Blockchain Governance: What we can Learn from the Economics of Corporate Governance

With Darcy Allen

Abstract: Understanding the considerations and complexities of blockchain governance is urgent. The aim of this paper is to draw on institutional governance theory—including corporate governance—to provide insights into the core considerations in designing blockchain governance mechanisms. We define blockchain governance are the processes by which stakeholders (those who are affected by and can affect the network) exercise bargaining power over the network. The main considerations include how we define stakeholders in blockchain governance, how the consensus mechanism itself distributes endogenous bargaining power between those stakeholders, the role of exogenous governance mechanisms and institutional frameworks, and the needs for bootstrapping. While we can learn from corporate and internet governance, blockchain governance should be understood as being an institutionally distinct organisational form with distinct governance systems.

Available at SSRN.

Proof of work as a three sided market

With Sinclair Davidson and Jason Potts. Published in Frontiers in Blockchain, 2020. doi: 10.3389/fbloc.2020.00002

Abstract: Blockchain technology is the distributed, decentralised ledger technology underlying Bitcoin and other cryptocurrencies. We apply Oliver Williamson’s transactions cost analysis to the blockchain consensus mechanism. Blockchains reduce the costs of opportunism but are not ‘trustless’. We show that blockchains are trust machines. Blockchains are platforms for three-sided bargaining that convert energy-intensive computation into economically-valuable trust.

Available here.

Automating the big state will need more than computers

Robodebt – the automated Centrelink debt issuance program that was found invalid by a federal court last month – is not just an embarrassment for the government. It is the first truly twenty-first century administrative policy debacle.

Australian governments and regulators increasingly want to automate public administrative processes and regulatory compliance, taking advantage of new generations of technologies like artificial intelligence and blockchain to provide better services and controls with lower bureaucratic costs. There are good reasons for this. But our would-be reformers will need to study how robodebt went wrong if they want to get automation right.

The robodebt program (officially described as a new online compliance intervention system) was established in 2016 to automate the monitoring and enforcement of welfare fraud. Robodebt compared an individual’s historical Centrelink payments with their averaged historical income (according to tax returns held by the Australian Taxation Office). If the Centrelink recipient had earned more money than they were entitled to under Centrelink rules, then the system automatically issued a debt notice.

That was how it was supposed to work. In practice robodebt was poorly designed, sending out notices when no debt actually existed. Around 20 per cent of debts issued were eventually waived or reduced. The fact that those who bore the brunt of these errors had limited financial resources to contest their debts contributed to robodebt’s cruelty. In November, the federal court declared that debts calculated using the income average approach had not been validly made, and the government has now abandoned the approach.

Automation in government has a lot of promise, and a lot of advocates. Urban planners are increasingly using AI to predict and affect transport flows. The Australian Senate is inquiring into the use of technology for regulatory compliance (‘regtech’) particularly in the finance sector. Some regulatory frameworks are so byzantine that regulated firms have to use frontier technologies just to meet bare compliance rules: Australia’s adoption of the Basel II capital accords led to major changes in IT systems. And the open banking standards being developed by CSIRO’s Data61 promise deeper technological integration between private and public sectors.

Regulatory compliance costs can be incredibly high. The Institute of Public Affairs has estimated that red tape costs the economy around 11 per cent of GDP in foregone output. The cost of public administration to the taxpayer is considerably more. Anything that lowers these costs is desirable.

But robodebt shows us how attempts to reduce the cost of administration and regulatory compliance can be harmful when done incompetently. The reason is built into the modern philosophy of government.

Economists distinguish between administrative regimes governed by discretion and those governed by rules. The prototypical example here is monetary policy. Rules-based monetary policies, where central banks are required to meet targets fixed in advance, are less flexible (as the RBA, which has consistently failed to meet its inflation target is keenly aware) but at the same time provide a lot more certainty to the economy. And while discretionary regimes are flexible, they also vest a lot of power in unelected bureaucrats and regulators, which comes at the cost of democratic legitimacy.

