I’m here to briefly share why decentralization is important and why startups should be decentralized. So the question now is how to achieve decentralization.
Here are three main frameworks for decentralizing power… including a key example of why this is also important legally.
#1 Technical decentralization
Blockchain and smart contract protocols can create a trustless and autonomous ecosystem where people can compute and transact without intermediaries. The baseline barrier to achieving technical decentralization depends on the type of protocol you are developing.
For a blockchain like Ethereum, technical decentralization is very challenging, as it relies on guarding against various attacks, such as from validators, node operators, and more. Ultimately, the system and everything must be able to continue running autonomously, fund itself, and defend against attacks.
On the other hand, if you look at a simple smart contract protocol – meaning, if you were to deploy a smart contract and make it immutable – then you would likely say it is immediately decentralized, as no one can intervene and make it immutable. Change it to a smart contract.
So, technical decentralization is a moving barrier, depending on the protocol you are building.
#2 Economic decentralization
When you introduce digital assets into the web3 ecosystem, you have a more complex product.
Again using Ethereum as an example, the system can use its own digital assets to reward people providing services to the system (and conducting transactions), creating a decentralized economy around Ethereum. With the creation of this economic body comes a new challenge – maintaining the decentralization of the economic system. If one person gains too much value, or one person can control the network by manipulating token prices, it would jeopardize the security and utility of the entire system.
#3 Legal power decentralization
Decentralization can eliminate some of the risks associated with asset transactions. In the financial field, our entire legal system is largely designed around trying to reduce the money risks that one person has to trust another. We have a lot of laws about intermediaries and how they operate – all to protect consumers from the potential conflicts of interest these intermediaries may have. In a peer-to-peer system, like blockchain, you don’t need intermediaries. Therefore, there is no need for a mediator-based legal system.
For example, since decentralized exchanges can enable non-intermediated peer-to-peer transactions of digital assets, broker-dealer rules aimed at protecting investors from the influence of intermediaries are largely unnecessary. If there are no conflicts of interest possible, rules about conflicts of interest are meaningless.
Similar concepts also apply to digital assets and securities law. Securities law aims to address risks by requiring disclosure and creating a fair competitive environment where all investors are on equal footing, as otherwise it would ultimately lead to market manipulation and people having an advantage over others, leading to market inefficiency.
Our legal system generally views securities in a way that is most likely to have information asymmetry when you are trying to push the value of a specific asset through management efforts.
Think about the difference between Apple stocks and oil:
One reason Apple stock is considered a security is because Tim Cook can have a lot of information that could affect the value of Apple stock. He knows how many iPhones they’ve sold, how many they’ve produced, and other various information that the general public doesn’t have access to. Therefore, to make Apple stock publicly traded on the market, they are obligated to disclose all significant information that may be relevant to the asset price. For securities, issuer-based disclosure is necessary to maintain a fair competitive environment for investors.
Now compare that to oil. Oil is not a security. It’s a commodity, and as a commodity, all information about oil and the possible oil price is public. There may be organizations like OPEC that change the amount of oil they are going to produce, which affects the price – but there are other organizations or countries that can take action to affect the oil price. So you’re not talking about the fundamental information asymmetry that exists in stocks. For commodities, asset-based disclosure helps establish a fair competitive environment for investors, and issuer-based disclosure is unnecessary.
So what do we do with digital assets in web3?
If a web3 system can eliminate significant information asymmetry and reliance on management efforts, we can say that the system is sufficiently decentralized and no longer needs to comply with securities law.
(Of course, when it comes to legal power decentralization, founders often feel confused, and the rules are not currently as clear as they should be, because the SEC has not formulated them in a very clear way.)
For more information on builders’ understanding of decentralization – principles, models, methods – please visit here. Because in a web3 system, you need to consider all three types of decentralization – technical, economic, legal. A change in one may affect the others, and it’s a delicate balance.