Big Wheels Keep on Turning
Vol #77: April 15th, 2022
Perpetual motion is a fiction, but flywheels are a fact we can believe in.
Whether economic or mechanical, a flywheel is an apparatus that supports, sustains, and amplifies the power derived from its energy source. Storing the kinetic energy of a steam engine or the goodwill of a brand, a flywheel harnesses this inertia and channels it back into further momentum.
The simplest and perhaps one of the oldest examples of flywheel design can be found in a pottery wheel. Using a foot pedal to spin a crank, a potter is able to turn the wheel under his clay such that he can mold a perfectly round vessel. No matter how good our internal metronome is, the rhythm will be somewhat erratic, and the weight of the wheel absorbs this erratic energy and smooths out the rotation.
While there were several mechanical applications as early as the 11th century, the Industrial Revolution saw an explosion of use cases. Steam engines, tractors, and heavy machinery of all types took advantage of the energy storage and distribution benefits of a flywheel.
In physics terms, a flywheel can be thought of as an “accumulator”. It acts as a well to store the intermittent energy of its power source, smoothing the delivery, and also able to unleash power surges that vastly exceed the capacity of the original source.
The softer sciences have co-opted this design, and apply the virtuous circle to economic or marketing systems. While they are not as tightly closed as a well designed mechanical system, an organization can build a self-sustaining sales cycle through flywheel marketing.
The theory goes that in order to further the sales growth of a business, the entire organization must focus on delivering a customer experience that makes other customers want to sing the product's praises and evangelize to their networks. Customers become promoters, who draw in new prospects that themselves become enthusiastic customers.
We can even talk about geopolitical flywheels, where the US dollar is arguably one of the greatest flywheels ever designed. Anchoring the global financial system through the petrodollar, the bid for greenbacks is a bottomless well. An inelastic and counter cyclical demand for US currency to buy oil, supports the value of the dollar and insures low cost access for Americans to global markets. This further instills confidence in the dollar and supports its global reserve status.
Whether it's the physical conservation of energy, growing a business, or maintaining hegemony, a flywheel supports an energy or economic moat. This can’t happen spontaneously though, and something needs to propel the flywheel into orbit. A satellite can circle the earth for decades, but first it needs to cross the Kármán line and officially enter outer space. It takes approximately 30 times more energy to reach orbital velocity than it does to get into outer space in the first place.
Traditional businesses can defend their moat and capture value through privileged access to some kind of resource - talent, capital, customers, etc. Technology - particularly distributed ledger technology - has dramatically reduced the depth of these moats. In the case of blockchains, their very ethos is permissionless access and open source code is a fundamental requirement.
So how does a blockchain create a flywheel and endogenous value?
At the most extreme end of the value spectrum you have hard assets like land or gold. These store value no matter what the unit of account is. Physical money started as metal currency that could be melted into something useful. Initially paper money was simply a representation of a claim on that physical asset. When the gold standard was dropped by Nixon, value became a mutually agreed upon fiction.
The cost for the United States of creating that fiction was decades of economic positioning and the ultimate threat of military force. Rule of law and ability to enforce contracts is one of the fundamental prerequisites for creating scalable capitalism that relies on trust and fractional reserves.
While an asset backed currency can exist on the blockchain (e.g. USDC or USDT), a fully decentralized money must be both scalable and trustworthy to achieve widespread adoption and durability. The greater the momentum of that flywheel, the more trustworthy the issuances are, which ultimately supports the underlying protocol.
As with any new enterprise, a charismatic and visionary founder is table stakes for launch. She must attract a talented team and convince them of the future potential value of their efforts. Often supported by outside investors, the team must then execute on a product that is functional and attractive to other users. This inherently supports the value of the enterprise, drawing in more users and greater demand for the native token’s value.
As this cycle continues, there is greater and greater adoption, cementing the power of network effects and underpinning the value of the network’s token. With this backstop, the protocol or network can create issuance mechanisms for tokens that have a stable value, and become demanded for their collateralization and transfer use cases. If the flywheel can support that objective, it will draw in even more energy to support its accelerating growth.
There continue to be many experiments in the digital asset space which convert our traditional economic models into a decentralized one. UST, FRAX and USDN are all working to stake their claim here as independently scalable stablecoins supported by various different flywheels.
The larger and more efficient the flywheel, the greater its sphere of influence, and more likely it is to sustain itself. The trick is achieving escape, and orbital velocity.