Better Aligning Value Creation & Value Capture


Last week we explored the idea that whoever generates the demand captures the value.

This week we’ll explore a world in which whoever creates the value (often by generating demand) captures the value, proportionate to the value created. We don’t live in this world yet, but new tech is bringing us closer to it.

To explain this, let’s start with a thought experiment around music:

Think about your favorite musician. How much money do you think you’ve paid them over the course of being their fan? Maybe you bought their album, went to a concert, or maybe you bought some merchandise. All in, though, it’s probably under $100, if you’ve paid them anything at all. And, of course, given how record deals work, the artist probably only saw a tiny amount of the total cash you paid.

The point is: even if you’re a die hard fan, your favorite musician has probably only captured a tiny fraction of the value they’ve created for you

Why? Well, because the music business model is messed up.

As we mentioned last week, artists sign shitty deals that give them cash advances upfront at the expense of their upside.

But it’s not just the artists who are getting screwed, it’s that the industry at large is undermonetizing as well. The whole music industry is something like $20B. Compare it to video games, a $140B market, and you see the discrepancy. Fortnite alone makes $3B a year, and most of it is profit. Same with League of Legends — they make $2B a year, mainly selling virtual goods.

Music has just as much engagement as video games; there’s basically no reason there should be a 7x difference in market size — except for the business model.

Indeed, music is probably the most popular medium in terms of enthusiasm and engagement. And the fact that it isn’t the biggest revenue driver for media is largely because music companies are stuck on pre-internet business models based on copyright, gate access, and the like.

Consider how video games have adapted their business model to the internet era. Video games used to cost $50-60 per game; now they're often free loss leaders for in-app purchases and digital currency, enabling game developers to monetize their whales. I heard recently somewhere that 5% of the customers make up 80% of virtual good purchases.

The best business model pre-internet was to charge for content. In the internet age, I think the rest of the world will become more like video games — give away the base layer, and let the internet do its thing, supercharging viral marketing to monetize the complement.

Video games learned this the hard way. Nintendo fought streaming for a long time. They had all sorts of restrictions on Twitch streaming, but they eventually realized it was no use. Streaming was coming whether they liked it or not. The marketing benefits outweighed the risk of copyright violation, and they’d sell more games than ever; plus the additional business models provided significant upsell opportunities through the sale of virtual goods.

It’s unclear what the perfect business model will be for music, but good things happen when an industry embraces the internet and we let a thousand flowers bloom. Who would have predicted that there’d be a $30B market for buying cosmetic goods in video games that do nothing to enhance performance in the game itself? It took 20 years of experimentation for the gaming world to figure this out.

“Crypto fixes this…”

Crypto enables new ways for musicians (and other creators) to directly capture the value they create in a couple key ways:

First, it allows for granular price tiering, which enables super fans to pay more based on their level of interest in the creator. Super fans can get special access to exclusive content or rewards in exchange for just paying more (Bitclout, anyone?).

Second, it allows customers to also be investors, sharing in the financial upside of their favorite creator. Imagine Kickstarter, but instead of just getting the album you also get financial upside in the album’s success.

This, of course, goes way beyond artists and into, well, every creator category.

Consider another thought experiment: If I set the price of my Substack at $10/month, that might be the right price for most people, but what about my super fans? Maybe they’d pay $100. Or what about people curious for a peek but aren’t ready to pay for the whole thing yet? Maybe they’d only be willing to pay $2.

We spoke last week about how Matt Yglesias and crew are making significantly more than they’d be making at legacy institutions. But if we had dynamic pricing, could their value capture even better reflect their value creation?

And from a fan perspective, the prospect of being able to profit from early support of an artist is a strong incentive to become a supporter in the first place, which means it will expand the total amount of supporters. So creators not only make more money per fan, they’d get more fans in total.

But it doesn’t just bring in more die-hard fans, it also brings in speculators. Some people buy NFTs because they love the creator, while others are more investment oriented. Take the example of finding an emerging artist who happened to release a creator token. If you have an investor mindset, you’d likely invest on the speculative prospect of the token’s appreciation. The price of the token goes up helps fund the artist’s career, and now the artist doesn’t have to rely on a record label anymore to get off the ground, so they can focus full-time on their art, which drives the price up even further and the flywheel continues.

The discrepancy between value capture and value creation isn’t unique to stars, it’s felt across the board. In every network or marketplace, for example, users/customers create a lot of value, but they don’t capture any of it financially. What’s valuable about Facebook and Twitter is the unique data they have, data that we have users have provided. Yet we see nothing from it. When someone’s property value in San Francisco goes up, it’s not because of anything they’ve done to the house necessarily, it’s because the value of the physical network is going up. Yet that value isn’t disseminated to the people who created it.

Before describing how this crypto networks unlock financial value for users, it’s important to understand how this wasn’t possible before..

The Corporation wasn’t built for this.

Many issues people have with social networks and technology arise from a mismatch between the nature of these networks and the legacy corporate structures that govern them.

