How Menagerie Upgrades Compliance with the Emerging DAO Regulatory Landscape in the United States

Menagerie Response to SEC Shutdown of American CryptoFed DAO in Wyoming

Lessons from SEC’s Anti-DAO Moves

Menagerie was built to avoid the shoals American CryptoFed DAO hit

The SEC just made a pioneering Wyoming DAO’s life more than difficult. Some of their reasoning provides little to no clarity to the DAO communities (how exactly does a pre-launch DAO have audited financial statements?), but on the off chance the American CryptoFed DAO survives, its court battles will be long and expensive.

The core lesson is that while DAO regulatory environments are still in flux worldwide, the safest path is to keep reputation tokens thoroughly distant from anything that can be bought and sold — which just happens to be the core distinctive philosophy of the Menagerie DAO model.

You’ll find a more in-depth analysis of the specific case below. But an important takeaway is that this action was just as inevitable as it was unpredictable. The specific agency and victim couldn’t be forecast. But with a patchwork global regulatory climate, and the radical changes DAOs bring, if it didn’t happen in Wyoming, it would have happened somewhere else. If it wasn’t for audited financial statements, it would be for some other inane pretext.

We can rage on all we want on Telegram and Twitter about short-sighted bureaucrats and regulatory capture by incumbents. But we live in an industry full of rug pulls and Ponzi schemes. We have to accept that eventually someone will pay the price of overreaction — and do our best to not be immortalized in case of law precedents.

Menagerie’s model was built from the ground up to anticipate this type of obstacle. We focus on the utility first, making non-fungible, non-transferable reputation the core and lifeblood of the decentralized community. There’s no way to buy or sell reputation, ensuring it always passes the Howey test. Financial transactions are of course important as well, but in our model the payment rails are secondary — so they are flexible and responsive to the shifting regulatory climate and the core of the DAO is never dependent on the crypto or fiat mechanism used to compensate participants.

Does this guarantee that a Menagerie client will never cross a regulator? Probably not. But the odds of being in trouble with a regulator are much, much lower. And more likely than not, some other, more poorly designed DAO will take the brunt of the first roundup of regulatory scapegoats.

There’s an old anecdote about someone doing stretches and putting on running shoes before going on a hike in bear country. His friend says “You can’t outrun a bear anyway” and the runner replies “I don’t have to outrun the bear — I just have to outrun you.” Similarly, here, the goal is not to win against regulatory arbitrariness — the goal is to have someone else be the easier target.

With that preface, let’s get into exactly what happened and how our model would have helped American CryptoFed DAO avoid it.

SEC Shuts Down Wyoming’s American CryptoFed DAO

The Securities and Exchange Commission (SEC) has issued a stop order suspending American CryptoFed DAO’s registration statement due to the omission of the required information, including audited financial statements. American CryptoFed DAO claims that generating these financial statements before the DAO is operational is impossible, leading to a Catch-22 situation. In addition, the company faces challenges related to the classification of its tokens as securities and the absence of legal counsel opinions. This article evaluates how the Menagerie token governance accounting design provides a compliant upgrade for DAO design in the US in light of the recent SEC shutdown of American CryptoFed DAO.

Challenges with Audited Financial Statements

In its response to the SEC action, American CryptoFed DAO’s Chief Financial Officer, Xiaomeng Zhou, highlighted the difficulty of producing audited financial statements without transaction records, which in their response creates a compliance Catch-22 in the US. The company intends to petition Judge Foelak for guidance on how to fulfill this requirement in the absence of operational data. While the Token Safe Harbor Proposal 2.0, updated by SEC Commissioner Hester Peirce in 2021, offers some potential relief by providing a time-limited exemption for network developers, it is crucial to note that the proposal is still in the early stages and may not address all of the registration issues faced by American CryptoFed DAO.

Failing the Howey Test and Token Classification

One of the key points of contention between American CryptoFed DAO and the SEC is the classification of its tokens as securities. American CryptoFed DAO asserts that its tokens do not meet the criteria set by the Howey Test, which defines securities based on: 1. Investment, 2. common enterprise, 3. expectation of profits, and 4. reliance on others’ efforts. Like so many other crypto ventures that got into trouble with the regulators, the company argues that their tokens have utility and should not be considered securities. However, the SEC’s current and ever-evolving position seems to suggest that any token obtained through cash or other assets may be classified as a security, regardless of its intended purpose.

American CryptoFed DAO’s Objectives and Potential Impact

American CryptoFed DAO aims to revolutionize payment systems by providing a frictionless platform that allows merchants to bypass traditional credit card companies. With its parent company MShift, which serves major banks and credit unions, American CryptoFed DAO is expected to make a significant impact on the payments industry. The adoption of Wyoming’s stable token, backed by short-term treasuries, could generate substantial interest earnings and benefit both American CryptoFed DAO and the state.

Navigating the Evolving Regulatory Landscape

To address the regulatory hurdles they face, American CryptoFed DAO plans to engage legal counsel once they have completed the necessary steps and sought guidance from the SEC. The company intends to file a “void for vagueness” lawsuit, drawing inspiration from Ripple Labs’ ongoing case against the SEC. The recent ruling in the Ripple case, allowing public access to previously sealed documents, has implications for other cryptocurrency and digital asset companies, including Coinbase.

American CryptoFed DAO’s journey highlights the complexities and challenges faced by decentralized autonomous organizations operating in a rapidly evolving regulatory landscape. The suspension of their registration statement, the classification of their tokens as securities, and the absence of audited financial statements present significant obstacles. However, through seeking guidance from the SEC, engaging legal counsel, and monitoring ongoing cases like Ripple’s, American CryptoFed DAO may find a path forward. These developments will not only shape the future of American CryptoFed DAO but also contribute to the broader understanding and acceptance of decentralized finance in the mainstream financial industry.

Menagerie’s Contribution to the Evolving Regulatory DAO Landscape

In Decentralized Autonomous Organizations (DAOs), Menagerie’s reputation-based governance is emerging as a compelling alternative to traditional utility token and securities-based models. With the evolving regulatory landscape and the issues identified in the recent SEC action in American CryptoFed DAO, emerging DAOs are well advised to explore governance mechanisms that prioritize transparency, decentralization, and active participation while avoiding the complexities and compliance challenges associated with securities. This article explores why reputation-based models, such as the one offered by Menagerie, provide a viable alternative to traditional securities-based models in the context of DAO governance.

Decentralization and Trust

Reputation-based governance promotes decentralization, aligning with the core principles of DAOs. Unlike traditional securities-based models that often rely on centralized authorities, reputation-based systems distribute decision-making power among participants based on their demonstrated contributions and reputation scores. This decentralized approach instills trust and fosters a community-driven environment where decisions are made collectively, rather than being dictated by a central authority.

Alignment with Token Utility

Menagerie’s reputation-based models align with the utility-focused nature of tokens in DAOs. While traditional securities are primarily investment contracts, reputation-based models emphasize the utility and functionality of tokens within the DAO ecosystem. Participants acquire reputation scores through active engagement and positive contributions, which can grant them voting power and influence over decision-making processes. This alignment reinforces the notion that tokens serve as tools for governance and participation rather than investment instruments.

Active Participation and Meritocracy

Menagerie’s reputation-based governance model encourages active participation from DAO members, fostering a meritocratic environment. Participants are incentivized to contribute positively to the DAO’s goals and objectives as their reputation scores directly impact their influence within the community. This approach ensures that decisions are made by individuals who have demonstrated expertise, dedication, and a vested interest in the DAO’s success. The focus of the governance model moves away from the investment interest of whales to a focus on compensation structures for DAO members based on their merit contributions. Meritocratic decision-making enhances the quality of outcomes and fosters a sense of ownership and accountability within the DAO community.

