Managing Partner at Dragonfly Capital. Effective Altruist. Airbnb, Earn.com (acquired by Coinbase) alum. Instructor @ Bradfield. Writer. Former poker pro. Donate 33% of my income to charity.
Most cryptocurrency pioneers would not call what they’re building “institutions.” The term reeks of centralization—it’s too unsexy. (Except when it’s “institutional capital”, then it’s welcomed with open arms.)
In a recent debate between Paul Krugman and Katie Haun on cryptocurrencies, Krugman is asked why he rejects the decentralized vision behind cryptocurrencies. He responds:
“We developed this socially ingenious thing: enduring institutions […] and it’s going to be really, really hard to come up with something better.”
This is an unpopular view within the crypto world, but I think he’s absolutely right.
Ask what has driven the economic vitality of the most advanced nations in the world, and we pretty much know the answer: it’s strong institutions. If you improve a country’s institutions, the society inevitably flourishes—economically, socially, and ethically. Institutions are essential, difficult to replicate, and hard-won through generations of social and political toil.
So if crypto is trying to make the world better, why be so quick to circumvent institutions? By embracing cryptocurrencies, aren’t we turning away from the one thing we know works?
Not so fast. In fact, crypto is all about institutions. Specifically, it’s about building scalable, global, decentralized institutions—institutions that survive any particular group, country, or time.
“Institution” is a famously broad and slippery term. In his seminal 1991 paper, Douglass North defines institutions as “the constraints that structure political, economic, and social interactions.” There are formal constraints (such as contract law, property rights, and court systems) and informal constraints (such as traditions, taboos, and social norms). In short, institutions are the rules that impose order and certainty onto our economic and social lives.
Institutions matter because risk and uncertainty are the enemy of commerce. If you don’t trust that your shipment will arrive safely or that your currency will hold value tomorrow, you won’t transact. With institutions in place, everyone is more willing to take risks, and thus a healthy market evolves—and with it, a healthy society.
New institutions don’t come around often. Arguably, the last major global institution to be built was the Internet.
One of the promises behind the Internet was that it would be a global informational commons. Once all of the world’s information was packetized and hosted on public servers, every human would have access to the corpus of human knowledge. And this mostly came true! For the majority of humans anywhere in the world, if they want to access the world’s information, they can run a Google or Wikipedia search and find it. Search engines are now a pervasive institution available almost everywhere in the world.
Notably, these institutions were built once and then enjoyed everywhere. There’s no need to rebuild Google or LinkedIn, whether for Brazil or for Burundi. All you need to do is translate the UI, and every society in the world can enjoy a search index or a social network (with a few caveats).
If this sounds obvious, it’s because we now take this scalability for granted. For most of human history, delivering an institution across the world was a feat of conquest and empire. Now it just requires having a computer with an open port.
And yet, if you look at finance, the story is the complete opposite. Every country has its own walled-off and homegrown financial infrastructure. Each nation must design and staff its own iteration on these institutions: banks, credit systems, exchanges, and legal structures. If they don’t, they’re doomed to be a financial backwater.
We know this. But when most of the money in the world is already digital—why isn’t money more like the Internet?
With cryptocurrencies, anyone is free to plug into a global financial system: a bank, savings account, payment rail, public registry, and system of contracts. Innovation in this sphere can be shared with everyone. The promise of crypto, then, is to be the first global financial commons. It purports to do to money what the Internet did to information.
This is incredibly powerful.
Today, most citizens across the world can’t do much to combat economic mismanagement. They can try to circumvent capital controls, they can engage in gray or black markets, they can dollarize, they can divest into gold. But in the future there will be another, more powerful option: adopt cryptocurrencies. This will allow people to opt into a global digital economy and financial system, complete with mature financial services.
So it’s incorrect to say that crypto will replace institutions. Instead, crypto will build alternative decentralized institutions. These decentralized institutions will be more portable and global, they will operate autonomously, and they will offer financial certainty to the rest of the world that doesn’t currently have it.
And this is an important point: in a world where more than 50 nations have undergone hyperinflation in the last century, cryptocurrencies will serve as a powerful check against wayward financial stewards.
The best antidote against bad governance is competition. Cryptocurrencies are the only serious competitor against centralized financial infrastructure. Economic choice, the power to exit, and the abilities of citizens to coordinate is precisely what leads to better local governance and institutions in the long run.
But crypto will only succeed in this if it builds compelling institutions.
Many crypto-anarchists would consider the term “decentralized institutions” nonsensical. The whole point of decentralization, they’d claim, is to abolish institutions. They see institutions as hallmarks of centralization, a temporary bike stand that will eventually get kicked away.
This is completely backwards. Institutions are critical to any stable economic system. They ensure graceful evolution (or upgrades), and they allow the individuals within that society to conduct their business safely, peacefully, and predictably.
Of course, cryptocurrency prices fluctuate like crazy—aren’t cryptocurrencies inherently risky? And what about Ethereum’s credo that “code is law”? Isn’t this all the antithesis of institutions?
Indeed, a fundamental property of most cryptocurrencies is immutability. No authority, no matter how powerful, can seize your assets without control of your private key. But make no mistake, this is also crypto institution: an enshrined norm around property rights.