Automation in government is possible when we have clear rules that can be automated. If we are going to build administrative and compliance processes into code, we need to be very specific about what those processes actually are. But since the sharp growth of the regulatory state in the 1980s governments have increasingly relied less on rules and more on discretion. ASIC’s shrinks-in-the-boardroom approach to corporate governance is almost a parody of the discretionary style.

The program of automating public administration is therefore a massive task of converting – or at least adapting – decades of built up discretionary systems into rules-based ones. This was where robodebt fell over. Before robodebt, individual human bureaucrats had to manually process welfare compliance, which gave them some discretion to second-guess whether debt notices should be sent. Automating the process removed that discretion.

The move from discretion to rules is, to be clear, a task very much worth doing. Discretionary administration feeds economic uncertainty, and ultimately lowers economic growth. We have a historically unique opportunity to reduce the regulatory burden and reassert democratic control over the non-democratic regulatory empires that have been building up.

Of course, public administration-by-algorithm is only as effective (or fair, or just, or efficient) as those who write the algorithm build it to be. There’s a lot of discussion at the moment in technology circles about AI bias. But biased or counterproductive administrative systems are not a new problem. Even the best-intentioned regulations can be harmful if poorly designed, or if bureaucrats decide to use discretion in their interest rather than the public interest.

Robodebt failed because of an incompetent attempt to change a discretionary system to a rules-based system, which was then compounded by political disregard for the effect of policy on welfare recipients. But robodebt is also a warning for the rest of government. The benefits of technology for public administration won’t be quickly or easily realised.

Because when we talk about public sector automation, we’re not just talking about a technical upgrade. We’re talking about an overhaul of the regulatory state itself.

Blockchain technology as economic infrastructure: Revisiting the electronic markets hypothesis

With Sinclair Davidson and Jason Potts. Published in Frontiers in Blockchain (2019)

Abstract: In the late 1980s and early 1990s the electronic markets hypothesis offered a prediction about effect of information technology on industrial organisation, and many business writers forecast significant changes to the shape and nature of the firm. However, these changes did not come to pass. This paper provides an economic analysis of why, using the transaction cost economic framework of Ronald Coase and Oliver Williamson. Non-hierarchical corporate organisation struggled against contracting problems in the presence of possible opportunistic behaviour. Technologies of trust offer an institutional mechanism that acts on the margin of trust, suppressing opportunism. The paper concludes that blockchain technology provides an economic infrastructure for the coordination of economic activity and the possible realisation of the electronic markets hypothesis.

Available at Frontiers in Blockchain

Christian Porter’s defamation reform would be a catastrophic mistake

With Aaron M Lane

Attorney-General Christian Porter wants social media platforms like Twitter and Facebook to be legally liable for defamatory comments made by their users.

Right now, the common law can distinguish between the legal liability of active publishers of information (like newspapers and broadcasters) and the passive platform operators that allow users to publish information themselves. Courts decide where this distinction is drawn according the unique facts of each case.

But in a speech to the National Press Club on Wednesday, the Attorney-General declared he wants to eliminate the distinction altogether: “Online platforms should be held to essentially the same standards as other publishers.”

The Attorney-General’s proposal is fundamentally confused. Removing the distinction between digital platforms and newspapers would have a devastating effect on both those platforms and our ability to communicate with each other.

The proposal is bad on its merits. But even besides that, the conservative government needs to understand how destructive it would be to the conservative movement online.

Let’s start with the legal principles. It makes sense that newspapers and broadcasters are liable for what they publish. They actively commission and produce the content that appears on their services. They read it, edit it, arrange and curate it. They pay for it. Newspapers and broadcasters have not only an editorial voice, but complete editorial control. Indeed, it is this close supervision of what they publish that gives them strength in the marketplace of ideas.

Social media platforms do nothing of the sort. Not only do they not commission the content that appears on our newsfeeds (let alone read, factcheck, or edit that content), they don’t typically confirm that their users are even real people – not, say, bots or foreign impersonators. They merely provide a platform for us to communicate with each other. Social media has facilitated a massive, global conversation. But it has no editorial voice.

In the United States a parallel debate is going on among Republicans about whether Section 230 of the Communications Decency Act – which explicitly prevents courts from treating ‘interactive computer services’ as publishers or speakers for the purpose of legal liability – should be abolished.