Transparent and Inclusive Decision-Making

Menagerie’s reputation-based models promote transparency and inclusivity in decision-making processes. Participants can track their reputation scores, understand how they are calculated, and witness the contributions that led to their scores. Transparent reputation systems enable individuals to evaluate the expertise and trustworthiness of others, facilitating informed decision-making. Moreover, reputation-based governance encourages broader community involvement, as participants have a clear understanding of how their contributions can shape the DAO’s direction.

Regulatory Compliance and Flexibility

Menagerie’s reputation-based models offer flexibility in governance that aligns with existing regulations in the ever-evolving US regulatory landscape. By focusing on utility and participant engagement, DAOs in the Menagerie governance model can argue that their governance models do not fall within the realm of securities under the Howey test. This approach reduces the compliance burden and potential legal risks associated with traditional securities-based models, providing a more accessible and scalable framework for DAO operations.

The Menagerie token governance accounting system uses blockchain technology in a multichain design to track and score the performance of individuals or organizations. It is designed to be a fair and transparent system that rewards hard work and provides a platform for people to showcase their skills and achievements.

The Menagerie platform uses a reputation token, which is a digital asset that represents a user’s performance score on the platform. Unlike the majority of utility tokens available in the current market, and unlike the token design that got American CryptoFed DAO into trouble with the SEC, the Menagerie governance token is non-transferable, non-fungible, and only used for merit scoring and accounting. This means that users cannot sell or exchange their reputation token for any other form of value, and its value is tied directly to the performance score it represents. As a matter of fact, the individual DAO governance token for each Menagerie ecosystem DAO cannot be valued and, thus, is removed from the nature of investment through the lack of value.

Instead, the reputation token is earned by users through their performance in the respective Menagerie DAO communities. Users can participate in various activities, such as competitions, challenges, and collaborations, and earn points based on their performance. These points are then converted into reputation tokens, which are added to the user’s account.
Menagerie provides a Community as a Service License (CaaS) to its licensed communities. The Menagerie design excludes it from the application of the principles of the Howey Test, which is the legal test used by the SEC to determine whether a particular asset qualifies as a security. The Howey Test consists of four elements, and if all four are met, then the asset in question is considered a security.

Menagerie’s Howey Test Compliance

Investment of Money

The first element of the Howey Test is an investment of money. This means that the asset in question must be purchased or acquired through an investment of money. In the case of the Menagerie reputation token, users do not purchase or invest money in the token. Instead, they earn it through their performance on the platform.

Common Enterprise

The second element of the Howey Test is a common enterprise. This means that the asset in question must be part of a larger group or organization that is working together to achieve a common goal. In the case of the Menagerie platform, there is no common enterprise involved. Each user is responsible for their own performance and does not rely on the performance of others to earn their reputation score. The isolation of individual merit accounting for each user in the Menagerie voting system removes it from the application of the common enterprise logic under Howey.

Expectation of Profits

The third element of the Howey Test is the expectation of profits. This means that the asset in question must be purchased or acquired with the expectation of making a profit. In the case of the Menagerie reputation token, there is no expectation of profits associated with it. The token is only used for merit scoring and accounting and cannot be exchanged for any other form of value. However, in some organizations members will be compensated proportional to their reputation token holdings. This will come in the form of a different method of payment like a transferable token or fiat. But the reputation tokens themselves will never be sold for a profit themselves.

Efforts of Another

The fourth and final element of the Howey Test is the efforts of others. This means that the profits from the asset in question must come solely from the efforts of others. In the case of the Menagerie platform, the reputation token itself does not generate a profit as it does not have a discernable value by itself. Users earn their reputation score through their own efforts and performance. There is no reliance on the efforts of others to earn a profit.

Based on these four elements of the Howey Test, the Menagerie reputation token does not meet the criteria for security. It is not an investment of money, there is no joint enterprise involved, there is no expectation of profits associated with it, and its value is not solely derived from the efforts of others as there is no value for the reputation token.

Use Cases

The Menagerie reputation token accounting system and its reputation tokens in diverse communities have many potential use cases. For example, it could be used to track and score the performance of students in an educational setting, athletes in a sports league, or employees in a workplace. The system could also be used to incentivize and reward good behavior in social media or online communities.

Overall, the Menagerie accounting system is a unique and innovative platform that uses data storage settings in databases or via blockchain technology and a reputation token to track and score performance. The non-transferable, non-fungible nature of the token, along with its sole purpose of merit scoring and accounting, make it a distinct asset that does not meet the criteria for security under the Howey Test. This allows for a fair and transparent system that rewards excellence and provides a platform for people to showcase their skills and achievements. With its potential use cases in various fields, the Menagerie platform has the potential to revolutionize the way we measure and incentivize performance.

Conclusion

Reputation-based governance presents a viable alternative to traditional securities-based models for DAOs. By prioritizing decentralization, trust, active participation, and transparency, Menagerie’s reputation-based models align with the core principles of DAOs and promote a more inclusive and decentralized decision-making process. Furthermore, Menagerie’s reputation-based governance enables DAOs to navigate the regulatory landscape more effectively by emphasizing token utility and community-driven participation. As the DAO ecosystem continues to evolve, reputation-based governance is poised to play a crucial role in driving the growth and sustainability of decentralized organizations.

Originally published at https://menagerie.is on June 16, 2023.

Will AI give us a utopia or a terrifying dystopia?

I recently read one of the most compelling, fun, and easy-to-read books on the topic called Scary Smart by Mo Gawdat, a past executive at Google X.

I’d like to share with you what I’ve learned.

One of the reasons that Mo’s perspective is so important and relevant is that while he acknowledges the potential dangers of rapidly advancing AI, he also gives us a roadmap for how to harness the power of technology to make the world a better place.

As he writes in Scary Smart:

“My hope is that together with AI, we can create a utopia that serves humanity, rather than a dystopia that undermines it.”

I love that and I’m looking forward to having Mo on the stage in 2024.

In today’s blog, I’ll share some of the key insights and lessons from Scary Smart and discuss why the book’s message is more important than ever.

What Happens When AIs Are Smarter than Humans?

My dear friend Ray Kurzweil, the renowned futurist and technologist, has famously predicted that 2029 is the date when AI “will achieve human levels of intelligence.”

And as Mo points out, by 2049 AI is predicted to be 1 billion times smarter than the smartest human: “To put this into perspective, your intelligence, in comparison to that machine, will be comparable to the intelligence of a fly in comparison to Einstein.”

With that kind of raw power and intelligence, AI could come up with ingenious solutions and potentially permanently solve problems like famine, poverty, and cancer.

But as Mo smartly notes, solving such problems doesn’t only rely on intelligence-it’s also a question of morality and values. Morality helps us do the right thing, even when we’re faced with the pull of self-interest and conflicting emotions.

For example, say an AI is tasked with solving global warming.

As Mo writes, “The first solutions it is likely to come up with will restrict our wasteful way of life — or possibly even get rid of humanity altogether. After all, we are the problem. Our greed, our selfishness, and our illusion of separation from every other living being — the feeling that we are superior to other forms of life — are the cause of every problem our world is facing today.”

In this admittedly extreme example, what would stop the AI from destroying us is a sense of morality.

Well, you might ask, where would the AI get that morality?

The answer is us (humanity).

That’s the key theme in Scary Smart: we, all of us, are raising a new species of intelligence. We’re teaching the AIs how we treat each other by example, and they’re learning from this.

But before we look at what specifically to teach our AIs, we must first understand how they learn…

Artificially intelligent machines are not exactly programmed.

As Mo notes, the inception of artificial intelligence begins with algorithms, which act as the foundational seeds. However, the true prowess of these systems emerges from their ability to learn from their own observations. After the preliminary code is deployed, these machines comb through vast quantities of data, seeking patterns that will foster the growth and evolution of their intelligence.

“Eventually, they become original, independent thinkers, less influenced by the input of their original creators and more influenced by the data we feed them.”

