Shun Yiu, PhD Candidate, The Wharton School; Matthew Bidwell, Management, The Wharton School
Abstract: Algorithms play an increasingly important role in today’s digital economy. An emerging view highlighted the viability of utilizing algorithms as a governance device. With innovations in blockchain infrastructure and smart contracts algorithms, platforms can delegate formal authority to exchange partners and involve them in organizational decision-making processes. While some are optimistic that this governance innovation can bring about a more collaborative and democratic digital economy, this paper highlights potential challenges associated with decentralized governance systems. I argue that decentralized governance shifts the locus of opportunism from platform owners to a body of diffuse exchange partners. Appropriation no longer come from platform owners only, but also existing and potential exchange partners who have or could acquire formal authority. This introduces heterogeneity in exchange partners’ exposure to appropriation hazard, leading to selective disengagement from platform participation. I examine these arguments with the staggered adoption of decentralized governance structures among a large sample of exchange platforms in the decentralized finance industry. I analyze depositors’ response to policy change from exchange platforms and find that the adoption of decentralized governance has a negative effect on participation among depositors. This negative effect is primarily driven by depositors with intermediate levels of investments. As a result of the overall decline in participation and hollowing out dynamics, participation became more concentrated following the adoption of decentralized governance. These results highlight the perhaps surprising centralization tendency of a decentralized governance system.