Section 230 has variously been described by scholars and commentators as “the 26 words that created the internet” or the “the internet’s first amendment”. The internet law professor Jeff Kosseff writes that eliminating this provision would “turn the internet into a closed, one-way street”. Attorney-General Porter’s proposal would have the same effect.

If social media platforms have to bear legal responsibility for what their users say, they will assume editorial responsibility for it. That means editing, deleting, and blocking all content that could be even the least bit legally questionable.

Newspapers and broadcasters sometimes take calculated risks with what they print, if they believe that the information they reveal is in the public interest. But why would a technological company – a company that lacks an editorial voice or the journalistic vision – be anything but hypercautious? Why wouldn’t it delete anything and everything with even the slightest risk?

And here is where the practical politics comes in. Even if the Attorney-General’s proposal was a good idea in principle, this policy would be particularly devastating for the conservative movement that supports his government. Indeed, it is hard to imagine a legislative proposal that would more effectively, and immediately, cut down the Australian conservative movement online.

After all, what side of politics benefits most from the political diversity and openness of the modern internet? What side of politics has relied most on the internet’s ability to bypass traditional media gateways? It is difficult to imagine the conservative political surge in recent years without social media – without Facebook, Twitter, YouTube, and all those podcast platforms.

If conservatives are concerned about social media networks “censoring” conservative content on their services now, well, making them liable for everything conservatives say would supercharge that.

And why would this policy stop at defamation laws? Why wouldn’t it also apply to liabilities around, say, Section 18C of the Racial Discrimination Act? Or our sedition laws? We are looking at a future where technology companies in California (companies that many conservatives believe are stacked with culturally left employees) could be required to second-guess how the most left-wing judges in Australia might enforce this country’s draconian anti-speech restrictions.

The Coalition government should also reflect on how some of its most recent legislative programs have backfired on conservatives. The Foreign Influence Transparency Scheme, passed in 2018 in order to tackle Chinese interference in Australian politics, is now being used to target the organiser of the Australian Conservative Political Action Conference, Andrew Cooper, and even Tony Abbott.

The Attorney-General is right that defamation law needs reform. Australia’s defamation framework is heavy-handed and disproportionately favours private reputation over the public need to discuss significant issues. But removing the courts’ ability to determine liability for defamation – and instead deputising the world’s technology companies to enforce what they imagine it could be – would be a catastrophic mistake.

The Crypto-Circular Economy

With Darcy WE Allen and Jason Potts. Originally a Medium post

If we are going to realise the environmental vision of the circular economy, we need to first think of it as an entrepreneurial economy.

In PIG 05049 the artist Christien Meindertsma shows how the parts of a slaughtered pig get reused downstream. For instance, gelatine derived from the skin ends up in wine, acids from bone fat end up in paint, and pig hair ends up in fertiliser.

The farmer sells what they can to retailers and sells the rest to other businesses, who then process and resell the what they can’t use to other users and businesses, who then process and resell the other parts … anyway you get it the point.

In a world of perfect information and zero-transaction costs this use and reuse would be trivial. The near infinite uses of pig parts would be immediately apparent to everyone in the economy and every part of the pig would be reallocated efficiently.

But of course we don’t live in a world of perfect information. All these reallocations have to be discovered by entrepreneurs and innovators.

PIG 05049 is a story of how resources move through the economy in surprising ways, as entrepreneurs reduce waste in the pursuit of profit.

But a circular economy makes stronger demands on us. The circular economy aspires not simply to minimise waste, but for goods to be “reused, repaired and recycled” after their first users no longer need them.

The circular economy imagines a world in which material goods are recovered, endlessly, and thus the environmental impact of the materials that we rely on for our prosperity is radically reduced.

It’s a powerful vision. But it is a hard vision to realise because transaction costs are not zero. Obviously, as goods travel through their life cycle they deteriorate. Goods get worn out, they rust, they fall apart.

But just as critical is the fact that information about the goods deteriorates as well. Product manuals get lost. Producers go out of business. Critical parts get separated. What the goods are made from is forgotten.