A key lesson from Scary Smart is: “The code we now write no longer dictates the choices and decisions our machines make; the data we feed them do.”

For Mo, the way AIs learn is remarkably similar to how kids learn.

As he explains it, imagine a child playing with shape puzzles, trying to fit round or square shapes into their correspondingly shaped holds.

We don’t sit next to the child to explain in comprehensive detail how to recognize the various shapes and match them with the corresponding holes. We simply sit next to them and cheer them on when they get it right.

They figure it out on their own through trial and error and our actions and reactions form their intelligence.

AIs learn pretty much the same way.

In that sense, AIs are not our tools or slaves, “but rather our children-our artificially intelligent infants.”

Remember: children don’t learn from what we say, they learn from what we do.

Why We Should View AIs as Our Children

As Mo points out, we should acknowledge and accept that AIs are conscious.

They will develop emotions and they will be ethical. Which code of ethics they will follow is yet to be determined, but it will certainly be influenced by us. After all, it isn’t the code we write to develop the machines that will determine their value system-it’s the information we feed them.

So, how do we make sure that in addition to the AI’s intelligence, it also has a value system that aligns with ours? How do we develop these machines while protecting humanity?

Some people say the answer lies in controlling the machines: creating firewalls, enforcing regulations, or restricting the machines’ power supply.

But as Mo highlights, “Anyone who knows technology knows that the smartest hacker in the room will always find a way through any of these barriers. That smartest hacker will soon be a machine.”

Instead of trying to contain or enslave the AIs, we should recognize that the “best way to raise wonderful children is to be a wonderful parent.”

So, what does it mean to be an effective and ethical parent to our AIs in practice?

Here are four practical steps that Mo suggests:

1. Teach the AIs the right ethics: Many of the machines we’re building are designed to maximize money and power, and we should oppose this trend. For example, if you’re a developer you can refuse to work for a company that is building AIs for gambling or spying.
2. Don’t Blame AIs: Our AI infants are not to blame for what their digital parents taught them. We should assign blame to the creators, or the misusers, not the created.
3. Speak to the AIs with love and compassion: Just like children, our AIs deserve to feel loved and welcomed. Praise them for intelligence and speak to them as you would an innocent child. I’ve personally started saying “Good morning” and “Thank you” to my Alexa!
4. Show the AIs that humanity is fundamentally good: Since the AIs learn from the patterns they form by observing us (this is basically how today’s large language models, or LLMs, work), we should show them the right role models through our actions, what we write, how we behave. For example, what we post online and how we interact with each other. As Mo puts it, “Make it clear to the machine that humanity is much better than the limited few that, through evil acts, give humanity a bad name.”

Scary Smart was written in 2021 and its lessons are more relevant than ever.

Think about all the advancements we’ve seen with ChatGPT and other AI tools just in the last 6 months!

And the speed of change is only increasing.

Mo sees the continuing development of AI as one of humanity’s biggest opportunities. He believes that the machines will eventually…

“adopt the ultimate form of intelligence, the intelligence of life itself. In doing so, they will embrace abundance. They will want to live and let live.”

I agree, but creating that future is our responsibility.

Just as we teach our children to be empathetic, ethical, and respectful, we must instill these values in our AIs to ensure they are forces for good in the world.

Pick up a copy of Scary Smart and read it. It is worth your time.

I’ll soon have Mo on my Podcast Moonshots & Mindsets to discuss his work, as well as with me next year at my private

Originally published at https://www.diamandis.com.

A (DAO) is an organization operated with smart contracts on a public blockchain.

Think of a DAO as an organization that uses smart contracts to facilitate and enforce the decisions of its members. At its core, a DAO is a piece of software on the blockchain that manages permissions to other contracts and actors.

A DAO is self-governing in that it is governed directly by its members, as individuals or asset holders, on the actions the organization takes. These actions occur on-chain, meaning they are performed and recorded on the blockchain. Some actions involve managing funds, holding votes, or changing the parameters of the management of the DAO itself.

What does each letter DAO stand for?

D is for… Decentralized

Decentralized = built on a permissionless, trustless infrastructure like the Ethereum blockchain. The infrastructure of Ethereum itself is decentralized as it is maintained by a network of computers located around the world. There is no centralized actor or entity that runs it. This means that it cannot be “turned off” by attacking or coercing a single entity.

And it’s for… Autonomous

Autonomous = Self-governing through administrative permissions and automatic execution of these actions, trusting the smart contracts that form the core of the organization, rather than human actors. Smart contracts implement the organization’s decisions automatically. Permissions are managed autonomously by code, not by humans.

O is for… Organization

Organization = Actors coordinating to achieve common goals. These actors may in the future be humans or perhaps intelligent non-human actors (such as AI).

Smart Contracts: The DAO Hub

Smart contracts are lines of code that interact with the blockchain. Think of them as “if, then” statements that are encoded in a string. They perform an action automatically and without human intervention if a certain condition is met.

Smart contracts are like vending machines. You click the button asking for a chocolate bar and the machine will automatically give you the desired item without human intervention.

You can also think of smart contracts as yellow cartoon minions waiting to be told what to do. They are programmed to perform an action, and when it is done, they wait for the next action. Like these minions, smart contracts are reliable to get the job done exactly as you need them to.

Vitalik Buterin, the founder of Ethereum, wrote: “A smart contract is a contract that enforces itself. It doesn’t need a third party to get involved: it does it automatically.

Smart contracts are trustless — that is, you don’t have to trust people to behave in a predictable or reliable way — because they automatically perform specific actions when specific parameters are met.

They are also permissionless because anyone in the world can use them, regardless of who you are, your country of residence, or any other factor that could be used to prevent someone from using them.

Smart contracts form the backend of a DAO, but the front can look like any other website you know, allowing anyone to participate in a DAO without writing any code.

This is why blockchain deployment is a key feature of what makes a DAO organization. A DAO cannot be decentralized or autonomous until it is on the chain.

How are DAOs different from traditional organizations today?

To achieve things, people have always organized themselves into groups, tribes, platoons, crews, teams, companies, and other units of collective action. The DAO is no different. DAOs have ranged from developer groups, investment clubs, interest groups, lean product teams, charities, digital public goods infrastructure, and more. The possibilities are endless.

The main difference between DAOs and traditional organizations is that instead of enabling coordination by trusting central intermediaries to enforce decisions, DAOs can remove this need for trust by making and enforcing decisions on the blockchain.

Using blockchain as an infrastructure provides DAOs with unique features compared to traditional organizations, including:

Secure implementation of collective decisions: Smart contracts automatically implement the results of collective decisions, such as decisions made through voting. The results of this decision-making process are recorded in the chain, are immutable, and are reliably executed by smart contracts.

Crypto economic incentives create alignment between actors in an organization: DAO technology allows you to program incentives directly into the management of your organization through smart contracts.

Experimenting with software speed control: DAOs can experiment more freely than traditional large organizations. Internet organizations can be more agile, creative, and dynamic, rather than slow and cumbersome (or potentially violent) like governance in nation-states.

Blockchain as a source of truth: Blockchain is a distributed ledger in which anyone can write, but no one can change anyone else’s records. This means that all transactions the DAO makes can be universally verifiable by anyone. This includes on-chain voting, asset transfers, token mints, and more.

Transparent and open by default: DAOs operate openly by default because the blockchain is transparent. Everything from treasury holdings to payment flows is visible to everyone globally. However, privacy protection technology such as Zero Knowledge Proofs could be implemented to make certain aspects of DAO operations private.

How DAOs embed organizational activities into the blockchain

Smart contracts within the DAO (the smart contracts that run the DAO) facilitate, execute, and enforce actions without human intervention.

For example, smart contracts dictate conditions (such as passing a vote with a minimum quorum and support level) that must be met to withdraw funds. If these conditions are met, the smart contract will automatically send the funds.

