The Price Of Anarchy
The one thing no one in web3 ever mentions…
Game theory, scarcity, deflation, decentralization. These are some of the qualities of blockchain technology and the new “web3” frontier that is staunchest supporters will rattle the saber with. It works too since the slant they give is one of the legacies system’s control and authority over ones one digital footprint. This message is particularly effective given the questionable track record of big tech and our government with our data and our monetary policy. But what you never hear these folks discussing is the some of the economic principles that counter web3 ideals. So today I am going to dive into one of them for you, and it could be a major achilles heel to this new decentralized model, it’s called The Price of Anarchy.
The Price of Anarchy is an economic principle that states that the efficiency of a decentralized system degrades as participants within it act selfishly. The idea is actually pretty straight forward, in open systems, users will typically choose the path of least resistance for themselves. How can I make the most money, how can I get there the quickest, how can I finish this fastest?
A perfect example of this in action is in social media. Social media giants like Facebook, Twitter, and Tok Tok centralize the mediation function of their platforms. By establishing the most efficient way for a centralized solution to mediate content on their platform. There is a single point and standard through which all users are forced to feed their content. It is what makes it economically efficient (and possible) to mediate these platforms.
Now let’s look at “decentralized” social media platforms. If there is no centralized authority to mediate then look at what happens to the mediation process. Say one member of the community posts something that another member believes should be taken down. Well instead of a single resource responsible for reviewing the flagged content, the entire network must review the flagged content and vote. We are already orders of magnitude more complex and less efficient, but in open and decentralized systems users have the freedom too and most often will optimize for individual convenience, more harshly put, we will all act in our own self interest. Example?
This was a chart posted on twitter in the last week. It is a plot and line chart showing the 860,000 ETH ($2,122,325,200.00) trading volume of Meebits over the history of the project. For those that care to look, I have linked to the Meebits website, but it is an NFT collection made up of 20,000 unique 3D characters. The dots on the graph are wallet addresses, the lines are transactions…see the problem here? The vast majority of the transactions are back and forth between the same wallets in a practice that is referred to as “wash trading”.
Wash trading is an illegal practice by which the same individual buys and sells the same financial instrument thus manipulating its price. Someone might buy a Meebit for 1 ETH, then buy it from themselves for 2 ETH, and then 3 ETH and so on, making the perceived price of the item more valuable until hopefully someone else comes along and buys it at the inflated, but mislead price that they believe has increased naturally.
In a centralized world, this is prevented by a centralized authority acting on behalf of all participants in a network. In a decentralized world, if a trade was flagged then every single member of the group would need to review it and vote to determine if it was legal or not in the instance of the Meebit example above. Clearly these users are, as The Price of Anarchy states, acting selfishly. They are taking the most efficient route (wash trading) to try and drive value creation for themselves.
This is where I struggle to grasp the reality of the situation from the messaging from a lot of the investors and champions in this space. Their messaging often revolves around decentralization and the ability for you, me and anyone else to participate in the governance of a network. But as we just discussed above, the more open the governance of a system is, the more complex and less efficient it gets.
Investors are looking for two core things, the ability to create value and the ability of capital to help create that value as efficiently as possibly.
I see a lot of people say that crypto and web3 needs to solve its user experience issue for mainstream adoption to take place. They then often refer to the issues of fiat (real money) onboarding and off-ramps, wallet and signature management (right now it’s pretty intimidating) and several others. But what they don’t ever bring up is the decreasing economic efficiency of these systems. This is why BTC and ETH gas fees are so high, as the network gets busier and busier and more of us act selfishly (offer higher gas fees so transactions get picked first) then the capital efficiency of the entire system becomes less and less capital efficient.
Yes, cryptographic consensus is meant to be a solve for this issue. Validators/nodes help confirm the state of a ledger and also the addition of new transactions to it to help create some order to a decentralized ecosystem.
But when it comes to user experience, what most people want above all else is the best price possible. How do you deliver the best price? The most efficient system.
We are still a long ways off from systems that can operate at scale and deliver on that promise. Those that are heavily invested into this world seem to forget that after they seed a project, the more and more people that buy into these systems the capital efficiency get exponentially worse and worse over time which obviously favors those that bought in early. What they don’t ever discuss (at least not publicly) is that the more and more people that buy into these systems today, the more and more you are quite literally paying a premium for the price of anarchy…
Originally published at https://talkinsaasy.beehiiv.com.