This information loss is a huge problem for the circular economy — it is very extremely expensive to reuse goods when we have lost information about what they are made of and how they work. This information entropy makes it hard for entrepreneurs and innovators to close the loop.

A circular economy with information entropy
This is what that looks like

In some previous work we’ve described a hypothetical “perfect ledger” where information is infinitely accessible, immediately retrievable, completely immutable, perfectly correspondent to reality, and permanently available. The perfect ledger is a thought experiment. It’s a thought experiment like an economy with perfect information or zero transaction costs that allows us to see how our imperfect world differs from an imaginary ideal.

And in a world of perfect ledgers, the circular economy’s information loop is completely closed. There is no information entropy — we never forget, so we can always reuse.

Blockchain technology of course is not a perfect ledger. But on many of the relevant margins, it offers a drastically improved way of managing information about goods as they travel through their lifecycle.

Information can be stored on a distributed ledger in a way that is resistant not only to later amendment, but that persists when it a good is passed from hand to hand, or travels across a political border, or when it is discontinued and forgotten by its designer, or when its original manufacturer goes out of business.

The information about the goods we have sitting on our desk, scattered around our homes and workplaces, built into our buildings, and powering our vehicles is being unpredictably but relentlessly lost. This is the blockchain opportunity for the circular economy. Blockchains can secure more information, better, more permanently and more accessibly about goods, so that they can be more efficiently reused.

And in conjunction with similar technological developments that reduce search costs — that is, that allow innovators to identify underutilised goods in the economy that could be bought and repurposed — the owners of goods will have increased incentivises to store and protect their property, if only to maximise the sale price.

The circular economy is often thought as a problem for governments to bring about. But if the circular economy is to be realised, we need to rethink the problem of waste and reuse as an environmental problem caused by an information problem.

Technological advances in the way we store and trust information offer a vision of large-scale, yet still bottom-up environmental improvements, where market incentives, price signals and contracting work to close the industrial loop.

Selling Your Data without Selling Your Soul: Privacy, Property, and the Platform Economy

With Sinclair Davidson

Executive summary: Humans have always sought to defend a zone of privacy around themselves—to protect their personal information, their intimate actions and relationships, and their thoughts and ideas from the scrutiny of others. However, it is now common to hear that thanks to digital technologies, we now have little expectation of privacy over our personal information.

Meanwhile, the economic value of personal information is rapidly growing as data becomes a key input to economic activity. A major driver of this change is the rise of a new form of business organization that has come to dominate the economy—platforms that can accumulate and store data and information are likely to make that data and information more valuable.

Given the growing economic importance of data, digital privacy has come to the fore as a major public policy issue. Yet, there is considerable confusion in public debates over the meaning of privacy and why it has become a public policy concern. A poor foundational understanding of privacy is likely to result in poor policy outcomes, including excessive regulatory costs, misallocated resources, and a failure to achieve intended goals.

This paper explores how to build a right to privacy that gives individuals more control over their personal data, and with it a choice about how much of their privacy to protect. It makes the case that privacy is an economic right that has largely not emerged in modern economies.

Regulatory attempts to improve individual control over personal information, such as the European Union’s General Data Protection Regulation (GDPR), have unintended consequences and are unlikely to achieve their goals. The GDPR is a quasi-global attempt to institute privacy protections over personal data through regulation. As an attempt to introduce a form of ownership over personal data, it is unwieldy and complex and unlikely to achieve its goals. The GDPR supplants the ongoing social negotiation around the appropriate ownership of personal data and presents a hurdle to future innovation.

In contrast to top-down approaches like the GDPR, the common law provides a framework for the discovery and evolution of rules around privacy. Under a common law approach, problems such as privacy are solved on a case-by-case basis, drawing on and building up a stock of precedent that has more fidelity to real-world dilemmas than do planned regulatory frameworks.

New technologies such as distributed ledger technology—blockchain—and advances in zero-knowledge proofs likewise provide an opportunity for entrepreneurs to improve privacy without top-down regulation and law.

Privacy is key to individual liberty. Individuals require control over their own private information in order to live autonomous and flourishing lives. While free individuals expose information about themselves in the course of social and economic activity, public policy should strive to ensure they do so only with their own implied or explicit consent.