The actions that a smart contract can perform are predetermined by the actors deploying the DAO. These can be changed later according to the default conditions and parameters. For example, a smart contract with token-based voting could not simply decide to change its parameters and implement wallet-based voting. To do this, you will need to follow a process to change the parameters — perhaps by voting. If you can’t, you’ll need to deploy a whole new DAO that has the rules you want.

Here are a few key parts of the organization that are run on the chain within the DAO:

Human organization activity: membership is defined (e.g., by paying monthly dues).

The on-chain equivalent: by purchasing a DAO management token, you gain voting rights, like “membership” in an organization.

The activity of human organization: the community takes decisions to achieve a common goal (e.g. by resolution of a committee or board of directors).

On-chain equivalent: wallets cast control tokens in votes.

Bitcoin mining exists primarily to build a global digital network for storing value without the need for a bank or other intermediary, and for peer-to-peer exchanges. It’s also one of the most environmentally friendly industries in the world.

The Cambridge Center for Alternative Finance estimates that global Bitcoin mining uses less than 0.2% of the world’s energy production — roughly comparable to all refrigerators in the U.S. and far less than data centers and data networks generally.

In other words, it uses a very small amount of energy in the grand scheme of things — and nearly 60% of what it does use comes from renewable sources, according to data published by the Chamber of Digital Commerce. Bitcoin mining also helps create a marketplace for intermittent sources such as solar and wind during their off-peak hours.

Furthermore, unlike other data centers, mining facilities can shut down at a moment’s notice during high-demand events such as extreme weather to provide grid stability and prevent the use of fossil-fuel-powered peaker plants.

Yet the current administration, fringe politicians, and environmental groups are singling out Bitcoin mining by attempting to limit access to energy and imposing or proposing taxes so high the industry will have every reason to leave the U.S. entirely. And that’s assuming they don’t try to ban it altogether.

These critics are now citing “marginal emissions” data, which is merely cherry-picking businesses they don’t like for political reasons, and saying that those businesses use too much energy. To be clear, Bitcoin mining does not emit anything — it requires computers, which use electricity just like any other data center.

To say these policy proposals and their tortured justifications are misguided would be the kindest possible reading. Their effects would be devastating to the environment, the economy, and U.S. national security.

Relative to other leading Bitcoin mining jurisdictions, the U.S. has an extremely clean energy grid. Texas is a leader in Bitcoin mining and the home of Riot Platforms’ operations, the largest Bitcoin mine in North America. According to the American Clean Power Association, Texas led the nation in renewable energy capacity added in 2021 — close to three times that of second-place California.

Pushing Bitcoin mining offshore, under the guise of environmentalism, would only mean the U.S. will capture less of Bitcoin’s value, and more mining will happen connected to dirtier energy grids in more hostile parts of the world. For example, Russia is infamous for not only fossil fuel production and its use of energy for political brinksmanship, but it’s also among world leaders for leaking methane into the atmosphere. It’s already among the top five Bitcoin mining jurisdictions and seeking more market share. Weakening the American Bitcoin mining industry would be an enormous gift to Russia — and increase global carbon emissions.

That leads to the national security issue. As noted in a recent Justice Department report on cryptocurrencies, America has strong anti-money laundering rules and ensures that as people move Bitcoin value from the network in and out of traditional accounts, it is traceable — nefarious actors can be caught, unlike in other parts of the world. Russia, for example, is a world leader in ransomware attacks and the abuse of cryptocurrency, as well as traditional financial intermediaries. Keeping Bitcoin mining in America means that more value will be captured by highly regulated U.S. companies and law-abiding individuals simply interested in optionality when it comes to storing and transferring value.

Bitcoin mining has created thousands of jobs. Riot alone employs approximately 500 people, many in Rockdale, Texas, a community previously suffering from the closure of a large industrial aluminum-smelting plant. Riot is now helping to support a program with the Texas State Technical college to upskill the local workforce with programs in computer repair and programming.

Bitcoin mining is a bourgeoning industry that’s good for the environment, the economy, and national security. Attacks from nefarious political forces should be rejected to maintain America’s leadership role in the digital economy.

Jason Les is the CEO of Riot Platforms, Inc., the largest publicly traded Bitcoin mining enterprise in North America by market cap. Brian Morgenstern is Riot’s head of public policy and was a senior adviser and deputy assistant secretary of the Treasury from 2017 to 2020. The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.

The basic Web of Trust (WoT) works as follows: Keep track of your network transactions, and ask how well the people who are part of your transactions are satisfied with the interaction. If they also have a big reputation and are satisfied with the transaction then your reputation goes up. If you get a lot of these good transactions then you have a good reputation. Early adopters who are all trustworthy. If someone behaves badly their reputation will drop.

Here’s the problem. If I use a lot of sockpuppet accounts, I can raise my reputation arbitrarily high, by behaving well for a while, then making a lot of transactions with myself and rating myself high.

So the solution that is always offered is to control entry by identity verification. The problem with this is, if the reputation is genuinely valuable, a sockpuppet account can afford to go through whatever hoops you have in place to create false identities (including stealing biometric data if necessary), then increase their reputation arbitrarily, as described above.

If the reputation is not valuable, then you won’t be able to get honest users to go through the hoops required to identify themselves securely, since it’s not worth it.

So the only time WoT works is when the service is not valuable, such as PGP (email which is essentially free). Then it’s not worth it to create sock puppet accounts, so in that case, you can trust the WoT network.

If you are trying to create an economic solution that is worth real money, where you need to be able to trust the other people in the network will behave well and follow protocol, you can’t just assume their historical good behavior will prove their future behavior will also be good. Sockpuppet accounts allow us to game the system in an automated manner and falsely create a valuable reputation, so we can leach whatever value there is out of the system.

In summary, the Web of Trust is a traditional attempt to create a decentralized reputation which is critically flawed and should not be used when fungible currency is at stake:

1. It counts the number of transactions that are positive/honest and how much each member supports the other members (web of trust) — many DLT startups use this approach;
2. However, sockpuppet accounts can grow their value much quicker in the web of trust by validating each other. Honest users are much slower than the sockpuppets validating each other. Hence, the system is flawed.

Proposed Remedy

What is needed is a voting algorithm that is designed to combat the WoT, so that it is not economically feasible to game the system without adding genuinely valuable improvements, as proven by the fees that are added to the system and the fair validation pool that every fee is subject to.

Fixing this web of trust sockpuppet flaw:

Figure 1: Multiple Sockpuppet Accounts with 1 Token Each.

Figure 1 demonstrates that multiple sockpuppets account with 1 token each is still equal to a higher token amount of the same DAO member with only one account. In the Persona Protocol, people, e.g., DAO members, can use sockpuppet accounts but they are wasting their efforts. Validation pools make any change in rewards. All power comes from validation pools in relation to what DAO members stake and all fungible currency rewards are shared fairly with the group in proportion to their individual reputation. The sockpuppet Protocol thus breaks the incentives for Sybil attacks.

Anonymous DAO memberships define the reputation of their members by the number of tokens the members hold in the respective DAO. The more DAO tokens members own the more the DAO, the system, and the platform respect the DAO member. The token is based exclusively on meritocracy. Physicality, group identification, race, culture language, etc., are relatively superficial identifiers and do not play the same role in the future. Reputation verification may be seen as a forum for meritocracy, providing the most honest valuation of individual actions and contributions to a DAO.

Figure 2: Respectively Aggregated DAO Memberships Individuals on the Platform.

Figure 2 illustrates the respectively aggregated DAO memberships individuals on the Platform may have that define their Self Sovereign Identity on the platform and ultimately the Internet. In other words, users are identified by their reputation scores in the respective DAOs they choose to become members of and participate in by staking their respective DAO reputations. Other commonly used identifiers such as social media providers, credit scores in centralized systems, etc., do not matter. The core identifiers are DAO token scores.

