It is Changes in Abundance and Scarcity That Drives Disruption

scarcity loop

A key question in business (and hence in investing) is: what drives change? Why do dominant businesses get disrupted so frequently by challengers? I posit in this post that most of this disruption is a consequence of a shift in economic scarcity, mainly caused by technological advances.

Most businesses can be conceptualized as offering a product or service bundle of value to their customers. The bundle is made up of various modules that combine together to provide the customer a valuable offering. I suggest that advances in technology cause changes in the relative scarcity or abundance in the underlying economics of these modules, and it is these changes in economics that create an opening for a challenger to topple a dominant business.

Consider an example given recently by Marc Andreessen:

“And so the newspaper bundle, the idea of this slug of news and sports scores and classifieds and stock quotes that arrives once a day was a consequence of the printing plant. Of the metro area printing plant, of the distribution network for newspapers using trucks and newsstands and newspaper vending machines and the famous newspaper delivery boy. That newspaper bundle was based on the distribution technology of a time and place.

When the distribution technology changed with the internet, there was going to be the great unwind, and then the great rebundle, in the form of Google and Facebook and Twitter and all these new bundles.

I think music is a great example of that. It made sense in the LP and CD era to [bundle] eight or 10 or 12 or 15 songs on a disc and press the disc and ship it out and have it sit in storage until somebody came along and bought it.

But, when you have the ability online to download or stream individual tracks, then all of a sudden that bundle just doesn’t make sense. So it [got unbundled] into individual MP3s.

And I think now it makes sense that it’s kind of re-bundling into streaming services like Pandora and Spotify.”

In general, once the deck of economic value has been shuffled by the shift in scarcity, it can create an opening to an entrepreneur to start from scratch by targeting a key module of the old bundle that is now relatively scarce — hence valuable — and leverage the newly created abundance. The Moore’s law driven plunge in the price of communications, for instance, is enabling a lot of startups to rethink existing business bundles by exploiting the “free” distribution available on the internet, just like iTunes did to unbundle CDs and Pandora is doing to iTunes in the example.

Once the challenger has won, it is fairly easy for the winner to bundle more and more features around the core module, to increase its value and to capture incremental marketshare. Of course, this process eventually sets up the bloated bundle to become a target for the next new challenger on the block, as technology changes the point of scarcity again!

The former CEO of Netscape, Jim Barksdale’s observation: ( “there’s only two ways I know of to make money: bundling and unbundling” captures this cycle of unbundling followed by bundling; but he does not really explain why should this be so? Andreessen, in a recent Tweetstorm, has provided a detailed example of this phenomenon of bundling and unbundling (

Thus the key driver of all the disruption and unbundling is technology driven changes in economic scarcity. A particularly powerful example of such a technology driver is the virtuous cycle of semiconductors and software advances feeding into each other, diagrammed below (I have previously written about this loop here:

I think it is vital for a disruptor to succeed that it be better aligned with this loop than the product it is challenging!

This is why I think the Christensen model of disruption, while insightful, is not complete. It comes in two flavors: low-end disruption and new-market disruption. Neither is fully satisfying as an adequate model of disruption – a counter-example to Christensen’s framework is the fact that the expensive, richly-featured iPhone manage to completely disrupt the cheaper, less functional feature-phone business (e.g., Nokia) — the exact opposite of what his model predicts! In my framework, by contrast, the key driver (driven by Moore’s law) was the relative abundance, and hence cheapness, of the internet. This allowed the iPhone to feature internet-enabled apps as the main attraction, rather than phone calls (in fact the initial iPhone was not all that great at making calls!). Thus the shift in scarcity/abundance created an opening for Apple to target internet connectivity as the core offering. This, I claim, is a better framework to explaining why they succeeded in disrupting the plain old cellphones despite being much more expensive; it was clearly not an attack from the bottom. (To be sure, smartphones also disrupted PCs, and that fact can be explained as an attack from the bottom as well as an unbundling of PCs due to a shift in scaricity/abundance; I chose the disruption of dumb-phones in this example since that cannot be adequately explained by one of the two frameworks).

To be sure, there can be other kinds of technology changes that are not related to semiconductors. But it is really hard to find other examples of something that can grow 40% per year for nearly 50 years! Moore’s law in likely unique in this aspect, which is why I think it has plays such a crucial part in the persistence of the disruption phenomenon, of the kind we have been experiencing in the last few decades.

Why Blockchain should be unchained from Bitcoins – two analogies

Like many, I see great value in the de-centralized blockchain protocol that enables the trusted transfer of a digital token. (Briefly: since the token can represent the ownership rights to just about anything in the digital world, or for that matter, in the physical world, the blockchain technology can make transactions much lighter weight and much cheaper, creating potentially enormous economic value.)

However, I do not share that optimism about the fate of Bitcoin as a global currency; in fact, I argue in this post that Bitcoin represents the Achilles heel of blockchain technology.

Of course, the reason why Bitcoins and blockchains are so tightly coupled together is that the blockchain protocol needs incentives for all those decentralized computers busily engaged in the reliable transfer of trust. And the current solution is to get this task done as a side-effect of the distributed systems trying to “mine” Bitcoins. In other words, the mining of Bitcoins incentivizes the distributed computing needed to implement any blockchain’s trusted ledger of transactions.

But unlike the obvious value in decentralized blockchain transactions, I think there are fundamental economic problems with the very notion of a currency that is not supported by a central bank of some kind.

