Thin Heads and Fat Tails Understanding the AI and Crypto Reinvention of Capitalism

Philipp Stauffer,
Co-Founder and MD of FYRFLY Venture Partners.

In Zug, Switzerland, the annual Carnival celebrates Greth Schell, a folk hero who carried her husband home in a basket on her back after he drank too much at the inn. Zug, now known as Crypto Valley, plays the role of Greth for an internet that appears to be inebriated and in need of help — that is, if you judge the internet by its founders’ intentions.

Located just outside Zurich, Zug is pioneering Web 3.0, a new internet architecture based on crypto technologies. Local startups like Ethereum Foundation, Bancor, Xapo, Dfinity, and Status.im are challenging Web 2.0, the architecture we have now, or that has us, depending on your perspective.

Companies such as Amazon, Microsoft, IBM, Google and Alibaba dominate Web 2.0’s open application ecosystems. Data from Synergy Research Group, published by The Economist, shows that these five companies control roughly two-thirds of worldwide cloud services.

Companies such as Amazon, Microsoft, IBM, Google and Alibaba dominate Web 2.0’s open application ecosystems. Data from Synergy Research Group, published by The Economist, shows that these five companies control roughly two-thirds of worldwide cloud services.

These companies are clustered in the U.S. and China, which espouse opposing principles of internet governance. As security expert Adam Segal explains in an article for Foreign Affairs, China’s strategy is “cyber-sovereignty,” whereas the U.S. largely supports a “global and open internet.” Thus, the power of Web 2.0 sits in a few companies and their national governments, though perhaps not for long.

In June 2017, in an article titled Dawn of the Ultimate Unfair Competitive Advantage (Part 1), I argued that data and intelligence would distinguish the most successful companies for the next decade. Data and intelligence form an even more important unfair competitive advantage in Web 3.0. Here, we’ll examine how crypto pushes proprietary, closed datasets to gain an unfair competitive advantage by becoming open and owned by no one.

Before I state the thesis, let’s define some terms. The blockchain is one manifestation of “distributed ledger technology,” known as DLT. We commonly refer to it as “crypto,” not to be confused with cryptocurrencies. In this article, “crypto” refers to all innovations that use cryptography to make transactions secure, transparent and decentralized.

Crypto technologies could level the foundations of the modern web and challenge the political, financial and cultural institutions on which it depends. Web 3.0 is a second appeal to the internet’s founding ideals — the establishment of free and open access to information, connection and exchange. On Greth’s back — a metaphor for all crypto startups — we may return home to a sobering night’s sleep and an internet that would make its creators proud.

Amara’s Law and the Game of Monopoly

Crypto innovation matters because it could reinvent capitalism. Normally, the invisible hand of the market rolls innovations into tightly packed conglomerates. The Rockefeller oil empire, Microsoft, and now Amazon, among many other examples, illustrate how conglomerates dominate an industry and disadvantage competitors. The play only backfires if, like Microsoft’s ploy with Internet Explorer, the dominant player fights unfairly and triggers antitrust investigations.

As Diagram A below shows, the dominant player’s innovation follows a pattern first described by computer scientist Roy Amara. First, the technology is overhyped and overestimated. Second, as a result, the public becomes disenchanted. Third, that same technology becomes so ubiquitous and important that we can’t imagine life without it.

Diagram A: Amara’s Law and the Impact of Technology

For an example in progress, look at self-driving cars. In his blog, author and futurist Matt Ridley describes the state of affairs: “I am repeatedly being told that lorry drivers and Uber cabbies will soon all be redundant. I would almost guarantee that 10 years from now there will be a rash of reports about how the reality has failed to match the forecasts, that there are more jobs for drivers than ever and the self-driving car may be a lot farther away than we thought. I will venture that 10 years after that such pessimism will look foolish as autonomous vehicles suddenly start popping up everywhere.”

Google, Tesla, and a short stack of other companies could control the self-driving market in 10 years. They would become the market’s “head,” the left side of Diagram B below. Startups and small businesses live in the “long tail,” the right side of the diagram where we usually find more diversity and differentiation but higher prices and less scalability.

Diagram B: The Head and Long-Tail “Tug of War”

The head monopolizes the profit pools leaving little or no space for long-tail companies. Eventually, the head uses lobbying, political influence, and other forms of so-called soft power to solidify dominance.

While the head drives innovation through organic and inorganic initiatives (e.g., acquisitions), it increasingly controls the market’s innovation agenda. This depresses the likelihood that innovations from the tail become mainstream. The long tail is too much of a threat to the entrenched powers, so they squelch it.

The area of plurality, decentralization, and competition in the long tail lies fallow if the dominant players entrench themselves well enough. The transaction costs for, say, a mom-and-pop insurer, oil company, or telecom provider are simply too high, and head players ensure it stays that way.

What if we could create a sustained level playing field that brings all the advantages of the head into the tail (scale, resources, brand, optimized friction, lobbying, stability) and the advantages of the tail into the head (agility, entrepreneurship, independence, risk tolerance, sense of urgency)?

I think we would unleash innovation in a completely new way, particularly if we succeeded in establishing clear laws and democratic self-governance. Mike Maples of Floodgate, citing Nobel Laureate Elinor Ostrom’s work on the tragedy of the commons, suggests that crypto will create “governance markets,” which would “allow the commons to scale and create abundance in the same way that the stock markets enabled corporations to scale.”

The analogy is sound and offers a new way to look at the article “The Nature of the Firm,” written by Ronald Coase in 1937. The Nobel Prize-winning paper argued that firms exist because they reduce the transaction costs an entrepreneur faces when operating bilaterally in the open market.

Perhaps the objectives and advantages of the firm could be better achieved by technology that empowers and governs collaboration networks. With crypto platforms, multilateral webs of smart contracts amongst individuals could reduce transactions costs more efficiently than a firm, at least in theory.

With technology as sophisticated as a self-driving car though, who can possibly afford to compete outside the head of the market? George Hotz, apparently.

The Long Tail Dilemma

As Bloomberg reported in 2015, Hotz, then a one-man show, converted an Audi into a self-driving system in one month. Whether he was trying to beat Tesla, sell to Tesla, disrupt Mobileye or do all three is somewhat unclear.

Hotz isn’t exactly modest, but perhaps you shouldn’t be if you hacked the iPhone and Sony PlayStation 3 in high school. He’s the perfect example of someone pushing a multibillion-dollar technology into the long tail, where he may — or may not — retain his competitive advantage. That will depend on who controls driving data.