The SEC vs community ownership
or, what I got wrong
I’ve written a lot about community ownership. In fact I named this newsletter two years ago after writing “Coase’s Penguin is Learning to Fly” in which I argue that Yochai Benkler’s famous essay “Coase’s Penguin” is due for an update. Benkler talked about how decentralized communities like Wikipedia — motivated purely intrinsically, without property or contract — can outcompete traditional firms. My argument was that we will see a new wave in which decentralized communities with digital forms of ownership (read: tokens) will outcompete both.
Crypto was again in the news last week as the SEC sued Binance and Coinbase, the two biggest exchanges, for violation of securities laws. I won’t dive into the details of the cases because there are others who have done that far better, but it does feel like an opportune time to share what I’ve learned from talking to hundreds of founders, publishing more than a dozen articles, and recording a full season of a podcast about this topic over the years. Namely:
The theory for the value of community ownership is still solid.
Value is only one part of the equation. Cost is the other.
Right now the biggest cost, from a builder’s perspective, isn’t money or UX. It’s legal risk.
Revisiting those points helps you square the circle between the beautiful theory and the lack of mainstream adoption we’ve seen so far. And it brings what’s happening now into sharper relief. It’s not a binary, but an equation with two key variables, one of which is clearly the limiting reagent.
There’s nothing wrong with the theory
The first piece I ever wrote that mentions crypto was “The Audience Grows the Creator” which made a pretty simple point:
“Audience members have more control in which creators will be successful. Smart creators see their audience as collaborators, and tools to incentivize different types of investment from audience members will continue to proliferate.”
Basically, in a world where attention is increasingly scarce, the power shifts more to the audience. If two creators are competing and one of them has shared upside with their early fans, all else being equal, we would expect that creator to be more successful.
That led me down the crypto rabbit hole and of course to startups, where I’ve spent my career. I wrote “Why crypto YC Will be Bigger than the Original” which explored how a token-led YC would work and lead to a more powerful flywheel. Hypothetically, if all of the companies and advisors that are part of YC had shares in it, it should work better. Presumably YC doesn’t do that because it would mean having thousands of people on its cap table, and the overhead just isn’t worth the benefit. Tokens are 100X easier to manage at scale, and could solve that problem.
More pieces followed, including “Tokens of Appreciating Appreciation” about the UX challenge of balancing intrinsic and extrinsic rewards, and “Community Ownership is a Self-Fulfilling Prophecy” about the benefits of retroactive allocation. I recorded a whole season of a podcast with Sari Azout called “Tokens, but How?” about how to actually implement token based systems into products.
Broadly speaking, I still believe everything in those articles and episodes. The trends at play – decreased cost of building products, increased power of community members, better tools for distributed cap tables — are all marching forward. When companies find ways to turn their community members into owners, there’s ample evidence that they will be more successful.
And there are examples of this happening now, many of which I included in the articles I wrote. There are DAOs, NFT communities, and other experiments from crypto as well as community crowdfunds, co-ops, and examples outside of crypto that all validate the theory when put into practice. But the obvious point to be made here is that we still just don’t see enough of those examples, which some argue is because this problem of community ownership isn’t a real problem to solve. They say it's evidence the theories above are false. I disagree, and I think Yochai Benkler would too.
The cost of ownership
Economists are rarely concise, but often for good reasons — the specifics matter. In “Coase’s Penguin” Benkler talked about how peer production, like Wikipedia, can outcompete firms only when the cost of implementing ownership is “higher than the value of the total
increase in the efficiency of utilization of the resource gained by the introduction of a
property regime.” In other words, if the cost of implementing shared ownership of Wikipedia is higher than the benefit you’ll get in efficiency from doing that, it won’t happen. That is the economic theory for why Wikipedia editors do not have some share of Wikipedia stock.
This is the critical point, so it’s worth reiterating in reverse. If the cost of buying an apple is lower than the value you get from eating that apple, you will buy the apple — only in this case the apple is a common property regime (think: system for shared ownership), and the value is the efficiency you get from that system.