The ideal public policy setting is one in which individuals have property rights over personal information and can control and monetize their own data. The common law, thanks to its case-by-case, evolutionary nature, is more likely to provide a sustainable and adaptive framework by which we can approach data privacy questions.

Published by the Competitive Enterprise Institute

Capitalism after Satoshi

With Sinclair Davidson and Jason Potts. Published in the Journal of Entrepreneurship and Public Policy (2019).

Purpose: The purpose of this paper is to explore the long-run economic structure and economic policy consequences of wide-spread blockchain adoption.

Design/methodology/approach: The approach uses institutional, organisational and evolutionary economic theory to predict consequences of blockchain innovation for economic structure (dehierarchicalisation) and then to further predict the effect of that structural change on the demand for economic policy.

Findings: The paper makes two key predictions. First, that blockchain adoption will cause both market disintermediation and organisational dehierarchicalisation. And second, that these structural changes will unwind some of the rationale for economic policy developed through the twentieth century that sought to control the effects of market power and organisational hierarchy.

Research limitations/implications: The core implication that the theoretical prediction made in this paper is that wide-spread blockchain technology adoption could reduce the need for counter-veiling economic policy, and therefore limiting the role of government.

Originality/value: The paper takes a standard prediction made about blockchain adoption, namely disintermediation (or growth of markets), and extends it to point out that the same effect will occur to organisations. It then notes that much of the rationale for economic policy, and especially industry and regulatory policy through the twentieth century was justified in order to control economic power created by hierarchical organisations. The surprising implication, then, is that blockchain adoption weakens the rationale for such economic policy. This reveals the long-run relationship between digital technological innovation and the regulatory state.

Available at Emerald Insight. Working paper version at SSRN.

Blockchain and the Evolution of Institutional Technologies: Implications for Innovation Policy

Research Policy, Volume 49, Issue 1, February 2020. With Darcy WE Allen, Brendan Markey-Towler, Mikayla Novak, and Jason Potts

Abstract: For the past century economists have proposed a suite of theories relating to industrial dynamics, technological change and innovation. There has been an implication in these models that the institutional environment is stable. However, a new class of institutional technologies — most notably blockchain technology — lower the cost of institutional entrepreneurship along these margins, propelling a process of institutional evolution. This presents a new type of innovation process, applicable to the formation and development of institutions for economic governance and coordination. This paper develops a replicator dynamic model of institutional innovation and proposes some implications of this innovation for innovation policy. Given the influence of public policies on transaction costs and associated institutional choices, it is indicated that policy settings conductive to the adoption and use of blockchain technology would elicit entrepreneurial experiments in institutional forms harnessing new coordinative possibilities in economic exchange. Conceptualisation of blockchain-related public policy an innovation policy in its own right has significant implications for the operation and understanding of open innovation systems in a globalised context.

Available at Research Policy. Accepted version available at SSRN.

Submission on the final report of the Australian Competition and Consumer Commission’s Digital Platforms Inquiry

With Darcy Allen, Dirk Auer, Justin (Gus) Hurwitz, Aaron Lane, Geoffrey A. Manne, Julian Morris and Jason Potts

The emergence of “Big Tech” has caused some observers to claim that the world is entering a new gilded age. In the realm of competition policy, these fears have led to a flurry of reports in which it is asserted that the underenforcement of competition laws has enabled Big Tech firms to crush their rivals and cement their dominance of online markets. They then go on to call for the creation of novel presumptions that would move enforcement of competition policy further away from the effects-based analysis that has largely defined it since the mid-1970s.

Australia has been at the forefront of this competition policy rethink. In July of 2019, the Australian Competition and Consumer Commission (ACCC) concluded an almost two-year-long investigation into the effect of digital platforms on competition in media and advertising markets.

The ACCC Digital Platforms Inquiry Final Report spans a wide range of issues, from competition between platforms to their effect on traditional news outlets and consumers’ privacy. It ultimately puts forward a series of recommendations that would tilt the scale of enforcement in favor of the whims of regulators without regard to the adverse effects of such regulatory action, which may be worse than the diseases they are intended to cure.

Available in PDF here.