[This article appears in the September-October 2015 issue of The Austrian.]

The costs of centralizing information are higher than people understand.

Until they have worked in actual organizations that have missions like fighting a war or making a profit, people tend to underestimate just how expensive it can be to centralize information.

If our mental picture of the world is like the pointy-haired manager in the Dilbert cartoons, we’ll tend to favor institutions where knowledge comes from the knowledge frontier, and is then moved to the central office where the managers sit and cogitate. The managers then push stupid orders back to the frontier.

And that pretty much describes the way collectivists want to organize the world.

They don’t want there to be peer-to-peer consent

because they think they can save a bunch of time and cost if everything can be centralized.

Hayek understood this well, especially in his 1945 article “The Use of Knowledge in Society.” This article influenced Thomas Sowell’s work in his books A Conflict of Visions and Knowledge and Decisions. And all of these works influenced me.

Thanks to the works of Hayek and Sowell, I’ve come to appreciate that whether we’re talking about business or social matters, life is all about avoiding the costs of centralizing information to some higher power that then spits orders out.

How To Build Enduring Organizations that Use Decentralized Information

I know the last thing I want to be is the Dilbert [cartoon] manager who sits in the corner and thinks he has all the answers. I know the smart people are on the front lines; the smart people with the ideas; the smart people who understand the marketplace and customer. So my job is

building institutions that let that distributed intelligence express itself.

So, in my businesses, I have built various mechanisms that let innovation come from the front lines, from customer agents, from people in marketing.

I want an institution that can let the knowledge of 2,000 colleagues form the new ideas, and their colleagues can work together to decide how to use the knowledge.

I want a system to crowdsource innovation. The wisdom of crowds is smarter, and more consistently intelligent, than any single person.

As owner I must sometimes say “I think you got that wrong, I have to veto you.” And by its nature, sometimes, employees, for legal reasons, can’t know everything about the company. But for the most part, I can let the company run, and by giving the employees what they need, they just get smarter and smarter, and do more and more.

There’s a field that evolved in the last seven years called Enterprise 2.0. The idea is to use online technology to keep organizations flat and to avoid hierarchy — and people collaborate through technology. A very simple example of this model is Wikipedia, and closely related to this is a field called “idea management.” Think of it as a super-sophisticated suggestion box in which people are making suggestions and other people are seeing their suggestions. People then vote others’ suggestions up and down. For example, suppose 200 ideas get proposed over a two-month period. Using idea management, we then have the crowd decide the best ten. And then we have the crowd rank them and decide which are best and which we should put capital into.

Here’s another example: at the end of last year, I knew I wanted to give my employees a $4 million raise. They had many suggestions including changes to the 401k, an addition of day care services, or just a simple pay raise. I gave their ideas to the accounting department to figure out what each one would cost. We put a price tag on each one, and I gave the list back to the 2,000 employees. They ranked each, and we ended up with a ranking, and we went down from the top, until we got to $4 million.

So more and more decisions are being made in our company, not by me, but by our people in general. The philosophy underlying this all comes from Hayek and Mises — the true knowledge among our colleagues is all out there.

I’ve got the staff that can figure out what each option will cost. But the truth is I don’t know which one is going to work, but I have found that when I turn that over to the group, the result is more intelligent than the executive group can do or what I can do by myself.

Why We Have Centralized Government Institutions

Naturally, this has applications far beyond some private companies. When we look at government in Washington, or what’s happening on Wall Street, we see so much centralization. But really, our goals should be to eliminate and overcome these central institutions.

And in recent years we have gained powerful new tools to do this, and most significant among those is the block chain, which is the software behind Bitcoin. But it’s so much bigger than just Bitcoin.

I’m not sure that even in our pro-freedom movement, that people are understanding the significance of the block chain. I discussed the topic at length in Wired, but even more important was a recent article in Politico in which my work with the block chain was featured, as was the central problem of consensual exchange in the marketplace.

This is where the block chain is most useful and revolutionary. It helps us to overcome the problem of mutual trust in exchange, which will in turn make many of our modern central institutions unnecessary.

So what is this problem of trust in mutual exchange? Well, if I have a camel and you’re going to give me a gold coin in exchange for it, I have to trust that you did not debase this coin.

Certain groups will then attempt to develop a business model that can address this problem. For example, an organization (i.e., a monarch) that has a monopoly on violence in some area can monetize this monopoly by saying “I will mint gold coins and put my face on them, and if anyone tries to debase those coins, I’ll kill him.”

That’s just a business model, and we happen to call that business model “government.”