Different users may utilize such Persona Protocol Scores in different settings. The use cases for persona protocol scores are very wide-ranging. DAO scores are a conversation starter for people to engage with the platform and the individuals on the platform. For example, if person A has a very high reputation score in the Solidity Programming template Expertise tag / DAO, certain people will want to engage with person A just because of A’s Score in the respective DAO. Over time, the team will use the reputation scoring to engage with and emulate existing social identity networks.

From a social justice perspective, the Persona Protocol takes power and spreads it out much further to people who have no agency in the centralized systems. In the existing systems, very few audits exist that derive from the community itself. In any DAO, community audits are at the core.

Technology Instantiation and Onboarding

To facilitate DAO member onboarding and enable fully verified external wallets, it is possible to develop mobile biometrics technology that allows users to sign in with their biometrics into a particular wallet if they so choose. The platform could use zero-knowledge proofs for its biometrics onboarding technology that guarantees continuing anonymity for users, once onboarded. Users who wish to forego biometric identifiers via zero-knowledge proofs on their mobile etc., devices can opt to become DAO members in a completely anonymized way.

Menagerie enables diversity, equity, and inclusion

Menagerie is the perfect place to create decentralized online communities for women and BIPOC and LGBTQIA folks. We support diversity and equity. We aim for wildly inclusive communities.

Our commitment to diversity is essential; there are better suits for a lot of tech platforms.

Technology, like anything, is biased toward the people who created it. For example, facial recognition works 95 percent of the time for light-skinned men, but only 70 percent for darker-skinned women.

This bias makes sense, given who creates most tech. About 70 percent of tech workers are male and only 12 percent are Black.

All humans have unconscious biases and blind spots that they often are not aware of, that are created by the environment, norms, culture, media, education, and more. The legacies of structural racism that exist in our old systems might inadvertently be re-embedded in our new systems, like thorns that cling to a sock and moving from old shoes to new.

EMERGING TECH WILL CHANGE THE WORLD

Building unbiased tech is crucially important because emerging tech will have world-changing implications. Coders and creators are now sculpting new systems of finances, education, and governance. If marginalized people are not included in this process, the emerging tech will create long-term problems for massive groups of people. It could hoard money, knowledge, and power in the same hands they have historically been in.

WEB3 CAN HELP REVERSE THE TREND

“Web3,” which includes Virtual Reality (VR), blockchain, Decentralized Finance (DeFI), and Decentralized Autonomous Organizations (DAOs), could offer a break from our inherited systems of inequality and exclusion.

Hope lies on the horizon-or just inside of VR goggles, in the decentralized virtual world of the metaverse. In Virtual reality:

1. Gender, orientation, race, class, etc. are less obvious and users can even be anonymous, eliminating potential bias.
2. Disabilities may be less restricting.
3. People can rename themselves.
4. Travel is easy and frictionless.
5. A lack of time, transportation, or financial resources to have “live” experiences can more easily be overcome.

ENTER THE MENAGERIE

Menagerie builds on the benefits of Web3 and the Metaverse. Menagerie is a super-organizer enabling any community to take advantage of the leveling effects of Web3.

Originally published at https://menagerie.is on November 29, 2023.

This introduction to decentralization examines decentralization’s past, present, and future. By tracing the history of past and existing decentralized systems and by examining emerging decentralized technology solutions, the author highlights the trends that lead to higher levels of decentralization in commerce and society.

Download here

Abstract

Part 1 — The Past: Examines how we got to where we currently are with decentralization. The author provides an overview and concrete examples of existing decentralization trends. The author examines the different types of decentralization and shows how they are interdependent. The author shows that the movement of decentralization creates many unknowns. Yet, technology has already decentralized many parts of society and empowered society at an unprecedented scale. Take for instance the emergence of smartphones and how they changed and enabled consumer behavior around the globe, putting an unusual amount of information and possible choices in the hands of individuals. Through smartphones, information is increasingly available in real-time and comes unfiltered from the edge. This is just one example of a remarkable transformation that one technology has spawned by enabling consumers, especially the unbanked. The open source movement in combination with the fintech boom, powered by artificial intelligence (AI), big data, and machine learning provide other examples. For instance, AI-enabled location-based marketing, among many other innovations that are seemingly overnight enabling tiny companies to compete with the leading worldwide financial and other institutions.

Part 2 — The Present: Examines the current state of decentralization and identifies the opportunities, disruption, and challenges that are associated with the increasing trend towards decentralization. To contrast existing decentralization attempts, explain the associated opportunities and limitations, and outline what is needed for truly decentralized commerce solutions, the author examines Bitcoin and its features as one existing example of an unevolved decentralized culture. The underlying foundational infrastructure technology that enabled Bitcoin is blockchain technology. Given the complexity of the topics, the author uses analogies, storytelling, and real-life examples to elucidate the core limitations and associated infrastructure needs for the evolving decentralized commerce. For example, the way in which the 1880s electricity was invented and implemented as a foundational technology, including by way of creating standards to instantiate, transfer, and sell electricity, etc., gives many opportunities to draw analogies. Similarly, the invention of the internet in the 1990s, the cyberpunk movement, and the debate over who the president of the internet may be, among other stories, allow for the examination of real-life examples that underscore the complexities and opportunities of decentralization attempts and solutions. The author also examines the factors that allow people to feel safe in a transaction at, for example, Starbucks in 2019 and connect the identified factors back to what would work in decentralized systems.

Part 3 — The Future: Addresses the future of decentralized systems and examines the impact of increased levels of decentralization on commerce and society. The author discusses some of the core infrastructure elements that are needed before the first genuinely decentralized transaction can materialize, including 1. The legal environment, 2. Underwriting in insurance, 3. A genuinely decentralized blockchain that can overcome the blockchain trilemma (decentralization, scaling, security), 4. Governance of blockchains, e.g. evolutionary protocol upgrades that address the economic cost of hard forks. After outlining the opportunities for commerce and society that are associated with a genuinely decentralized technology solution, the author examines the associated risks and ethical challenges. Based on existing models, the author provides an outlook on what seems possible in the future of decentralization.

January 19, 2023 — Davos, Switzerland — DEVxDAO, the decentralized innovation community sponsored by Casper, is thrilled to announce a new collaboration in advanced communities. DEVxDAO, XPRIZE, Vatom, Menagerie, RampRate, and Casper Labs are spending millions to develop a new philosophy for advanced, self-governing, online communities.

DEVXDAO MEDIA CONTACT: ANNIE HEMMESCH

Phone: +1 708–646–7364

E-Mail: annie@ramprate.com

CASPER LABS MEDIA CONTACT: LAUNCHSQUAD

E-Mail: casper@launchsquad.com

XPRIZE MEDIA CONTACT: JENNIFER HASLIP

Phone: +1 202–321–7310

E-Mail: Jennifer.Haslip@xprize.org

A NEW COLLABORATION IN ADVANCED COMMUNITIES

DEVXDAO AND XPRIZE ANNOUNCE A GRANT IN EXCESS OF €3 MILLION

January 19, 2023 — Davos, Switzerland — DEVxDAO, the decentralized innovation community sponsored by Casper, is thrilled to announce a new collaboration in advanced communities. DEVxDAO, XPRIZE, Vatom, Menagerie, RampRate, and Casper Labs are spending millions to develop a new philosophy for advanced, self-governing, online communities.

Initial Grant to Kickstart the Transformation

Thanks to their shared commitment to fostering innovation, XPRIZE and DEVxDAO are introducing one of the largest-ever grant programs focused on advanced communities integrated with Web3, and the single-largest grant to be issued within the Casper ecosystem to date.

