Source: When is decentralizing on a blockchain valuable #Resource
Assume users are smart.
Smart users expect Internet platforms — Facebook, Twitter, Airbnb, Amazon — to take advantage of them. To exploit them.
Smart users want compensation, monetary or a perk, to get them to use the protocol or app. Smart users know they are being locked in — the switching costs are high, the network effects are great. So they're fine with being exploited as long as they get something for it.
Twitter is a good example. Smart users hate Twitter yet there is a high switching cost. So users stay on this platform that exploits them.
==The future of applications though should be decentralized because decentralization helps to prevent user exploitation. ==
In the a16z article, he argues that decentralization is valuable when the lock-in effect is strong. Users know they will be locked in so they need a carrot to entice them to stay. That carrot can be governance.
An entrepreneur is enticed to monetize when the time is right. Monetization however can make users leave or have new users not join. You don’t want to monetize too soon. An entrepreneur with strong lock-in effects will be tempted to exploit their users. Users will not have a choice but to stay.
One big responsibility of an entreprenuer is to monetize their platform. When to do it though? It’s easy to exploit users like when market research shows that you can start to sell ads or charge fees. Users don’t want this. So with a decentralized platform you can offload the monetization decisions to users. This is credible commitment.
Now users decide when to bring in ads or when to charge fees. Ofc users won't exploit themselves. They'll be in charge of monetization. Even if they are locked in, they know the rules won't change up on them later or they won't start to get fees or rugged.
My metaphor: Decentralized governance is the carrot for a business with strong lock-in effects.
Monetization is linked to growth. When the network is growing a lot, you don’t want to monetize because you will lock out new users. But when growth slows down, you want to take advantage of locked in effects with existing users.
Users have become so used to being subject to the whims of Web2 platforms, they expect to be exploited. So they want to be compensated beforehand, monetary or with little ads. But this is costly. So in a centralized system you have to pay users upfront.
In a decentralized system, users don’t need to be compensated beforehand. Because they control monetization decisions and know you won’t exploit them.
Upfront compensation is the carrot to not exploiting users later. You need to share revenues with users.
Decentralized governance with airdropped tokens, revenue sharing, governance tokens, is making a commitment to users that they will not exploited.
But only delegates have sufficient voting power. So users will pick delegates who are like them, who are watching out for their interests. What are the interests of most token holders? What are interests of liquidity providers? Of all the stakeholders?
If you want to create a “new Facebook” or “new Google,” should you use a regular company or leverage a decentralized implementation through a blockchain? The answer may seem straightforward: crypto enthusiasts would answer with a resounding “yes,” while skeptics shake their heads. But the decision has less to do with faith than with practical market design considerations.
The fundamental question is how, precisely, decentralization through a blockchain can bring value to your business. In this article, I will guide you through an analysis of this question that’s rooted in economic theory and provide some insights to inform your decision.
Like all models in economics, mine is built on several simplifying assumptions, which may not be applicable in all contexts. But the simplified model nevertheless helps uncover key sources of value for blockchains, and also helps characterize the context in which when decentralization may or may not be valuable.
At the center of this analysis is the “locked-in effect”. Users may incur switching costs – the cost of the annoyance of setting up an account in another network
Alternatively, users may find leaving less attractive after they have spent time and effort training the algorithm of the network to adapt to their needs – think how Google learns from your past searches and personalizes search results to match your interests. Additionally, locked-in effects can be exacerbated by network effects that can give large networks significant advantages over competitors. Locked-in effects are inherent to many businesses, but their size varies case-by-case.
> For the business owner, locked-in effects come with a temptation to exploit locked-in users to increase profits. Suppose you own a company that has millions or potentially even billions of users and market research indicates that you can increase monetization – perhaps through advertising or charging higher platform fees – without losing customers. What would you do? A game theoretic analysis (and, quite frankly, common sense) predicts that you should increase monetization. Users are smart and know that you will exploit them later by charging high fees or ads or something else.
The obvious danger, though, is that users may know that they can become locked-in and don’t want to be exploited. If you can’t credibly commit to not exploiting them (and you often can’t), then rational users, in my model, would demand “compensation” upfront. Such compensation might be monetary, but it can also take the form of no or very little advertisement during the growth phase of the network. Alternatively, users may refuse to join the network at all for the fear of being locked-in.
The key insight when considering using a blockchain, though, is that it allows you to generate credible commitment through the design of the network. That is, you surrender control over monetization decisions to the users, enabling them to decide it through decentralized governance. This means that users can safely join the network because they aren’t worried about it being exploited later, even if they do get locked in. hey user, we’ll give you free tokens and perks at the beginning but by also giving you governance rights, you don’t have to worry about being exploited. As long as the governance system is sufficiently capture resistant, you can make decisions. So we may sell ads later of charge fees but you can make those decisions? This leads to the main result of my analysis: It makes sense to decentralize your business using a blockchain when the locked-in effect is sufficiently strong.
The model: game-theoretic analysis
If you decide to implement the network through a regular company, you can change the intensity of monetization daily as you deem fit. If you decentralize the network through a blockchain, users will decide on the intensity of monetization through on-chain voting.
Now we can solve the model through backward induction. That is, we look at the game-theoretic predictions for centralized and decentralized governance, which will show which mode of governance you should choose at the inception of your network to maximize profits.
Choosing centralized governance
Centralized governance allows you, the entrepreneur, to decide the level of monetization in every period. Two levels of monetization seem reasonable intuitively: first, a low level of monetization such that new users are willing to join, or a higher level of monetization that, while off-putting to new users, is not so high that it makes the the existing, locked-in users leave. The monetization strategy that is more profitable depends crucially on the network’s growth prospects. When future growth is sufficiently strong, you are incentivized not to exploit the locked-in effect because you want to maintain network growth. But when growth slows down sufficiently, it makes more sense to forego network growth in favor of exploiting the locked-in effect of existing users by increasing monetization.
However, in equilibrium, users – having been subject to the whims of Web2 platforms for so many years – have gotten smart and anticipate future exploitation. They therefore insist on being “compensated” beforehand (in my model, compensation might be monetary, but it can also take the form of little or no advertisement during the growth phase of the network, for example), which is costly to you. Thus, the control over monetization that you retain in centralized governance serves as both the advantage and the disadvantage of centralization. You can freely increase monetization to increase profits. However, you can’t commit to future monetization choices but will instead do what is optimal at each particular moment.
### Decentralizing using a blockchain
The tradeoffs are clear. If users have control over monetization, then you cannot exploit the users’ locked-in effect, and they will not exploit their own locked-in effect either. As such, users do not need to be wary of future exploitation and need not be “compensated” beforehand. Thus, the network will be able to grow continuously rather than experience a growth phase followed by an exploitation phase.
Yet surrendering control and giving away governance tokens imposes serious costs. First, you cannot choose monetization of the network. Second, you have to share revenues with the users through the governance tokens. This is necessary to align the incentives between you and the users. If you did not share any revenues, users would not want any monetization of the network.
Should you decentralize at the start?
Without the locked-in effect, though, there is also no lack of commitment. This eliminates the disadvantage from centralization, and only the advantages remain. As a result, centralization will generally be preferred if there are no locked-in effects or if they are very small.
If locked-in effects are very large, it may not even be possible to attract users to the network. In particular, the threat of exploitation in the future may be too substantial to overcome, even if you did offer monetary compensation or to not monetize the network during the growth phase. In this case, decentralization is clearly preferable, as only then users can be attracted to the network.