Decentralized Autonomous Corporations

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Decentralized Autonomous Corporations are currently experiencing an enormous growth. In theory DACs don’t need human involvement and have the ability to take the right decisions at the right time. DACs consists of primarily intangible assets, which makes their business structure easily scalable, and their potential is huge as everything can get connected to their network. This growth of DACs doesn’t happen without obstacles but is worth attention as it appears to be an interesting investment case.

Traditional Business Structures

Traditionally the structure of businesses is hierarchically formed with the Head, the mid-level managers and then the majority of the employees at the floor-level. Every level of a traditional business structure has different roles, rules, and responsibilities. The structure is determining for how information moves internally.         
The structure can be very hierarchical or more flat, but one central aspect of this is that there is a contract between people that declares who has which permissions. All these connections between people have some flaws in terms of mistakes or even corruption which impacts the overall performance of the organization.

But is it possible to run a corporation not including employees in the same way as we are used to?

DAC – A New Business Structure

Decentralized Autonomous Corporations originates from the thinking of DAOs or Decentralized Autonomous Organizations. DACs differentiates from DAOs by having the purpose of generating profits.        
DACs works in the same way as a normal company except that all processes are digitalized, and all the company’s bylaws are written in code. In DACs there is no need for employees as computers are coded to do their jobs. In this way there is no corruption, little to no mistakes and no salaries to be paid. That is the foundation of a way more effective cloud-based company with no physical form. Corporations have different purposes and for DACs it would depend on the original coded bylaws. In this writing the purpose of a DAC is assumed to be the same as most other corporations – maximization of shareholder value. This business structure is decentralized, and autonomous as daily operations are computer-driven, and no humans are influencing this. You can discuss if a DAC per definition can be fully decentralized as corporations are defined as companies who aim to make profits and maximize shareholder value which doesn’t sound like being decentralized.  

Today, there is no company that is a 100% DAC, but many companies benefit from this thinking by making certain processes decentralized and autonomous. Hereafter the use of the term DAC will be used for companies with the same elements as presented in the section above.

Many of the biggest, most successful, and fastest growing companies are practising the earlier mentioned characteristics of a DAC. One characteristic that is repeatedly observed is that many DACs creates the infrastructure for user generated content which provides value to the company. This is seen with: Apple’s Appstore that connects app developers with app consumers, Uber who connects independent taxi drivers with costumers who want to get from A to B or Facebook who monetizes on connecting billions of users with each other and generate valuable circumstances for advertisers and vendors. A newer example is the rapidly growing company Kahoot, who provides the tools needed for teachers to make teaching more fun and entertaining.

Airbnb as an Example of a DAC

An example of a DAC could be Airbnb who is known for being the biggest hotel company without owning one single hotel. Airbnb has a technological platform that connects renters with property-owners in more than 220 countries and has more than 5.6m listings on their platform.

*Number of employees and mkt. value is from 02-15-2021.

In comparison with the world biggest hotel company who has its own locations Marriott International, Airbnb has a bigger global presence, a bigger market value, but with only a fraction of the number of employees. Even though these two companies aren’t fully comparable they both sell accommodations. It seems to indicate that Airbnb who is used as a representation for DAC’s is more valuable than traditional businesses.

Airbnb isn’t the only DAC that facilitates and monetizes from technological infrastructures. Apple’s Appstore provides apps developed by external producers that gets downloaded by consumers. Apple then takes a part of the revenue generated by consumer purchasing apps or making in-app purchases. In this way, Apple’s Appstore is connecting external developers with consumers and generating income from selling apps without developing any itself.

There are other examples of DAC’s with similar processes:

• Facebook, the world’s most popular media owner who creates no content.
• Uber, the world’s largest taxi company who owns no vehicles.
• Alibaba, one of the world’s most valuable retailer who has no inventory.

Just to mention a few…

Metcalfe’s Law

How can these more cloud-based DACs be valued so much higher than their older competitors who have more employees and more physical assets?    
Metcalfe’s Law declares that the value of a network is proportional to the square of the number of nodes in the network. With n as the number of nodes the equation for Metcalfe’s Law is:           

Value of a Network = n(n-1) / 2.

Below is an illustration of how the network effects intensifies as more users connects to the network. It is shown that with 3 users there is 3 links between them but with 9 users there is 36. Assumed that each link has the same value, the value per user is 3,6 times higher with 9 users rather than 3. In reality each link isn’t identically valuated, but it is the theory behind that is important.

Metcalfe’s Law and Network Effect in Shipping (https://www.searates.com/blog/post/metcalfs-law-and-network-effect-in-shipping)

This means that the valuation of digital companies with a growing number of nodes in their network increases exponentially. The valuation of companies like Airbnb increases progressively for every new listing or consumer on their platform as the network effects gets bigger while traditional businesses tend to grow in a more linear direction as a result of investments in physical assets like hotels.


