The values of fairness are eroded, how should power and wealth be distributed in the crypto economy?

This article is from Babbit, original title: "Exclusive | A Brief Discussion on PoW and PoS: Distribution of Power and Wealth in Crypto Economy" Author: Ryan Watkins, Translation: Glendon.

Imagine you are designing a new economic system from scratch. You have to decide everything, from resource allocation to property rights, and how the entire system will ultimately be governed and controlled. How would you design it?

In fact, there is no right answer. For centuries, this has been a problem that philosophers, politicians, and economists have struggled to solve when designing institutions. In any case, these architects have tried to meet the common ideals of society, such as freedom, opportunity, fairness, and security.

Whether blockchain architects realize it or not, they face similar questions when designing blockchains. Like corporations, markets, and governments, blockchains are also institutional technologies. They not only regulate the supply and distribution of scarce digital assets but also provide a governance system for a wide range of social, political, and economic activities. Ultimately, blockchains may grow to become the foundation of the global economy and lead a new economic system. But before achieving this ambition, they must first answer the most fundamental questions about the distribution of power and wealth.

With this in mind, how have blockchain architects performed so far? The results are mixed.

Erosion of Values?

The initial idea supporting token sales was that the community would fund open-source projects and receive ownership in return. Many early smart contract platforms kept this idea in mind, allocating a large portion of the token supply to the community in this way. For example, projects like Ethereum, Cosmos, Tezos, and EOS allocated over 70% of their token supply to the community.

However, since then, the situation seems to have changed, and the supply distribution of newer projects is no longer as generous. Whether it is the increasing number of venture capitalists viewing blockchain as a company seeking greater ownership distribution, the strengthening of regulations, or the erosion of early egalitarian ideals, many new entrants in the smart contract space, such as Binance, Solana, Flow, and Avalanche, have higher internal distributions. In these cases, insiders own more than 40% of each project's token supply, and when considering the foundation's allocation, the situation becomes even more extreme.

Power and Wealth in the Crypto Economy

Ideally, blockchain architects would not need to decide the initial distribution of tokens. Instead, they could supply from scratch and fairly issue new tokens on an ongoing basis to those who contribute resources. This is the origin of Bitcoin, where every token ever issued was allocated to miners for their crucial role in securing the Bitcoin blockchain.

However, as interest in this asset class grows and profit expectations for new projects rise, such fair issuance may no longer be possible. Today, a product similar to Bitcoin could attract tens of millions or even hundreds of millions of dollars seeking early entry into a new project, making it difficult for early contributors to accumulate profits in the project and lacking motivation to continue contributing.

As a result, many projects choose to mint a portion (if not all) of the token supply at genesis to reserve some supply for core contributors and early supporters of the project. Ethereum started this way, pre-mining its supply and initiating a public sale for early supporters to fund the project.

This issuance model has significant implications when considering consensus algorithms. Projects using Proof of Work (PoW) tend to issue new tokens more broadly than those using Proof of Stake (PoS). PoW miners need to make substantial upfront and ongoing investments in their mining operations to remain competitive. This competition naturally compresses profits over time, forcing many miners to become sellers for a period to stay profitable. Therefore, most newly mined coins ultimately end up being distributed to the market rather than accumulating on miners' balance sheets.

The PoS function is different. In a PoS system, little ongoing investment is needed to obtain new issuance. Once holders acquire their tokens and stake them in the PoS system, they gain rights to a certain proportion of all future token issuance of the network. This permanently solidifies their ownership stake in the network and eliminates the distribution effects of new issuance in PoW.

Considering that most tokens in PoS systems not only have rights to new issuance but also to network fees and voting rights, this phenomenon has significant implications for how power and wealth accumulate over time in the crypto economy.

Control in a Decentralized World

We are striving to build permissionless, open technology. Most processes are open, but the most closed and opaque parts remain early financing… Under this veil of opacity, the same norms and structures that have historically led to imbalanced wealth and power distribution are at play. If we do not openly discuss the circumstances surrounding the birth of crypto networks, we are bound to repeat the social mistakes of the past… Where capital accumulates, power will also accumulate.

------Chris Burniske

In many ways, blockchains resemble governments more than companies. Like governments, blockchains manage property rights, enforce contracts, and even have social contracts and governance systems. In the future, we may view these blockchains as reliable public infrastructure for the global economy.

However, this vision is compromised when wealth and power concentrate in the hands of a limited number of insiders. Token holders in PoS systems can directly control the blockchain, such as through which votes to cast, which upgrades to push, which transactions to include, and ultimately how much transaction cost is required. This is akin to the wealthiest individuals in the U.S. directly and formally controlling the U.S. government and the Federal Reserve simply because they hold the most dollars.

When a group of people ultimately controls a blockchain, we lose all the interesting aspects of it. Blockchains that can be shut down, manipulated, destroyed, and restricted are useless. People around the world have lost trust in many institutions that govern our lives today. Why would they adopt a new system that is even less fair?

Source: Edelman Trust Barometer 2017

This is Not Just an Ideological Issue

The desire for more distributed power and wealth in blockchains is not merely an ideological appeal but a practical one. Trustworthy and neutral blockchains (not favoring any stakeholder group) are more likely to scale globally and thus attract more capital and high-value transactions. The more concentrated power and wealth are in a blockchain, the more users need to believe that the actions of those in power will benefit them, leading to a decreased willingness to use it. Projects that concentrate power and wealth from the outset and offer token holders the ability to lock in their ownership through staking may find it difficult to escape this fate.

But perhaps only time will tell us the answer.