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Principle #6: Systems Evolve Over Time
The sixth principle of systems science states that systems evolve.
Let’s take a look at some of the key aspects of evolution by exploring the ways in which cryptoeconomic systems have evolved over time and some of the important forces that will shape their future evolution.
Evolution is an ongoing process that generally leads to systems becoming more complex over time. It involves permanent modifications to the structure and behavior of species or populations which slowly unfold.
Bitcoin represented a significant stage in the evolution of the digital currency ecosystem. Technologists have been experimenting with ways of creating peer-to-peer decentralized electronic cash systems since the early 1990’s, but none of them took off until Bitcoin.
By combining core aspects of previous attempts such as e-cash, b-money, and Bit Gold, Bitcoin achieved a fundamental breakthrough in computer science and game theory by solving the long standing game theoretical “Byzantine General’s problem.” For the first time in the history of electronic cash, a group of strangers distributed across the world could coordinate to maintain a global ledger of transactions without needing to know or trust each other. Anyone could access the Bitcoin blockchain and use it to send bitcoins without needing permission from a centralized authority or depending on a third party to validate transactions.
While there is plenty of skepticism regarding Bitcoin’s future as a currency, there is a growing consensus that the “blockchain technology” it pioneered can be a valuable tool for improving how our society transmits value and organizes itself. The sprawling ecosystem of blockchain-based technologies, referred to by many as “Web3”, is an environment in which constant innovation is leading to increased complexity with new structures and behaviors appearing on a daily basis.
Evolution is a very complex topic. This piece will highlight just a few basic components of the process that are easily observable and especially relevant within cryptoeconomic systems: adaptation, selection, mutation, and emergence. As usual, see the Principles of Systems Science textbook for a more detailed treatment.
Adaptation occurs when a system changes a form or function in response to a force from the environment acting upon it. It represents the capacity of a system to respond to environmental shifts by reallocating internal resources to respond to novel inputs.
George Mobus makes a clear distinction between adaptation and evolution that I find useful:
Adaptation applies to reversible changes in structures or behaviors within individual systems.
Evolution describes the process of selecting which systems are the most fit among individuals over time. Individual organisms may change and adapt, but they do not evolve. Only species or groups of systems evolve over extended time periods.
Bitcoin adapted to increased demand for use of its blockchain which led to rising transaction fees by allocating resources towards the development of the lightning network. The lightning network is a decentralized system that uses the Bitcoin blockchain as a mechanism for securing “off-chain” micropayments between users. It allows Bitcoin users to experience instant payments, low transaction costs, smart contracts, and cross-blockchain functionality.
The crypto ecosystem as a whole evolved when Ethereum was created, giving blockchain developers the necessary tools and freedom to easily build whatever sort of programs they wanted on a blockchain, not just currencies.
Selection is the process in which the environment gradually passes judgment on the fitness of a system. Fit systems that have the qualities necessary to grow and adapt within their environment survive and propagate more of their kind into the future. Unfit systems which struggle to survive lose out to competing systems and eventually die off.
Gitcoin’s Kevin Owocki points out that, “natural ecosystems are evolutionary and powered by natural selection. Similarly, Web3 is an evolutionary ecosystem powered by market selection.”
We can observe the market selection process by looking at how the composition of the top 10 cryptoassets has changed over the years. In September of 2014, Bitcoin and Litecoin were the top two cryptocurrencies as measured by market capitalization (price of a coin multiplied by the total units of that coin in circulation.) Ethereum didn’t exist.
Fast forward to March of 2017 and Ethereum has arrived on the scene and secured the number two spot, with Litecoin falling down to number six. Previous heavyweights like Peercoin, Namecoin, and Dogecoin are nowhere to be found.
In January 2020, Bitcoin and Ethereum were still on top. Aside from Ripple and Litecoin, the rest of the top 10 is filled with newcomers.
Today, Bitcoin and Ethereum remain dominant, maintaining a firm grip on their top spots. The rest of the top 10 consists of a mixture of some winners from 2020 along with newcomers.
Selection is a process in which combinations of subsystems that prove beneficial are favored in the long run, whether by reproductive fitness, business success, or ecosystem stability. Bitcoin and Ethereum have demonstrated fitness where many others have failed.
“If we speed run this ecosystem evolution, we see the degenerative species (which by definition are short term greedy, but over long term tend to self terminate) collapse, and we see the regenerative species (which are long term greedy, resistant to shock, and grow over time) grow. Cast the dice 1000 times, the results will be the same each time!” – Kevin Owocki
In biological systems, mutations are the inevitable errors that occur during the process of systems (such as cells or DNA) making copies of structures in order to replicate them.
Human organizations, unlike biological systems, can consciously alter a system if they believe it might improve its functioning. Humans have a unique capacity to anticipate the future and act strategically to meet their desires.
There are two different types of forks in crypto. Soft forks are upgrades to existing blockchains that bring new functionality. Hard forks create code changes that are so significant that the new software is no longer compatible with the old software, leading to the creation of a new blockchain.
Both Bitcoin and Ethereum have a long and rich history of soft forks being used to improve functionality, and hard forks arising when internal disagreements have led to groups creating new blockchains that are more aligned with their goals.
Sometimes the mutations result in powerful, widely adopted upgrades like Bitcoin’s Segwit, or Ethereum’s Merge. Sometimes they lead to the creation of new blockchains, like Bitcoin Cash or Ethereum Classic, which die off after an initial burst of activity and enthusiasm. There are also cases where new blockchains manage to find fitness within a certain niche, like Dogecoin and Litecoin which are Bitcoin forks.
