Economics and Finance of Decentralized Organizations

A REVIEW OF THE ECONOMIC LITERATURE.

COSTS AND BENEFITS OF DECENTRALIZATION

The literature focusing on the cost-benefit analysis of decentralization is scarce and even the definition of a “decentralized organization” is not uniform across different studies.

One important reason for this scarcity is a common view that is well stated by Mokherjee (2006), “the traditional literature identifies a number of potential costs of delegation: moral hazard for intermediaries owing to noncoincidence of their own objectives with the principal's, and their monopsony power over subordinates. These can result in production distortions (insufficient sourcing from subordinates), cascading of information rents across vertical layers, and problems of coordinating different horizontal branches”.

In fact, fragmentation and pitfalls of the decentralization are well studied in the financial economic literature. According to this view, decentralization of funding and decision powers are second best outcomes with respect a centralized first best. Decentralization implies financial fragility, lower financial capacity, and higher monitoring costs.

A more recent literature, see Aghion et al.  (2014), Bloom et al. (2012 and 2017), have explored on empirical grounds the determinants of decentralization statements and found a more heterogeneous landscape. They observe that:

• increasing levels of competition, human capital, and IT promote decentralization. 
• within multinational firms, higher levels of bilateral trust between the multinational's country of origin and subsidiary's country of location increases decentralization.
• the greater turbulence following macro shocks may benefit decentralized firms because the value of local information increases.

One notable modeling approach is provided by Alonso et al. (2008) that introduce a model to compare the levels of centralized and decentralized coordination when managers are privately informed and communicate strategically in a multidivisional organization. They analyze the conditions to achieve the best trade-off between coordination and adaptation when it is impossible within the organization to commit ex-ante on decisions contingent on the information receive. A higher need for coordination improves horizontal communication but worsens vertical communication. They show that decentralization can dominate centralization even when coordination is extremely important relative to adaptation.

DECENTRALIZATION AND THE INDUSTRIAL ORGANIZATION OF DIGITAL PLATFORMS

Recent years have seen a mounting interest on the role of digital platforms and in the degree of centralization of their ownership and control. Companies like Alibaba, Amazon, Facebook, and Google are platform businesses with short histories that have quickly become centralized organizations with a key role for the intermediation of information in the global economy.

Costantinides et. al (2018) define digital platforms as a set of digital resources—including services and content—that enable value-creating interactions between external producers and consumers. 

A platform can be seen as an extreme evolution of a value-chain. The network of interactions between all platform participants, including consumers above and beyond producers and third parties, forms the ecosystem sustaining the platform. Its intangible value grows non-linearly with its size and complexity.

Accordingly, the organization underlying a platform exhibit architectural and governance rules must seek a balance between a centralized platform control and a fully decentralized model that gives incentives to platform participants to foster engagement and generate value for one another.

In addition to the ecosystem, the value of a platform and its governance depend also on the ownership and on the architecture of the underlying digital infrastructure, i.e. the computing and network resources that allow multiple stakeholders to orchestrate their service and content needs.

The relationship between the ownership structure of the platforms and the value that it is produced is heterogeneous, ranging between two extremes:

• A pure ‘private corporation’ revenue model where all the value produced in the ecosystem is ‘taxed’ and generates transfers the franchise value produced in the ecosystem to the equity-shareholders. In this case, the organization of the firm exploits the economies of scale of a fully centralized management of the digital infrastructure.
• A decentralized model where the management of the platform commits to the principles of open-source development providing appropriate infrastructures and incentives for value-creation and balancing openness and control among different stakeholders.

There is a consolidated tradition of studies that have analyzed the financial economic principles underlying the conflicts and incentives for the stakeholders of the centralized model, where the corporations underlying the platform is funded through capital markets and by financial intermediaries.

On the contrary, the financial-economic principles underlying the interaction between stakeholders of decentralized organizations and the optimal funding channels in a pure decentralized model of platform management are less understood and a topic at the forefront of financial economic research.

Vergne et al. (2020) observe that decentralization may identify two distinct phenomena: dispersion of organizational communications or the dispersion of organizational decision-making. This proposed distinction has implications for understanding the growth of digital platforms in the already developed so called Web 2.0. Prominent existing platforms have a dispersed model for communications since they typically use machine learning as their core technology to transform inputs (e.g. data) into outputs (e.g. matchmaking services) but retain a centralized decision-making model. On the contrary, they argue that platform based on blockchain that emerged after the definition of the bitcoin protocol, offer an alternative technological blueprint enabling platforms that are both decentralized and distributed. They claim that the adoption of the distributed ledger technologies might offer a viable solution to reduce the “increasing centralization of data within a handful of platform behemoths”.  Their antitrust recommendations would act “at the data level and formulate actionable policy recommendations to level the competitive playing field – after acknowledging the dual tension between legal and illegal (or ‘pirate’) competition, and between centralized and decentralized platforms”.

THE VALUE ADDED FROM DISTRIBUTED LEDGER TECHNOLOGY.

In order to clarify the goals of the project, it is worth listing the potential economic advantages that may derive from the adoption of DLT. It is important to remark that the diffusion of cryptocurrencies and of the public blockchain models have obscured a number of important alternative applications of this technology that on the contrary may play central roles when applied to existing decentralized organizations.

The public blockchain was originally conceived to process monetary transactions in a peer-to-peer network while preventing double-spending. This original application is now only one of the many potential applications that are being explored. An interesting, more comprehensive perspective on the potential applications of the blockchain technology is the one that emphasizes its role as a technology that can be used to enforce trust in economic transactions. While we refrain from the oversimplistic narratives that sell the blockchain technology as a 'trustless' technology, it is true that the use of decentralized validation approaches, of smart contracts and of decentralized remuneration mechanisms may be used to implement credible mechanisms and provide economic incentives.

Theoretical and empirical evidence emphasizing the pivotal role that trust and incentives play in modern markets and economic systems and the potential benefits deriving from the adoption of the blockchain technology are breifly reviewed in the following:

Trust and confidence

When considering a specific range of potential applications, it is necessary to consider the most appropriate architecture that can be adopted and