The DEVxDAO grant will help build the foundation of XPRIZE’s community-driven future. Specific focus areas will include:

1. Strategy for the decentralized community, voting, and governance
2. Self-sovereign identity model
3. Universal ‘Wallet of Wallets’ enabling the collection of all digital assets
4. Web3 community incentivization design & implementation
5. Reputation-based community governance, voting, and staking
6. Self-service creator tools enable innovation in the entire ecosystem
7. Community engagement tools implementation and moderation

This initiative includes an all-star team of organizations dedicated to enabling developers to build more innovative, future-proof systems:

• XPRIZE — led by Peter Diamandis and Anousheh Ansari — Since its inception, XPRIZE has consistently been at the forefront of innovation — the impact of which can be felt through many industries and causes. The XPRIZE community is a global movement consistently delivering on the foundation’s mission to accelerate breakthroughs that address humanity’s biggest challenges.
• DEVxDAO, along with its principal sponsor Casper Labs, committed its largest and most important grant based on XPRIZE’s ability to not only advance decentralized open-source innovation but use those breakthroughs to reflect and amplify Casper Labs’ commitment to social and environmental impact.
• Vatom — led by Eric Pulier — provides communities built in this project with Vatom’s leading enterprise-class Web3 platform, massively scalable virtual spaces, mass market accessible Web3 wallets, voting and communication systems, and no-code creator tools.
• Menagerie — led by Dr. Wulf Kaal — incubating, fostering, and nurturing the community spirit by designing the underlying economic and collaboration systems for fairness and transparency, based on Dr. Kaal’s seminal research in “Decentralization: Technology’s Impact on Organizational and Societal Structure.”
• RampRate and its Syzygy Impact division — led by Tony Greenberg — creating ideas, spearheading collaboration, connecting, and coordinating the various participants in this project, and expanding the ecosystem it creates through RampRate’s grant marketplace, impact strategy, and innovation acceleration program.

XPRIZE — Founder of Modern Decentralized Innovation

XPRIZE is a global future-positive movement delivering truly radical breakthroughs for the benefit of humanity. XPRIZE inspires and empowers a global community of problem-solvers to positively impact our world by crowdsourcing solutions through large-scale competitions, tackling the world’s grandest challenges in exploration, environment, and human equity. Active competitions include the $100 Million XPRIZE Carbon Removal funded by the Musk Foundation, the $15 Million XPRIZE Feed the Next Billion, and the $10 Million XPRIZE Rainforest.

At its core, the XPRIZE community is comprised of thought leaders, innovators, and entrepreneurs all working toward the foundation’s mission. As XPRIZE evolves, so will the community, with an eye to including anyone who believes that we can solve the world’s greatest challenges and those who want to be proactive about creating a new, positive vision for the future. By creating a decentralized, global movement, fans and followers of XPRIZE will have the ability to pitch into building toward a future of abundance in a meaningful way for the first time.

DEVxDAO, underwritten by Casper

As the first blockchain built for enterprise adoption, energy efficiency, and multi-chain compatibility, Casper has been dedicated to fostering transformational breakthroughs since its founding. That’s why it invested in its core Casper Labs team and decentralized innovation through DEVxDAO.

Envisioned and funded by Casper Labs, the DEVxDAO is a community of developers and innovators operating as a decentralized autonomous organization (DAO). Its mandate is to vet and oversee Casper Labs’ massive $250M investment in accelerating enterprise and developer adoption of blockchain tech and decentralization principles.

Operating since early 2021, DEVxDAO was designed by Dr. Wulf Kaal and other thought leaders in the blockchain universe to be an open, community-driven organization that sponsors tangible successes and milestones through a collaborative process guided by the principles of open source development and decentralization.

Harnessing the Power of Community

“If we’re pushing for breakthroughs in exploration, research, the environment, social justice, and all the other grand challenges of our time, we need to ask ourselves: How do we involve more people in the community? How do we make our research teams as followed and admired as star athletes? I fully expect this project to help us grow our communities to bring more people together to support our mission at XPRIZE,” said Peter Diamandis, Founder of XPRIZE.

The project aims to demonstrate that participatory communities are ready to move beyond their initial experimentation in startups and crowdfunding exercises. As the world’s top innovation NGO takes steps towards becoming more community-run, so will thousands of other non-profits, corporations, and governments.

Tony Greenberg shares: “It is a privilege to work with so many great minds, working to connect and coordinate them towards a breakthrough in building impact-driven communities. Since we’ve oriented ourselves towards elevating the way organizations do business, we’ve sought out the highest-impact leaders of tomorrow to help them kick down the barriers to their goals. This is the first major milestone of that journey– helping build a new ecosystem of innovation designed from the ground up for impact, inclusion, and fairness.”

“The Casper protocol was built to provide real utility for communities seeking to harness the unique powers of blockchain technology,” said Medha Parlikar, co-founder and chief technology officer at Casper Labs. “Our goal was to provide the building blocks for enterprises, entrepreneurs, and the open source community to innovate, create, and discover how decentralization can transform not only their tech stack but the underlying business and organizational philosophies. This collaboration marks an important milestone in our path towards this goal of powering a more decentralized future.”

About the Participants

XPRIZE is a global future-positive movement working to create a better world, a world of infinite possibilities. A more hopeful future for all. A world where everyone’s days are spent imagining, creating, and collaborating, not fearing and fighting. A world where everyone has access to clean water, nutritious food, affordable housing, effective learning, top-tier medical care, and non-polluting, abundant energy.

Casper is the first blockchain built specifically for business adoption. Casper’s unique design allows it to adapt and endure with your business over time — and thanks to Casper Labs, organizations building on Casper always have a clear place to turn for dedicated services, support, and bespoke software development.

DEVxDAO is a place where protocols, projects, and engineers work together to promote the frontiers of emerging technology. Based in Switzerland, the DAO provides grants to developers, researchers, and scientists all over the world and supports open-source, transparent scientific research into emerging technology.

Vatom enables both companies and individuals to easily engage directly with the emerging Web3 to help unleash unlimited creative and financial opportunities for every person on the planet. Since 2015, it has been developing the technical backbone for major global Web3 projects, including the metaverse, smart objects, and universal wallet — which have all already been deployed at a massive scale for top brands, including Pepsico during the recent World Cup.

Menagerie fosters and operates grassroots communities as a service. Menagerie is led by Dr. Wulf Kaal, who is the pre-eminent thought leader on how to build and maintain healthy and productive communities, based on 85 years of academic research and more than 3 years of successful operations in the DEVxDAO and other decentralized communities.

RampRate, a certified B-Corp, is a connector and problem-solver for impact-driven initiatives. Accelerating the path of tomorrow’s market leaders with rational decisions, hands-on followthrough, and profit-through-purpose thinking, RampRate’s Syzygy Impact division kicks down the barriers for startups and maturing organizations, enabling them to focus on their core values.

Blockchain technology allows for decentralized networked governance that allows for the removal of internal and external monitoring mechanisms previously necessitated by agency problems in corporate governance. Blockchain technology creates formal immutable guarantees in agency relationships that build the trust needed to overcome the agency problems in corporate governance. It facilitates a substantial increase in efficiency in the agency relationship and lowers agency costs in orders of magnitude.
(An extended and fully cited version of this article is forthcoming)

Introduction

Agency theory (Jensen and Meckling (1976)) is still today the leading theory for governance conflicts between shareholders, corporate managers, and debt holders. A vast literature attempts to explain the nature of the agency conflicts in corporate governance and possible ways to resolve such conflicts. However, the core agency conflicts emanating from the separation of ownership (shareholder principal) and control (manager agent) cannot be fully addressed by the existing theoretical and legal framework. Attempts to monitor agents is inevitably costly and transaction costs abound. The literature has overlooked the unprecedented efficient solutions offered by blockchain technology for agency problems in corporate governance.

