for taking risks and innovating.
Microeconomics 101 — in a world with perfect competition, the price of any good is equal to the cost of producing an additional unit of that good (marginal cost). Only when a firm has monopoly power can they set a price higher than the marginal cost.
As an example, airlines don’t make profits because they have little monopoly power (I have many options to fly from New York to San Francisco). Youtube on the other hand is a near monopoly, so it takes 45% of ad revenues from your cat videos. The marginal cost to Youtube for hosting that cat video is probably close to zero.
Let’s say a group of clever engineers build a decentralized Youtube (D-tube?) on the ethereum blockchain that provides a similar user experience to traditional Youtube. The D-tube app is setup as following:
- The engineers create 100 dtube crypto-coins, keeping 30, and selling the rest to raise money for their engineering efforts. Coin holders are basically equity holders of the network.
- Each time a content producer wants to post a video, they will send the D-tube network 1 dollar (or equivalent ETH). This fee is then distributed to dtube coin holders.
- The dtube coin supply is fixed and finite
- The 1 dollar fee is fixed and hardcoded in the code
- In reality content producers/viewers will also have to pay an ethereum network fee for posting video but let's assume it is zero
- All of the software written by the engineers is open source
Now imagine that the app grows rapidly and millions of users publish and view content on a daily basis. As the network becomes more valuable, so does the value of the dtube coin. The engineers earn large financial returns from their coin holdings. Content producers get to keep all of their ad revenues and have to pay $1 to post videos. Equity holders earn a return for risking their capital by buying the coin when the network was small.
Founders can now continue to innovate and improve their network with the expectation that their coin appreciates even more. However if they choose not to innovate and the network doesn't grow, the coin will not appreciate as its value is tied to the value of the network. In other words, they only earn when they innovate. This is different from a monopoly, where the firm earns profits even when there is no innovation.
Let’s say these founders get lazy and greedy. They no longer want to innovate (it’s hard work!) but they want to earn a bigger piece of the economic activity on this new network. So they make a software update to change the fee from $1 to $50 per video. The user community is not thrilled.
The community can then come together and reject the software update. Founders cannot force the network to update because they don’t control the network. That's the whole point of decentralization!
Another group of enterprising engineers can fork (copy) the software (open source), keep the fee at $1, and work on improving the software. They can also buy dtube coins and as equity holders, can earn by improving the network.
The key difference is that d-tube equity holders (including founders) dont control the network the way Youtube (Google) does today. This is a feature of decentralized blockchain networks.
Once a network becomes large, founders will no longer be able to charge monopoly profits because if they do, users of the network will simply switch to a version of software that has lower fee. The return on innovation will always remain high, but it won't lead to persistent monopoly profits.
Peter Thiel in his book Zero to One, makes the claim that monopoly profit is beneficial as it promotes innovation. Youtube’s monopoly profits allow Google to heavily invest in R&D and innovate which is good for all. That may be true in the case of Google or Amazon, but certainly there are many firms with monopoly power that don’t innovate (Goldman Sachs?) and just return monopoly profits to equity holders. Perhaps this model fuels income inequality?
Even if it does not, monopoly profits to non-innovators are not optimal because this creates incentives for firms to preserve their monopoly power by preventing others from innovating. Lobbying to create regulations to increase entry costs is a great example of this behavior. Apple fighting for patent infringement because Samsung’s phones look like Apple’s is another way of preserving monopolistic profits.
Blockchain based decentralized apps will push monopolistic profit makers out of business. In this new world, where monopolies cannot exist, business will be forced to innovate or die.