In Ethereum, there are continual debates around economic policy, inflation, and property rights. Of course, these have evolved over time: there have been times where its governance has favored safety and restitution over property rights (e.g., the DAO fork), and other times when it has weighed in favor of immutability (e.g., rejecting the Parity rescue fork). In the recent Constantinople postponement, the norm of maintaining smart contract invariants was upheld over timely software upgrades. These are all reflections of the formal and informal institutions that govern Ethereum.
All this churn and debate might make some believe that Ethereum is poorly governed, but this is a mistake: these are precisely the instantiations of Ethereum’s institutions. If you believe in the principles underlying Ethereum, then Ethereum does an impressive job of satisfying those constraints. And institutions encompass more than just governance—they also include the software, the economics, and the community. Infrastructure like Infura, Metamask, and ERC-20 are all part of what makes Ethereum continuous and predictable.
Users, companies, miners, developers, and entrepreneurs are all counting on Ethereum fulfilling its promises to them. In other words, they participate because they trust in the underlying institutions.
Most institutions are valuable because they make our lives predictable. Without them, businesses and entrepreneurs could not plan effectively for the future. This is precisely why judicial precedent is so central to every mature legal system: it allows people to predict the outcome of a trial without having to undergo expensive litigation. It makes the law more predictable.
This is one of the reasons why I am skeptical of on-chain governance. While it’s elegant in theory, meting out justice via randomly sampled crowds (or worse, an unelected cabal of plutocrats) is unlikely to end well.
If you want me to use your blockchain, I’ll ask: why should I trust you? If an on-chain vote can completely change the blockchain’s properties or seize my coins, I want to be damn sure that I can predict how these votes will turn out. More often than not, any coin-based voting mechanism can be swung by one or two whales.
On-chain governance makes a splendid first impression. It sounds more transparent than the messy, humanoid governance systems around us. But the pseudonymous, unaccountable identities behind any on-chain voting system ultimately makes the system more opaque and harder to predict.
I don’t mean to imply that on-chain governance is intrinsically bad! But with any radical experiment in governance, we should expect it probably won’t work (as is the case with most experiments). Until we know one way or another, it is inevitable that on-chain governance schemes will be treated as risky and unstable.
But what about forking? Can’t we just fork a network if we want something better?
Crypto commentators like to blithely claim that the threat of forking is a constant check against crypto networks. But they are missing something deep about what makes any economic system valuable. It’s not the code, it’s not the ticker name, and it’s not the UTXO set. It’s the institutions, and institutions cannot be forked.
Imagine a group of violent revolutionaries who carve out a subsection of a peaceful country. If they establish a junta, brandish a flag, and call themselves a competing state, would any outsider consider it an improvement over the original?
Likewise, a fork that doesn’t improve on its originating institutions is only compelling to those designed to profit from it. A large fundraise and a well-stocked war chest is not enough: institutions cannot be bought, only built. This has been borne out by the fact that almost all cryptocurrency forks have failed (the most notable exception being Monero, which unequivocally improved on the institutions of its predecessor, Bytecoin).
At the end of the day, crypto is not just technological innovation. It’s also social and political innovation. If you want to build valuable institutions, it takes time, patience, and a lot of missteps.
If you’re just benchmarking on prices, it might look like crypto has failed at this project. Reading Twitter and Bloomberg, you might even be convinced that crypto is dead (Bitcoin recently celebrated its 10th birthday and 300th obituary).
But the arc of change is long. We can agree with Paul Krugman on this point: it doesn’t happen in a year or two. Most technological revolutions started with similar speculative ups and downs—railroads, automobiles, video games, and the Internet, to name just a few. Crypto will be no different. Indeed, the nature of the technology will likely magnify these cycles.
I’d be remiss if I didn’t touch on ICOs here. ICOs are the apotheosis of why institutions matter. Lately I was revisiting some of my writing from when I first started blogging about crypto last year:
It’s unfortunate that right now, blockchain-as-speculation is dominating most people’s attention. The signal is getting drowned in the noise.
But that’s to be expected. We’ve seen this before.
When people first realized the extraordinary potential of the internet, tons of money was pumped into random dot coms. Anticipating mass adoption and astronomical value creation, speculation fed speculation, until the frenzy finally crashed in 2001.
What’s going on right now is comparable. There will eventually be a comedown.
It’s become clear to everyone now that the ICO boom was a circus of global, unregulated penny stocks. ICOs did not disrupt venture capital—they made a parody of it. It will take some time for crypto to clean itself off, cast out the scammers and profiteers, and start focusing again on building real value.
Going forward, we will need to develop better institutions around how projects get funding: more norms around transparency, disclosures, incentives, advisors, partnerships, marketing, lockups and liquidity restrictions, and what it means to both create and capture value. Organizations like Messari and Gemini are trailblazers in self-regulation, but there’s more work to be done.
This is the only way to win people over in the end. Not by shouting at them that they’re not decentralized enough, but by showing them that your institutions are a compelling alternative to their own.
I’ll end on something I wrote in that blog post a year ago:
But when the dust is cleared, like after the dot com crash, those who were serious - the Microsofts, the Amazons, the Googles - will have to come in and do the graceless work of building the future.
There’s much work to do.
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