The firm has historically exploited trust arbitrage, especially true for wealth managers. Autocracies, a beneficiary of trust arbitrage, lost ground to democracy when the “founding fathers” endowed certain rights to the individual. We argue that blockchain innovations potentially bestow the same attributes to economic agents at an atomic level, thus reducing the impact of trust arbitrage. If and when that happens, performance and client service remain the two levers a wealth manager can work with. Will it be back to the basics or the doomsday ahead for today’s wealth managers?

The concept of the company, “the firm”, persists and prospers even when other authoritarian experiments have failed in history. Utopian visions of “productive agents” coming together to perform one economic task only to regroup thereafter has not happened, even in a “networked/connected economy”. It has been a secular trend that authoritarian constructs have given way to political constructs that explicitly allow for reasonably free association and commerce. Public space is by and for the people.

It can be argued that many public goods could, individually, be produced by profit-seeking private entities more efficiently. That said, nobody wants a return to authoritarian disbursal of essential public goods – no privatized police or judiciary is contemplated.

The firm as an autocratic construct prospers in the economic domain. This is because the founding fathers caused a rupture by granting a few rights that we hold so dear. We will argue further that the latest technological advancements, especially in the blockchain space, will make a similar disruption possible in the commercial sector.

Founding Fathers Ring the Death Knell for Autocracy with a Pen

The founding fathers gave individuals the right to determine their own destiny. The fathers bestowed on us an identity, a right to organize as we please, (in effect) an institutional memory to look back and take away lessons. Combined, we create reputation for and by ourselves, which in turn empowers us to choose our representatives.

• Right to freely assemble and organize. Existence of the manager precludes free organization, in turn the absence of free organizations necessitates supervision by managers.
• Self-sovereign identity. The individual is considered sacrosanct in a democracy – you do not have to depend on recognition by a ruling person/body.
• Institutional memory. The implicit or explicit authority to act on decisions essentially resides in the manager, the same as in feudal societies.

A self-sovereign identity is at the core of what the founding fathers did; they took the privilege away from the lordship. Complemented by institutional memory, hence the capacity to recognize what’s good for them, and the right to freely organize, people were truly empowered to be masters of their collective public domain. In our view, the same three self-enforcing themes, or specifically the lack thereof, bestowed the firm with the power to prosper against reasonable odds.

The Story of the Firm, as Told by Economists

The firm is notorious for the inefficiencies it represents. Economists have tried to explain why.

Ronald Coase¹ (and subsequently others) attributed the success to a cost–benefit analysis. Costs were classified as

• information/search cost
• contracting cost
• cost of administration/allocation of resources.

Technology has already reduced the comparative advantage the firm enjoyed on two of these. Information/search cost has been minimized with Google (for example) – equally available to a firm and outside. Contracting cost – the cost to enforce and supervise execution per terms agreed – is arguably lower outside a firm for most plain vanilla economic transactions. The firm fosters inefficiencies, not the opposite.

Allocation of resources is the single biggest argument for the firm to exist, thereby raising questions of agency costs (e.g. Holmstrom,² Jensen and Meckling³). The market allocates resources most efficiently wherever there is a price. Arguably, within the firm there is no clear quantifiable metric for most purposes. The “manager” is tasked to allocate resources (tasks) because the effect of individual decisions towards the objective of the firm (profit maximization) may not be immediately evident.

In our view, the “manager” represents the “lord” in an autocratic political system. The manager holds the same power of resource allocation, including preservation of memories, recognition of identities and intermediation of most commercial activities within the borders. These powers are mutually self-enforcing, and the efficiency of management is often hard to judge.

Blockchain Innovations Can Make the Firm Feel the Pain

Blockchain innovations replicate in the digital world the rights that the founding fathers bestowed on us.

• Capacity to freely assemble and organize. Exciting new work is being done in the blockchain space in this area. Protocols developed at the MIT Media Lab and elsewhere make it technologically possible for a decentralized autonomous organization (DAO) to form teams, who will themselves have the power to associate and organize. In addition, these teams have the power to execute smart contracts that can be written as an overlay, just as in the “real” world.
• Self-sovereign identity. Identity is derived from our past and memory of the same. Every agent in a digital ecosystem has the power to be whatever they want to be, so long as their subsequent actions validate their identity.
• Indelible memory. Blockchain, by design, endows systems with the power to remember. It is the invisible secret sauce that binds everything – providing recognition to enable a self-sovereign identity.

A parallel can be drawn between the rights the founding fathers gave us and the attributes blockchain promises for an economic agent in the digital world. Autocratic regimes crumbled in front of these three rights, while the absence of the same allowed companies to exploit a trust arbitrage. It is highly likely that traditional company structures and management layers will become obsolete.

Wealth Managers are Especially Vulnerable to – and Benefit from – Trust Arbitrage

For wealth managers, trust arbitrage has been absolutely essential for their business. As a result, this makes them particularly more vulnerable.

• Sine qua non. Hand me your money smilingly, said no (wo)man ever – except your wealth manager.
• Perception. Wealth managers are good at creating an aura of aspirational quality. Not that there’s anything wrong with that, but the reality does not always match the customer’s expectations.
• The good steward. All things considered, the main value proposition of wealth managers still remains a claim to be “the good steward” of client capital, as evidenced by safety and reasonable growth.

Metrics of reasonable growth abound; academia and practitioner associations proffer many that are suitable for various client profiles. However, business realities creep in, and delivering consistently on the metrics of being “a good steward” is nearly impossible. Which leads us back to the trust arbitrage question – if true alignment of interests is hard to find, how do we cultivate trust by our clients?

Smaller Wealth Managers are Getting a Raw Deal

When trust is difficult to attain – and harder to communicate coherently – selecting large, established brand names becomes the default option.

• History is hard. One day at a time takes many days for history to be built – especially when you are young.
• Façade is easier. A good fall-back option is to create a façade giving clients a misleading or not completely accurate impression of one’s true capabilities.
• Performance is the hardest. The good steward high-water is the hardest to maintain.

Even if a wealth manager is a good steward, the manager has to compete with the asset management leaders in the industry. It takes years for small investment managers to truly achieve scale and run a profitable business – thereby preventing entrepreneurial ventures.

The creative juices of American capitalism are being squeezed out, especially for new traditional and alternative wealth managers.

What If…

What if blockchain were to unravel trust arbitrage? Smaller investment managers could grow faster and customers could be in a better position overall.

• The brash and the beautiful. Self-sovereign identity will help the newcomer, the brash and the beautiful power to compete with the incumbent on the basis of performance metrics mostly.
• The cream shall rise to the top. Even in established firms, the performing few will have no reason to be in the company of a crowd that makes the herd. Firms as an association of many diverse people may exist only as an insurance mechanism, protecting all members against turns of the tide they have no control over.
• Abundance to choose from. For consumers, it shall be an abundant offering. Some operators may not survive the test of time. Notwithstanding, whoever survives will be there because they offered tangible value to the client.

In other words, blockchain innovations will disrupt the market as we know it. We will move to granular levels of tangible value added for customers. Creative destruction had no better example than this.

Predictions are Difficult, Especially About the Future

• We predict that firms as a powerhouse of economic systems will be disrupted as blockchain takes away their raison d’être and capacity to exploit trust arbitrage. Further, wealth managers will be impacted because they have nowhere to hide but behind their performance, which has often not outperformed their peers or the index. In a world where digital and real existences merge, who says your next wealth manager will not be a machine?