To see why, consider the following analogy to build up some intuition.

Circulating blood is the medium of exchange of energy in our bodies, just like circulating currency (whether digital or physical) is the medium of exchange of goods and services in an economy. As the body grows larger, the amount of total blood needed to fulfill its exchange-of-energy role is proportional to the body size. If there is too little blood, the energy exchange will be deficient; we need to transfuse blood in extreme cases of blood loss. By analogy, as the global GDP level grows, as it does every year, the amount of currency in circulation must also rise, roughly in proportion!

The Bitcoin algorithm, however, has no relation to the level or growth of the global GDP. This may well prove to be a significant fatal flaw in its design.

To further deepen intuition, I recommend the brilliant essay Paul Krugman wrote for Slate magazine way back when he was a professor at MIT. In it, he explains the irreplaceable role played by the central bank in maintaining a stable currency — one that is neither inflationary not deflationary —  using an insightful baby-sitting analogy based on a real world case study. I suggest pausing here to read that brief (one-page) essay, mentally replacing Bitcoins for the baby-sitting scrips in his example: “Baby-Sitting the Economy.”

A strong implication of thecurrency experiment described in that essay is that any form of currency —  including Bitcoin  — just cannot become a stable, mainstream currency without a central bank function that acts to stabilizes their value from time to time, and keeps the circulating base of currency proportional to the size of the economy. One could, perhaps, imagine an algorthmic replacement for a human central banker —  say a Taylor-type rule —  implemented in a decentralized manner, although it would still be a central policy decision, in essence, since it needs to control the aggregate amount of the currency in circulation. However, all that is besides the point since the current algorithm behind Bitcoins is completely decoupled from the size of the economy, since there are going to be exactly 21 millions Bitcoins, a fixed parameter in its very design. This is a major problem that I think will prevent Bitcoins from becoming a global currency of any major standing (as envisioned by its enthusiasts).

Perhaps, however, it can survive as a limited sort of transient exchange medium, its value always secured at both ends by currencies that are stably backed by central banking. Indeed, this is exactly how it seems to be working these days. But I am dubious of the long term fate of this as well, since the point about the need to be proportional to the size of the economic “body” still stands, even for transient exchanges; after all, the number of simultaneous exchanges will surely rise in line with the growth of the global economy, thus raising the need for more Bitcoins in circulation.

More importantly, if all Bitcoins do is transmit money, then their role as a store of value becomes problematical. Every succesful currency must perform both functions (store of value and medium of exchange) simultaneously. If all Bitcoins do is transmit money, then Warren Buffett has this to say about its ability to hold any intrinsic value:

“It’s a method of transmitting money. It’s a very effective way of transmitting money and you can do it anonymously and all that. A check is a way of transmitting money, too. Are checks worth a whole lot of money just because they can transmit money? Are money orders? You can transmit money by money orders. People do it. I hope bitcoin becomes a better way of doing it, but you can replicate it a bunch of different ways and it will be. The idea that it has some huge intrinsic value is just a joke in my view.”Buffett quoted by CNBC.

In response to this, Marc Andreessen, the venture capitalist behind many Bitcoin related investments has tweeted:

“Warren has gone out of his way for decades to avoid understanding new technology. Not a surprising result.”

Much as I admire Andreessen, I think this completely misses Buffett’s point, which is not about technology at all. Buffett understands moats, and he is saying that there is no moat in any technology in the role of a transmitter of money. As he says, there have been many technologies to transmit money in the past but that this carrier function has never managed to have much value, primarily due to competition. (Incidentally, Buffett is a student of business moats and has written in the past about the lack of moats in many innovative technological breakthroughs — airplanes, and cars being two examples that immediately jump to mind.)

Buffett’s point about money transmitters not being moated implies that the motivation of miners will be surely affected if the value of what they are mining is subject to competitive erosion over time. Note that Buffett is carefully not saying anything about the value of the blockchain protocol itself. Most articles on Bitcoin end up laying out the future possibilities of blockchains, rather than Bitcoins. I actually agree that the blockchain protocol has great potential; but I find the conceptual foundation behind Bitcoin not quite up to the task.

At least for now the two are tightly joined at the hip, and that is a bug, not a feature, in my opinion!

My argument so far is about the long-term issues with Bitcoins. But even over the short term, the recent plunge in Bitcoin prices is troublesome — in fact, it is now worse than the notable crash of both the ruble and oil prices:

This matters, since it will affect the motivation of Bitcoin miners. As explained in NYT’s DealBook blog:

Bitcoin miners are computers that run Bitcoin’s open-source program and perform complex algorithms. If they find the solution before other miners, they are rewarded with a block of 25 Bitcoins — essentially “unearthing” new Bitcoins from the digital currency’s decentralized network. Such mining operations, though potentially lucrative, are also expensive, requiring huge amounts of equipment and electricity.

It is vital for the integrity of blockchain protocol that Bitcoin miners continue to mine, since blockchain maintenance is a side-effect of Bitcoin mining! Any plunge in the motivation level, and hence the capital investment level, of Bitcoin miners clearly slows things down. If I am right about this (I am not a professional economist), the conceptual deficiency behind Bitcoin could really undermine the long-term prospects of blockchains.

The key question: Can the blockchain protocol be decoupled from Bitcoins in some way?

If only there was some other way to incentivize all those miners performing the distributed computations needed to maintain the integrity of blockchains …

Disclosure: I have no Bitcoin related investments at the time this post was written.