So the question is: can we just have consensual exchange, or do we have to pick some central institution that we can trust, so we don’t have to trust each other?

There are, of course, many other examples of the usefulness of central institutions in exchange. If we want to buy and sell land, and we don’t trust each other, we can use a central institution called a land title office, which will ensure that the sellers actually own the land they’re selling. Governments all across the world are involved in this every day. And as Hernando de Soto discussed in his book The Mystery of Capital, it is difficult to have capital formation when you don’t know for sure who owns what.

So, throughout human history, we have relied on these central institutions to help us overcome this problem of trust in exchange.

But, as we know, there are problems that arise from these systems, as well.

Decentralizing Wall Street

Not all of these central institutions are what we call government. Yes, many of these institutions are run by guys in two-piece suits in Washington. And some are run by guys in black robes. Some are done by people with badges and guns. But many of them are done by guys in three-piece suits on Wall Street.

Wall Street, however, is not immune to fraud and abuse, and this problem is often made worse by centralization. But most people don’t know how these central institutions work.

When you watch a movie, for example, you know there are things going on behind the scenes, and you probably assume the same is true for Wall Street. But on Wall Street, that behind-the-scenes stuff works a lot differently than you think it does.

Unbeknownst to many, Wall Street now relies on central institutions that were created in the 1970s all allegedly with the purpose of accomplishing what’s called “settlement” which is the process through which securities actually change hands in exchange for payment.

These central institutions were created to replace the old “stock-jobbers” who carried around sacks of stock certificates in the old days, but who couldn’t keep up with the tripling of trading volume that occurred during the 1960s.

So we now have these central institutions that handle the problem of settlement by controlling the flow of information and the stocks themselves. But new problems have arisen as a result. As of 2008, for example, it was quite possible that Merrill Lynch was sending you a statement at the end of the month saying you own 100 shares of IBM, and other people saying the same thing. But back at Merrill Lynch, they only had 100 shares. They were telling five different people they had 100 shares.

On most days that won’t make a difference. But deep down that’s a game that looks a lot like fractional reserve banking.

And as a result, the system was being looted, and just like if someone practiced fractional reserve banking and wasn’t telling anyone, someone could loot that vault and take advantage of investors for a long time before anyone noticed.

And just in general, this is what happens when you have centralized institutions.

Getting Rid of Centralization

The key to overcoming the problems in these central institutions is the block chain. Because, with the block chain, for the first time, we no longer need these central institutions for settlement, or for guaranteeing the value of coins, or for land titling. All of these functions can be replaced by a transparent public ledger that is safe from tampering, and which can make value and ownership clear and open for everyone. This is information that is decentralized, and is not controlled by any central organization. We don’t need central institutions to control or protect this information anymore. Using the block chain, we can disrupt all these systems — and much more, too — and the institutions behind them. In turn, this spreads decision-making and the use of knowledge to a much larger number of people and institutions. The advantages of decentralization that are already being employed in private companies can then be felt society-wide.

In other words, with the block chain, we liberals — those of us who have been fighting authoritarianism, whether it’s socialism or fascism or “social justice-ism,” for 500 years — just got “the bomb” in this fight. It’s something new.

And this is why the block chain and I got so much attention in response to that recent Politico article. I was told that the article was being talked about all over Washington. And they were talking about it because these institutions that are threatened by the block chain have finally figured out that they’re in trouble.

The CEO of JPMorgan, Jamie Dimon, for example, wrote a letter to shareholders in April that basically freaked out over the block chain. He told shareholders that “Silicon Valley is coming to eat Wall Street’s lunch.” Since he did that, everybody on Wall Street in the last three months — it seems every day, there is a new announcement coming from another corporation — whether UBS, Credit Suisse, Morgan Stanley, saying “we have to study this and get involved.”

But it’s too late for them. A year and a half ago, we started on this, and we’ve been very aggressive about developing new systems that can challenge these old central institutions.

I’m not doing this because I want to create a new monopoly. On the contrary, I want to create a bomb to blow up these central institutions.

Whether it’s a single company, or a stock exchange, or an entire society, we know — thanks to Hayek — that information is best used when it’s not centralized and when it’s not being monopolized by some central institution.

We know that flat and non-hierarchical systems use information best. I’ve tried to do that with my own company because it works better that way. And society at large will work better as well, if we can get rid of these old institutions and hierarchies. New innovations like the block chain can make this possible.

We knew when the internet was being created, that it was going to cause profound changes. But this new invention and the crypto revolution is going to be more significant than the internet itself.