Limited Liability Corporations (LLCs) were first developed in the 1830s and with the rise of railroads. Before that you basically had partnerships where each partner had full liability. Because of these, people would only do business with their family members — if anything bad happened, you’d be personally liable. Who’d want to give money to some stranger when your liability extended far beyond your financial outlay?

Something had to be done when the world took on capital intensive projects like railroads. With projects that required greater capital aggregation came increased pressure to limit liability, one of the greatest inventions of the 19th century.

Things have changed since then. The LLC as we know it is bumping up against its limitations; wealth is now concentrated on the edges of these networks, and there’s misalignment between the network’s participants, owners, and the complementary builders adjacent to the network.

Chris Dixon described it well in his piece “Why Decentralization Matters”:

“Let’s look at the problems with centralized platforms. Centralized platforms follow a predictable life cycle. When they start out, they do everything they can to recruit users and 3rd-party complements like developers, businesses, and media organizations. They do this to make their services more valuable, as platforms (by definition) are systems with multi-sided network effects. As platforms move up the adoption S-curve, their power over users and 3rd parties steadily grows.

When they hit the top of the S-curve, their relationships with network participants change from positive-sum to zero-sum. The easiest way to continue growing lies in extracting data from users and competing with complements over audiences and profits. Historical examples of this are Microsoft vs. Netscape, Google vs. Yelp, Facebook vs. Zynga, and Twitter vs. its 3rd-party clients. Operating systems like iOS and Android have behaved better, although still take a healthy 30% tax, reject apps for seemingly arbitrary reasons, and subsume the functionality of 3rd-party apps at will.”

Reviving The Co-Op

Crypto networks will be as big of a step function improvement over joint stock corporations as joint stock corporations were over what came before them.

The joint stock corporation expanded the group of people who had financial upside from just founders to founders and employees. Crypto networks will expand this from founders and employees to founders, employees, and users.

To be sure, Co-ops have always done this, and there have been some real successes. Visa actually started as a co-op — a bunch of banks came together, pooled money, built a network, and grew the network effects of the payment system really quickly (because they all had skin in the game to do so). But as it grew and competition got more fierce, MasterCard and American Express entered the market while Visa converted from a cooperative to a for-profit entity, mainly because they could raise more capital through that structure.

The problem with co-ops has always been structural barriers preventing them from accessing capital markets. This made it harder to raise money as a co-op, giving non-co-ops an advantage. Any entity designed as a co-op was, in a real sense, sacrificing profits to do so.

Crypto networks make it easier to raise money and get customers by making those same people investors. They make the financial incentives work for all stakeholders.

Enter the ownership economy

This idea is what's core to the success of Bitcoin and Ethereum, two multi-billion dollar networks where there is no company, but instead many independent users all over the world governing the network. Many of these people were developers and technologists who built the network in the early days, earning an ownership stake in it as a result.

This same economic model is now crossing the chasm from developers to consumers:

Crypto, as we just discussed, helped creators and collectors realize, “Hey, I can own a piece of the internet value I create, and I can capture that value directly by selling to my audience, and charge them in a granular way that makes more money per fan and financially incentivize them in a way that makes it likely I’ll have more fans.”

The ownership economy thesis is that value in past web platforms — Wikipedia, YouTube, Twitter, Peer-to-peer networks/marketplaces, etc — is generated by users who never retain any of it. Users contribute value, but they don’t capture it.

This isn’t just some social mission for inclusion, as valuable as that is in its own right — this is a necessary distribution hack to disrupt the network-effect juggernauts. How do you get people to leave these Web 2.0 platforms where there’s high switching cost? You have to give them something they haven’t had before: Financial upside is as good a value prop as any.

For startups today, the opportunity is massive: platforms that are built, operated, and owned by their users can grow to be much bigger, much faster than their institutionally owned counterparts.

The ownership economy is correcting for the gaps the LLC created, reviving the concept of co-ops and making it sustainable.

This means, for the first time ever, we can have community ownership and network alignment completely consistent with capitalism. And this is uniquely unlocked by crypto tokens that enable us to distribute the value of ownership in the same way we distribute information — instantly, to anyone, anywhere in the world.

Zooming out, this is where capitalists and socialists should finally find common ground. In this new world, everyone becomes an investor. We go from thousands of people with financial upside in companies, to millions. We go from 1% capital to 99% capital. On any given platform, labor becomes capital. The ethos of a co-op merged with the efficiency of a corporation. Finally.

Maybe the ownership economy is what will makes capitalism more palatable to a wider audience. Maybe it leads to a world where instead of putting guillotines outside entrepreneur’s homes, we cheer for them knowing we’re much more financially aligned--that the more money entrepreneurs like Jeff Bezos and Mark Zuckerberg make, the more money its users make directly (as opposed to indirectly through government services paid for by their tax dollars).

In the ownership economy, capitalism becomes positive sum in a legible way.

The ownership economy creates a world in which whoever creates the value, captures the value.

Thanks to Chris Dixon and Jesse Walden, from whom I learned much of this by speaking with them and studying their work.

Until next week,