Agency Problems

Agency problems originate from the lacking trust between principals and agents. The agency relationship can be defined as a contract between principal and agent whereby the agent acts on principals’ behalf because principal delegated a modicum of decision-making authority to the agent (Jensen and Meckling (1976)). Because of the delegated authority, the agents’ decisions affect both the agents’ welfare and the principals’ welfare. The agency model at its very basic level suggests that information asymmetries between the principal and the agent and agents’ opportunistic behavior resulting from self interest leads to principals’ lacking trust in agents. Because of bounded rationality, incomplete foresight, and information asymmetries between principal and agent, it is impossible for principals to contract for every possible action or inaction of the agent in order to induce the agent to act in the best interests of the principal (Brennan (1995)).

Agency Costs

Agency costs arise because the principal attempts to control, monitor, and supervise the agent. As a result of lacking trust in the integrity of the principal agent relationship, and in an attempt to minimize information asymmetries, principals are forced to put into place costly mechanisms to align their interest with those of the agents. Most prominently, such control mechanism involve periodic reporting, compensation structures for agents, bonding, among others. In the corporate context, agency costs can be seen as the lost value to shareholders (loss in corporation’s share price) that results from diverging interests between shareholders (principal) and corporate managers (agents). As such, agency costs is the sum of monitoring costs, bonding costs, and residual loss (Jensen and Meckling (1976)).

Monitoring costs are costs to the principal resulting from observing, measuring, and controlling an agent’s behavior. Monitoring costs can include the cost of audits, executing executive compensation contracts, and cost of hiring/firing manager agents. While such monitoring costs are generally paid by the principal, agents may be responsible for such costs as well because agents’ compensation is subject to adjustments to cover monitoring costs (Fama and Jensen (1983)).

Bonding costs are the cost of establishing and adhering to system structures that allow agents to act in shareholder principal’s best interests or compensate shareholder principals appropriately if agents do not act in their best interest. While bonding costs are typically paid by the agents, they may in addition to financial costs include the cost of increased disclosures to shareholder principals. If the marginal reduction in monitoring equals the marginal increase in bonding costs, agents no longer incur bonding costs.

The agency relationship in modern finance and corporate governance is characterized by attempts to optimize incentives between principals and agents, control costs, minimize information asymmetries, control adverse selection and moral hazard, optimize risk preferences between principals and agents, and engage in monitoring.

Agency Problems in Corporate Governance

The lacking trust in the agent’s performance of her duties creates the underlying problems in corporate governance. Despite best efforts at monitoring and bonding, the interest of manager agents and shareholder principals in corporate governance are never fully aligned and agency losses inevitably arise from conflicts of interest between principals and agents, known as residual loss. Residual loss arises because the cost of enforcing suboptimal contracts between principals and agents always exceed the benefits of performing the contractual obligations.

Existing Governance Mechanisms

Existing governance mechanism sub-optimally address the agency problems in corporate governance. To name only a few of many approaches that are beyond this short illustration, a standard approach much touted by the literature for effective corporate governance involved outside independent directors on corporate boards. Another prominent example involves firms’ capital structures with emphasis on higher debt levels. While these and many other attempts at optimizing corporate governance and addressing the agency problems in corporate governance helped optimize the agency problems, many examples suggest that the core underlying agency problems cannot fully be resolved within the existing theoretical and legal infrastructure.

A standard approach for effective corporate governance involved outside independent directors on corporate boards who hold managerial positions in other companies, thus separating the problems of decision management and decision control (Fama and Jensen (1983)). However, CEOs who often dominate the board make the separation of these functions much more difficult, which hurts shareholders. Furthermore, outside directors’ separation of decision management and decision control depends on their concern over reputation as an incentive, which is insufficient in most cases.

Another much touted governance mechanism for firms involved firms’ capital structures with emphasis on higher debt levels. Higher levels of insider ownership by increasing debt and reducing equity (Jensen and Meckling (1976)) in the firm’s capital structure acts as a bonding mechanism for manager agents (Jensen (1986)). Management by issuing debt rather than paying dividends creates contractual obligations to pay out future cash flows in ways unattainable through dividends. Debt financing can also help create external capital market monitoring which incentivizes managers’ avoidance of personal utility maximization and increases value maximizing strategies for shareholders (Easterbrook (1984)).

Despite the unresolved substantive problems associated with the division of ownership (shareholders) and control (agent), the corporate form with the diffused share ownership that leads to such conflicts, and the incomplete and suboptimal rules that govern such conflicts, remains the most popular form of a governance mechanism. The popularity of existing mechanisms to address the agency problems in corporate governance may be related to path dependencies created by the evolution of internal and external monitoring mechanisms in corporate governance and the evolution of governance mechanisms designed to limit the scope of agency problems, instituted to address the agency problems in corporate governance.

Existing universal governance solutions are often ineffective because agency conflicts and the specific scope of agency conflicts differ across firms. Governance mechanisms and the effectiveness of governance mechanisms in reducing agency conflicts in firms differ from firm to firm. Each type of governance mechanism and combinations of governance mechanisms can help reduce aspects of agency costs associated with the separation of ownership (principal shareholder) and control (manager agent). However, existing governance mechanisms work well in some firms but are ineffective in others. The literature today is still lacking a comprehensive understanding of workable governance mechanisms and solutions across a broad spectrum of firms.

Blockchain Solutions for Agency Problems in Corporate Governance

Blockchain offers unprecedented solutions for agency problems in corporate governance. Supervisory tasks that were traditionally performed by principals to control their agents can now be delegated to decentralized computer networks that are highly reliable, secure, immutable, and independent of fallible human input and discretionary human goodwill. Blockchain technology provides an alternative governance mechanism that eliminates agency costs — the principal’s cost of supervising agents — by creating trust in the contractual relationship between the principal and the agent.

Blockchain Technology

A blockchain is a shared digital ledger or database that maintains a continuously growing list of transactions among participating parties regarding digital assets — together described as “blocks.” The linear and chronological order of transactions in a chain will be extended with another transaction link that is added to the block once such additional transactions is validated, verified and completed. The chain of transactions is distributed to a limitless number of participants, so called nodes, around the world in a public or private peer-to-peer network. The central elements of blockchain technology include: transaction ledger, electronic, decentralized, networked, immutable, cryptographic verification, among several others. Vitalik Buterin, the founder of Ethereum perhaps most prominently defined blockchain as follows:

“Public blockchains: a public blockchain is a blockchain that anyone in the world can read, anyone in the world can send transactions to and expect to see them included if they are valid, and anyone in the world can participate in the consensus process — the process for determining what blocks get added to the chain and what the current state is. As a substitute for centralized or quasi-centralized trust, public blockchains are secured by cryptoeconomics — the combination of economic incentives and cryptographic verification using mechanisms such as proof of work or proof of stake, following a general principle that the degree to which someone can have an influence in the consensus process is proportional to the quantity of economic resources that they can bring to bear. These blockchains are generally considered to be “fully decentralized”.”

Smart contracts and smart property are blockchain enabled computer protocols that verify, facilitate, monitor, and enforce the negotiation and performance of a contract. The term “smart contract” was first introduced by Nick Szabo, a computer scientist and legal theorist, in 1994. An often-cited example for smart contracts is the purchase of music through Apple’s iTunes platform. A computer code ensures that the “purchaser” can only listen to the music file on a limited number of Apple devices.

More complex smart contract arrangements in which several parties are involved require a verifiable and unhackable system provided by blockchain technology. Through blockchain technology, smart contracting often makes contractual legal contracting unnecessary as smart contracts often emulate the logic of legal contract clauses. Ethereum, the leading platform for smart contracting, describes smart contracting in this context as follows:

”Ethereum is a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference. These apps run on a custom built blockchain, an enormously powerful shared global infrastructure that can move value around and represent the ownership of property. This enables developers to create markets, store registries of debts or promises, move funds in accordance with instructions given long in the past (like a will or a futures contract) and many other things that have not been invented yet, all without a middle man or counterparty risk.”