The difference between exponentially growing DACs and traditional linear-growing companies and their valuation is illustrated below. The graphs shows that the value of each user is relatively lower for DACs in the beginning, but as the network escalates so does the valuation of each user or node in the network and at some point, the valuation of DACs will surpass the valuation of linear growing competitors.

DACs are characterized by being asset light. The assets of a DAC are the network effects, data, and partnerships. The workforce in terms of number of humans is way lower which decreases the costs to salaries. Human workers get replaced by server power that is quicker, makes less mistakes, and cheaper to upscale.

Issues with DACs

One downside related to DACs is that their exponential growth can be harder to control. Facebook for instance, is now having difficulties with controlling the behavior of their users who share Fake News, fraud or uses offensive language etc.    

   
In other cases, it has been revealed how social media networks have been weaponized to manipulate public decisions such as elections. When 72% of U.S citizens of voting age is active on social media and the same percentage of U.S adults agrees that social media platforms have too much power and influence in politics. As long as the majority is not being held accountable for their online behavior it is difficult to see an end of this.
A third difficulty with DACs is about the employment status of external workers. Some companies can by the use of their platforms disrupt old and recognized businesses partly because of the employment status of external workers. As described earlier DACs are characterized by having only a fraction of the total amount of workers relatively to linear businesses. A relevant case regarding to this is Uber who is considering their taxi drivers as independent contractors which reduces administrative work and avoids minimum wages. The reason why Uber’s taxi service is illegal in a number of countries is primarily because their taxi drivers don’t follow local conventions for taxi drivers which motivates unfair competition.

Potential of DACs

Imagine a network where everyone and everything is connected, that might be the maximum growth limit for a DAC. In theory a DAC can connect everyone with everything and run solely by the power of computers and this could actually become reality one day when technologies within robotics, AI and IoT develops and get more accessible. Think of Airbnb, their platform could be led by Artificial Intelligence instead of a CEO and could thereby potentially always take the right decisions as Big Data gets analyzed all the time. The DAC would know exactly when and how they should expand to new markets or optimize/develop new products etc. The cloud-based DAC would even know exactly what the right pricing and strategy should be to maximize profits and thereby value for shareholders.


DAC’s are just superior to human-driven companies as they react faster in changing environments and has a better foundation for decision-making.

The Investment Case of DACs

There is no doubt that DACs as an investment case are interesting. They have unbelievable growth opportunities as the world continues its digitalization. Amazon has benefitted from the digitalization of the retail industry and Delivery Hero takes advantage of the fact that more people prioritize convenience and buy their food online.  With little to no physical assets DACs are highly scalable as the need of time and physical resources are limited. Airbnb doesn’t have to do massive financial investments and wait many years for hotels to be built before entering new markets like Marriott would.
With low marginal costs for every new consumer and only a little amount of money bound in physical assets the profitability increases as the business upscales.
Traditionally, growth rates drop as the market cap increases, but with Metcalfe’s Law and the huge potential for connecting endless nodes to the network in mind, the high growth rates will probably continue for a longer time and reach values that has not been observed so far. In terms of growth, it might even be an advantage for DACs to reach great market caps as the value of each new user grows progressively as explained earlier

As earlier mentioned, DACs don’t grow without issues. Fake news, manipulation, and employment difficulties all substantiates the need for more strict regulations. How these regulations will be is still unknown. They would probably be about validating content on social media platforms to prevent sharing of fake news and manipulation or about splitting up large DACs to lessen their power etc. Regulation is not solely a bad thing as validated content might increase the reliability of social media platforms as a news source or a splitting of large DACs could encourage more social media platforms to differentiate and thereby target smaller sections of the populations, which might give a better user experience.

The ability of being highly scalable and very profitable without a significant amount of physical assets makes the business structure and thereby investment case of a DAC really attractive. The question is how expected future regulations impacts the evolution of DACs. Their growth would probably slow down a bit or maybe it will continue, but one thing is for sure – no one can predict the future.           

 

Sources

Lasse Mejlholm

Lasse Mejlholm

With seven years of investing experience in different securities types, he is currently finishing his Economics and Business Administration studies at Aalborg University Business School. Hereafter he intends to begin his master’s degree within finance. Specializes in analyzing the financials on sector and company-level, mostly focusing on growth-KPIs and the valuation of a company, but also analyzing megatrends and how we can apply that knowledge into our strategy.

NewDeal Invest’s posts, articles and other material must and must not be seen as a recommendation or support regarding the purchase or sale of shares in general or for the companies mentioned. It can not be expected that the mentioned or other recommendations in the future will give a positive return. Every post, article or other material contains its own opinions and assumptions.

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