Emergence occurs when new forms or levels of organization, such as new properties or functions, arise within a system. Emergent entities have unique properties which cannot be found in any of their individual parts. The phenomena of emergence explains how new functions come into existence.
When Vitalik Buterin, college-dropout, Thiel fellow, and co-founder of Bitcoin Magazine realized that Bitcoin was too inflexible to support his creative ambitions, he outlined a vision for Ethereum.
Ethereum aimed to be “an alternative protocol for building decentralized applications” and “to provide [a] blockchain with a built-in fully fledged Turing-complete programming language.”
It would have “vastly more power than that offered by Bitcoin scripting because of the added powers of Turing-completeness, value-awareness, blockchain-awareness and state.” It would support the creation of “smart contracts, cryptographic ‘boxes’ that contain value and only unlock it if certain conditions are met that could be created “simply by writing up the logic in a few lines of code.”
Buterin laid the foundations necessary for blockchain technology, web3, and crypto as a broad social phenomenon much larger than Bitcoin to emerge. Ethereum was an emergent phenomenon within the blockchain ecosystem because it introduced new functionality and allowed programmers to build complex applications on blockchains in a way that simply wasn’t possible before. Because of Ethereum’s flexibility and capacity to support the development of complex applications, it led to a variety of novel and surprising applications emerging.
“NFTs are probably the one thing that I did not predict, by the way. If you look at the list of applications that were in the Ethereum Whitepaper, and you look at the applications that are popular today, the big thing that's in the second list and not the first is NFTs.” – Vitalik Buterin
No one saw Cryptokitties coming. The game put NFTS on the map by gaining traction among normal consumers who typically didn’t care about crypto and clogging up Ethereum’s network with increased demand leading to high transaction fees.
Competition, Cooperation, and Coordination
Competition occurs when different systems that require the same resource must fight to acquire what they need. When resources are abundant and entities are scarce, competition isn’t a strong selection factor. But when resources are sparse or there are too many entities competing for what is there, then competition becomes a very strong selection factor. The benefit of competition is that through selection pressures, it improves the fitness of various systems over time.
Crypto projects compete with each other for various forms of resources such as funding, talent, and attention. There will also be new competition emerging between decentralized, open-source cryptoassets and the centralized digital currencies that are being deployed by central banks around the world.
Cooperation occurs when systems send and receive messages to one another in order to facilitate the exchange of material, energy, or information. It is an important mechanism for coordinating activities between systems.
MakerDAO and Aave are two projects that compete within the same market with similar product offerings while still finding ways to cooperate.
Maker’s core product is the DAI stablecoin which avoids volatility by maintaining a peg to the U.S. Dollar. Aave’s core product is a decentralized lending protocol that allows lenders and borrowers to loan out money and borrow with their interactions being managed by smart contracts instead of a corporation.
Maker forked Aave in February to launch its own Spark lending protocol. Maker, acknowledging the fact that Spark wouldn’t be possible without Aave, will be paying 10% of all profits from Spark to Aave until August 2025.
The two projects cooperate by exchanging code and money in order to work towards their shared goal of shifting society towards more decentralized financial infrastructure.
Coordination is the process of organizing the behavior of systems to ensure they work together effectively.
Coordination between a system and its environment is called tactics. When demand for DAI started to drop, the organization made a tactical decision to raise the DAI savings rate to 8% . This resulted in an immediate increased demand for DAI and surging revenues for the Maker Protocol.
Coordination that takes place over long time horizons to develop adaptive responses in response to a changing environment is called strategy. Last summer, MakerDAO founder Rune Christensen unveiled his vision for Maker Endgame, a strategic proposal designed to transform Maker “from an unclear structure towards a reality where all aspects of MakerDAO are well documented and understood, and operate based on defensible incentives and derisked processes.”
When there are many systems attempting to cooperate there is a need for a special type of decision making entity to coordinate them. A hierarchical, cybernetic system is needed to process much more information than the individual entities could manage.
When DAI launched in 2017 it was an ambitious experiment. Today, it is a giant within the world of decentralized finance that many people, protocols, and organizations across the world depend on. As MakerDAO grew, its various decentralized governance structures and subsystems became unwieldy.
The Endgame Plan is an effort to develop the necessary control and coordination structures that will enable MakerDAO to continue thriving into the future.
Looking at the evolution of MakerDAO over time shows us that while decentralization can be an asset, any complex adaptive system requires some degree of top-down hierarchical control to operate effectively. With cryptoeconomic systems we get to see how these control systems can emerge based on the needs of the system and be voted on and approved by system stakeholders rather than being arbitrarily imposed through sheer will and force by a select few.
Systems scientists need to constantly be aware that the systems they study are subject to a variety of evolutionary pressures. Understanding evolutionary pressures is vital to making sense of systems.
Adaptation is what allows a system to react and respond to its environment. The process of selection kills off the weak and propagates the qualities of the strong. Mutation introduces variations and changes, some of which are beneficial and others harmful. New functionalities, behaviors, and properties come into being via emergence. Competition, cooperation, and coordination determine how resources are allocated and which systems achieve their goals.
Failure to pay attention to evolutionary processes across time can cause our models to become inaccurate and outdated. Many changes within a system are the result of environmental changes and external pressures. If these factors aren’t considered, your perception of what a system is will be distorted. You may be seeing the system as it was, not as it is or is in the process of becoming.
As I argued last week, cryptoeconomic systems are the perfect space to observe these dynamics at play.
“In abundant times, 100s of experiments will blossom. In scarce times, 97% will fail. But the 3% that survive will be the keystone species of the next boom. Innovate, iterate, evolve, repeat. It’s elegant, even beautiful!” – Kevin Owocki