Governance and determination of value are connected. If you’ve already read Our Measurement Problem, first of all, pls do. Second, rest assured we will not provide a solution here. However, we do want to delineate a path.

Adam Smith left us with a powerful ethos - trust the market to balance itself. The way most of us interpret his vision today is simple: In an efficient market (or close to efficient), that has enough participants, the supply and demand are expressed by the sum of all transactions. It is comparable to a system of governance in which the actions of the governed members act as voting. By deciding to buy a stock, the market participant/group member casts her vote in regards to the question: “is this stock undervalued?” This continuous voting process should, ideally, form a pragmatic, liquid democracy that deals directly with that question of value.

It sounds great in theory. However, the reality is quite different. The self-balancing market assumes, among others, equal access to factual information, equal access to bid, and rationality. None of those are true to “free” markets. Ironically, the closest market to that ideal is the crypto market [and it too is still so far removed from the ideal as to make the self-balancing market model irrelevant].

Nevertheless, let’s entertain this ideal market for a bit. It describes a space in which the price is set by what the market will bear. The key problem with that is the uneven distribution of information. Some people know more than others. We’re not implying insider trading [although that is an issue]. We’re saying that it is impossible for everyone to know everything [unless you have access to Plato’s Philosopher King, which we might soon have]. Some people are experts in some fields and others in others, and most are neither. We rely on experts all the time. They are not infallible. However, all things being equal, they tend to be more informed than us [the unqualified, general public] and therefore they are more likely to make better decisions.

In Our Measurement Problem, we state that “blockchain consensus protocols such as PoW and PoS are two examples that seem to provide, perhaps inadvertently, a [partial] solution to our MP.” It’s time to start unpacking this vague proposition.

First know this, Proof of X protocols are governance mechanisms! They are designed to achieve a stable consensus over the state of a blockchain ledger in a distributed network of machines. In other words, they are designed to make decisions for a community by giving authority to a member of the community [to append a block to the blockchain]. Proof of Work bases the eligibility for that decision on the expenditure of a certain amount of computational work. Proof of Stake does the same only based on a staked monetary amount. Both protocols are cool examples of a very narrow form of liquid governance practiced on a single question.

One more example. Consider a fictional hospital that is trying to decide on two issues. The first is should they try meatless Monday in the cafeteria. The second is should the hospital invest $15K in a new Da Vinci Robotic System for surgery. Answering the first question might be achieved by a simple vote of all the employees. Answering the second question should NOT be “democratic”. It should be left in the hands of a small group of experts. Of course, all that depends on the assumption that those experts do not stand to gain anything from this decision. If the Head of Surgery in our fictional hospital is also the Da Vinci sales-person, we should worry about a conflict of interests.

In financial markets the experts ARE the sales-people and they transact in an environment saturated with, if not defined by, architectural conflicts of interests. That’s a long winded way of saying what we all know or suspect: professionals in financial markets have an unfair advantage over the non-experts. Governments have been aware of this risk for many decades and have been doing their best to protect unqualified investors. Laudable as their efforts may be, they tend to address mostly overt cases of abuse of uneven distribution of information. The vast majority of trading done in financial markets relies on the uneven distribution of information, either legally or simply under the enforcement “radar”. Moreover, other unfair advantages are also employed. For example, reaction speed is everything in today’s trading. Having a super computer that is physically close to the stock-market and connected to it by state-of-the-art optical cables translates into an unfair advantage in bidding.

Where is all of this leading? Well, we are suggesting that the determination of value is a question of consensus and therefore a specific case of governance, Furthermore, we are suggesting that it should be based on a balance of two poles. On the one hemisphere we have the “democratic” à la Adam Smith mechanism that either asks the public directly, or infers through their willingness to pay. On the other hemisphere there is the Philosopher King and other experts, preferably insulated from conflicts of interests, that dictate value based on accrued knowledge [which includes what the market bore in the past]. They price assets by integrating “hard” factual data such as rarity and performance/quality, with “soft” opinion-based information about market trends, or moods, etc. This is something that already happens in some non-fungible markets. If an art expert values a painting at a million dollars and it actually sells for much more or much less, we expect the expert to take that information into account for his next valuation and reflect the market forces in his dictated price. This is much harder to do in fungible markets.

Here’s the kicker. We are not suggesting that all questions of value for all fungible or non-fungible markets and types of assets should be determined by applying both mechanisms 50/50. We are suggesting, much like the Meatless Monday and Da Vinci Robot questions, that a granular / case by case, iterative approach might work better. More about this to follow.