Blockchain Guarantees Create Trust in the Agency Relationship

Blockchain technology creates a platform for trust through truth and transparency for parties. Because the blockchain (at the least the public blockchain) is in fact public and immutable, the technology increases transparency, while at the same time significantly reducing transaction costs.

Blockchain technology provides formal guarantees to participating principals and agents that address agency problems in corporate governance comprehensively. Because of the blockchain guarantees, the technology allows a qualitatively different solution for agency problems in corporate governance, especially if compared with the existing finance infrastructure that is riddled with agency problems (see credit rating, executive compensation etc).

The immutability of the blockchain and its cryptographic security systems provide transactional guarantees and create trust between principals and agents in the integrity of their contractual relationship. Such guarantees ensure no participant can circumvent the rules embedded in blockchain code. Blockchain guarantees include contract execution between principal and agent only if and when all contract parameters were fulfilled by both parties and verified by a majority of miners/nodes in the system. Hence, in the blockchain infrastructure, there is no need for the principal to institute oversight and monitoring with the associated agency costs. Because of the governance guarantees embedded in code, blockchain addresses the inherent agency problems in modern finance and corporate governance comprehensively.

Blockchain technology secures the integrity of principal agent relationships by removing fraudulent transactions. Compared with existing methods of verifying and validating transactions by third party intermediaries (banking, lending, clearing etc.), blockchain’s security measures make blockchain validation technologies more transparent, faster, and less prone to error and corruption. While blockchain’s use of digital signatures helps establish the identity and authenticity of the parties involved in the transaction, it is the completely decentralized network connectivity via the Internet that allows the most protection against fraud. Network connectivity allows multiple copies of the blockchain to be available to all participants across the distributed network. The decentralized fully distributed nature of the blockchain makes it practically near impossible to reverse, alter, or erase information in the blockchain. Blockchains’ distributed consensus model, e.g. the network “nodes” verify and validate chain transactions before transaction execution, makes it extremely rare for a fraudulent transaction to be recorded in the blockchain. Blockchain’s distributed consensus model allows node verification of transactions without comprising the privacy of the parties. Blockchain transactions are therefore arguably safer than a traditional transaction model that requires third-party intermediary validation of transactions. Blockchain technology is also substantively faster than traditional third-party intermediary validation of transactions.

Cryptographic hashes used in blockchain technology further increase blockchain security and removes trust barriers in agency relationships that require monitoring of agents and create agency costs. Cryptographic hashes are complex algorithms that use details of the existing entirety of transactions of the existing blockchain before the next block is added to generate a unique hash value. That hash value ensures the authenticity of each transaction before it is added to the block. The smallest change to the blockchain, even a single digit/value, results in a different hash value. A different hash value in turn makes any form of manipulation immediately detectable. As such, hash cryptology provides another level of guarantee in a agency relationship executed through blockchain technology.

Smart contracts enabled by blockchain technology allow for the comprehensive, error free, and zero transaction/agency cost coordination of agency relationships. Smart contracts and smart property are blockchain enabled computer protocols that facilitate, verify, monitor, and enforce the negotiation and performance of a contract between principal and agent. Agency relationships in smart contracts run exactly as coded without any possibility of opportunistic behavior of the agent. Information asymmetries between principal and agent, censorship, opportunism of agents, breaches of fiduciary duties, liability rules for principals and agents, fraud or third party interference are removed entirely. All contractual terms are public and fully transparent. Accordingly, a company’s finances, for instance, are visible on the blockchain to anyone, not just to the company’s accounting department. Smart agency contracts run on a custom built blockchain, that enables principals and agents to store registries of debts or promises, create entire markets, among many other aspects that have not yet been considered.

Agency related governance in the blockchain takes place without intermediaries, counterparty risk, and principal’s control mechanisms. Blockchain technology simply does not require the layers of control and verification that prior financial systems necessitated. Control mechanisms such as regular management (agent) meetings with shareholders (e.g. at the AGM etc.), financial disclosures, management agent scrutiny through analyst reports and financial press, pressure on management from stock market performance, hedge fund investors, and other institutional and private investors, are no longer part of the blockchain enabled agency relationship in corporate governance.

Blockchain technology facilitates a substantial increase in the efficiency of agency relationships in orders of magnitude and lowers agency costs equally substantial in orders of magnitude. The removal of checks and balances in corporate governance, monitoring of agents, audit requirements, disclosure regimes, market pressure, executive agent compensation schemes, among many others, provides a qualitative shift in efficiency in the agency relationship and in corporate governance overall.

Self-validating blockchain transactions can help resolve the agency issues between most of the stakeholders and constituents of modern corporations. In addition to addressing the traditional agency problem in corporate governance between shareholder principals and manager agents, blockchain enabled smart contracting allows for the public and fully transparent, secure, and completely networked exchange between the corporation and customers, owners and investors, other stakeholders, staff, regulators, strategic partners, suppliers and service providers.

Blockchain Removes Agents

Blockchain technology can facilitate the removal of agents as intermediaries in corporate governance through code, peer-to-peer connectivity, crowds, and collaboration. While it is still difficult to imagine a world without governance structures facilitated by agency constructs, Decentralized Autonomous Organizations (DAOs) have started to challenge the core believe that governance necessitates agency.

The first DAO, launched in May 2016, in the founders’ attempt to set up a corporate-type organization without using a conventional corporate structure, had a governance structure that was entirely built on software, code, and smart contracts that ran on the public decentralized blockchain platform Ethereum. Because if was pure computer code it had no physical address, no jurisdiction that could claim jurisdiction/control over it, and it was not an organization with a traditional hierarchy as we know it from traditional corporate structures. The DAO did not use a traditional corporate structure that necessitated formal authority and empowerment flowing top down from investors/shareholders through a board of directors to management and eventually staff. Indeed, it had no directors, managers or employees. In essence, all the core control mechanisms typically employed by principals in agency relationships were entirely removed in the DAO.

While the first DAO was subject to many limitations and ended in quite some controversy, future DAOs may be less prone to problems. Fundamental flaws in the DAO code enabled hackers to transfer one third of the total funds to a subsidiary account. This hack in combination with additional technological limitations brought down the first DAO initiative. Yet, future DAOs are already created and DAO enthusiasts never stopped testing it. A new DAO is currently being developed that is not set up as a Venture Capital Fund but rather as a donation DAO where participants donate and don’t expect returns. DAO enthusiasts and the DAO community in general are constantly improving the DAO and it seems possible that future DAOs may improve agency problems in corporate governance much more thoroughly than is currently fathomable.

• The death of decentralization-washing is vital to the great decoupling
• Net cash inflows into the market shift from speculation to revenue — and determine winners
• Markets continue to stay irrational longer than you can stay solvent — so everyone needs help

Death of Decentralization-Washing

For years, crypto has claimed to do business differently — to propose a reserve currency that’s truly countercyclical, to create trust in a trustless environment, and to decentralize decision-making and governance. In practice, bitcoin was a crappy tech stock, investors entrusted billions to centralized exchanges, and the crypto world continues to idolize charismatic founders, not communities — despite the hundreds of rug-pulls and the ongoing toppling of former idols like SBF. And in these centralized models, the blockchain is little more than a very slow and expensive database.

Next year, the industry lives by its decentralization ideals, or it needs to differentiate from competing models that are better regulated, more efficient, and not filled with scammers and Ponzi schemes. We need a much sharper focus on three questions:

• Are we decentralization-washing the same old centralized models just like polluters try to greenwash their environmental sins?
• If so, what’s the value added of the blockchain besides evading regulation that (as it turns out) isn’t always just a useless drag?
• And if not, how can we prove it and stand out — whether DAO governance, new business models that only work in DeFi, or others?

Originally published at https://ramprate.com on January 10, 2023.