The takeaway here is that it’s not a binary thing. It’s an equation with two dials: value and cost. The more you dial the cost of implementing ownership down, the more things that previously weren’t worth owning will become worth owning. So if crypto could decrease the cost of implementing that ownership by a lot then you’d unlock an entire new category of organizations (namely, communities with shared ownership of what they help build). And crypto is unquestionably a 10X better system for internet money, so technically speaking if you wanted a system to decrease that cost, crypto would be it.
The gas is too damn high
Anyone who has been around crypto for a while will be familiar with the phenomena in which you pay $10 in gas fees (the fees you pay for executing a transaction on a blockchain) for something that costs $10. It’s like buying a sandwich for $10 and paying $10 in credit card fees, and it feels just about as absurd.
Gas fees are a very good reason to not buy a $10 NFT even if you think that NFT might appreciate in value by 200% to $20 dollars, because you’d have to pay $10 in gas to get it and $10 in gas to sell it. The cost of owning that thing, to you, is less than the value of owning it.
That’s how most founders feel about crypto, and why this SEC lawsuit matters. Sure, from a technical perspective crypto makes it stupidly easy to create a system of ownership and give that to whoever you want, but the real cost of doing that is that you might go to jail. Regardless of whether the tokens on Binance and Coinbase will be seen as securities by the court, we can say for damn sure that most founders intuitively want to use tokens as something akin to a security — they want to share ownership of what they are building with their community. The fact that most of the tokens we see at scale are “utility tokens” is not because utility is the only thing that makes sense, it’s because that’s the only thing that’s plausibly legal.
And by the way, I can say the above with confidence because I am that founder. I am still committed to building a radically different cap table with a lot of our community members on it, but I’ve explored every avenue to do that in a way that allows us to experiment in lightweight ways without taking on a ton of risk and overhead, and there’s just no great solution at the moment.
Let me briefly pause to address two things you might be thinking. First, I’m not saying that complex systems where tokens are utilities and unlock internal economies is not interesting — it is! And there are plenty of cool examples of it being built. But I’m specifically talking about community ownership here and my point is just that most builders don’t set out to create complex internal economies. They set out to create products which people pay for with some stable currency. Second, it is correct that community ownership even if it costs nothing to implement would be less important for founders than building a great product. But so is a lot of other stuff founders do — the relative cost matters.
Seeing community ownership as a problem of cost, not of value, also explains why another bad argument that the theory is invalid is pointing at the lack of traction for companies like Fairmint or OwnCo or UpsideCoop (companies that help you create compliant versions of community ownership). None have found real scale yet because the cost of implementing those forms of ownership is still pretty high as well — they cost money, are too new/unproven for most founders, and are often illiquid. I’m still bullish on those platforms long term if they can find ways to continue to decrease those costs, and as the value of community ownership continues to go up.
The long arc of the internet bends towards decentralization
All of this explains why these lawsuits are so important. What a lot of builders, myself included, underestimated is just how stubbornly high the cost of implementing these systems would continue to be, and how much of that cost would come from legal risk. We are used to the law catching up to innovation and establishing new precedence that allows it to continue to thrive, because that is largely what we have seen.
And perhaps that is what we will get here as well — it’s very hard to say. It’s a complex topic and anyone who positions it as black and white is misleading you. Are a lot of tokens securities, as defined by the strict interpretation of the Howey test? Absolutely! Does consumer protection for securities matter? Of course. Are existing securities laws antiquated and in need of revisiting to enable more innovation and access? No doubt.
Personally, I would hope that they carve out an exemption for smaller companies and projects, because where community ownership would really make a difference is in the cold start problem. Projects with lots of money and resources have a much bigger potential to harm consumers and more money to deal with the overhead of working with regulators.
Crypto is not going anywhere, nor is community ownership. The theory is rock solid, the writing is on the wall — building something new is incredibly difficult, especially in terms of getting people’s attention, and anything that can solve that problem would be massively beneficial. We have a technology in blockchains that makes programmable ownership possible at scale. But any argument about theory has to take into account the cost of implementing ownership, and right now the perhaps unfortunate truth is that the courts are in control of that for the US in the immediate future.
Thanks to Adam Delehanty for the editing help.
If you enjoyed this, I publish a few articles a year on systems for innovation, and how people in the future will build great products.