Facebook’s monetary revolution

With Sinclair Davidson and Jason Potts

With its new digital money, Libra, a Facebook-led global consortium has created the world’s first private international reserve currency.

Announced on Wednesday, this is no small thing. For the first time since the collapse of the Bretton Woods system there is a clear competitor to the US dollar for global dominance in the currency market.

For simplicity’s sake think of Libra as a return to the global gold standard. But rather than governments setting the rules and exchange rates, with gold being the underlying store of value, we’re seeing a private organisation setting the rules and a portfolio of relatively risk-free assets playing the role of gold.

To be clear – Libra is not a cryptocurrency like, say, Bitcoin; but it has many Bitcoin-like characteristics. It is a private money. It is not government money – ultimately fiat is backed only by the taxing powers of the state. Libra will be backed by tangible assets.

Rather than Bitcoin, Libra is more like PayPal, or WeChat Pay, on steroids – a payment gateway and a new money system all rolled into one. This is perhaps a good halfway house to introduce the world to the concept of non-government digital money.

The implications are huge. Facebook has disrupted digital money in a way central banks and the commercial banking system never could. Facebook has brand recognition that even the global banks must envy.

For those consumers who may baulk at using Facebook to transact, other large tech companies cannot be far behind with their own products. So what now?

We predict a large uptake in these digital money products. Largely because consumers tend to emphasise convenience. Libra will very quickly achieve global acceptance among consumers and merchants. If that prediction comes true, many other firms will launch their own competing monetary systems. In short, there is going to be a lot of competition in this space in the very near future.

The short-term consequences include the immediate disruption of the remittance market. Those companies charging exorbitant fees to move money around the world will see their rivers of gold drying up. Debit cards will also quickly become redundant – accelerating the move to phone-based tap and pay systems. The world’s “unbanked” will quickly become “banked”.

There are other immediate practical concerns. Within the next year, both Australian consumers and merchants will be wanting to use Libra. How will this be done? How will it be taxed? Will it be taxed? But any work that has been done so far on these questions has come in the context of Bitcoin and cryptocurrency – an extremely niche market. A general use private money has simply not been on the radar.

Those central banks that tolerate high rates of inflation will see disintermediation. Governments that pursue irresponsible fiscal policies will see even greater capital flight. Ironically the presence of a convenient, sound and private digital money will provide incentives to institutionally challenged governments to lift their game or lose total control over their domestic policy environments.

Every country in the world faces policy challenges from a viable private international reserve currency. Control over the monetary system lies at the heart of the modern economy. A viable alternative to fiat currency, with international mobility, undermines both the conduct of monetary policy and fiscal policy.

No doubt governments and their regulators will be looking very closely at Libra. They may treat it as a threat. But it is an opportunity for a forward-thinking government. It should come as no surprise that Libra is being set up in Switzerland. They have sensible laws relating to financial matters. The question we should be asking is why Australia isn’t being considered as a location for these products?

Australia should consider becoming a currency haven. Not only should a suite of policies be developed that facilitates the use of a private international reserve currency within Australia, a suite of policies that attracts the providers of such currencies to Australia should be considered. The use of Australian markets to purchase the underlying assets should encouraged and especially the inclusion of Australian assets in those portfolios should be encouraged.

With the announcement of Libra, the global monetary system – and arguably the structures of global financial capitalism – changed irreversibly. And just 10 years after the invention of Bitcoin and blockchain technology. The rate of disruptive innovation is only going to accelerate.

How well Australia adapts to this change will be determined over the next six months. Libra is coming in 2020. Regulatory obstruction is simply not an option.

Blockchain and the manufacturing industry

With Darcy Allen and Jason Potts

Bitcoin was invented in 2008 by Satoshi Nakamoto as a censorship-resistant cryptocurrency built for the internet. With regular fiat money centralised bodies such as banks and governments control the records of who owns what. For bitcoin those records are held in a decentralised blockchain. Blockchains are updated and maintained by a decentralised network. To ensure the transactions and records are correct, economic incentives to continually drive the blockchain network towards consensus.

Applications of blockchain extends beyond records of money. We rely on trusted third parties to maintain our registries, enforce our contracts, and maintain our records. Entrepreneurs are now discovering which roles carried out by third parties such as governments and firms will be shifted towards blockchain-based decentralised networks.

Blockchain is now being applied to trace goods along supply chains, to give control of medical records to patients, and to create decentralized identities that help people move across borders.

What does blockchain mean for Australia’s manufacturing industry?

At first glance manufacturers produce physical products and then transport those goods to consumers. More deeply, the manufacturing process is heavily reliant on databases of information in multiple directions along their supply chains. This is especially true for advanced manufacturing. When goods and inputs move, information about them must move too. This includes information about the provenance of sub-components and intermediate parts, information about the integrity of rare products prone to counterfeit, and information about ethical standards in production.

It’s harder to produce this supply chain information than you think. The information must be coordinated between hundreds of parties in the supply chain. Most of those parties don’t know or trust each other. And this information is still often paper-based or siloed within organisational hierarchies. The result is a trail of information about manufactured goods that is prone to error, fraud and loss. And these problems only get worse as supply chains get longer in a globalised world, and manufactured goods become more complex.

Blockchain technology presents a different way to govern supply chain data that centres on the movement of the good itself. Rather than passing pieces of paper between supply chain participants to track goods, information can be recorded in a decentralised blockchain. In practice goods are given a digital representation. Then as the goods move, information about them is timestamped in an immutable blockchain. Importantly this information is stored outside of organisational boundaries, making blockchain an alternative mechanism to solving the age-old problems of provenance and quality. What information is stored in a blockchain could be the historical location of a good, who produced it, how it has been stored, and who has finance on the goods.

Supply chain information extends beyond a single supply chain. To produce a complex product involves first mining raw materials, transforming those into intermediate parts, before manufacturing of the final good. Blockchains are critical here because they can track goods and components across multiple supply chains, giving more visibility and traceability deeper into complex manufactured goods.

Blockchain supply chains will leverage other frontier technologies such as the Internet of Things (IoT). Containers and products will contain sensors to record information such as GPS location and temperature. This information won’t be sent to a centralised party, but recorded cryptographically into a blockchain. This information can help consumers in verifying genuine products, assist producers in creating analytics of consumer demand and ensuring their inputs are legitimate, and governments in ensuring compliance with domestic rules and regulations.

The first and most obvious application of blockchain in supply chains has been in agricultural products such as wine, meat and seafood. The common characteristic of these goods is that they are information-rich. Information about their provenance and stewardship is often hard to verify by observing the final goods, but radically affects the price that consumers will pay.

This means the next wave of applications is likely to be other high-value information-high goods. Goods that are highly-customised, such as 3D printed medical devices, aeroplane parts and pharmaceuticals, are perfectly poised to apply blockchain technology.

Blockchain in advanced manufacturing is more than just tracking goods once they’ve been produced. We can use blockchains to coordinate the highly valuable digital files that sit behind many of these products. How can you ensure that the CAD file being 3D printed was the one originally intended? Similarly, blockchains are being used for intellectual property rights, helping to ensure compliance in an increasingly digital world.

In the physical manufacturing process itself blockchain can be used to record information about the lifecycle of manufacturing equipment. We can now have more cost-efficient and credible auditable ledgers that extend beyond organisational hierarchies.

What we have proposed here is a general movement away from intermediaries being trusted to maintain information about goods and their production, towards information governance through decentralised blockchain platforms. To be sure, many of these applications are in the trial and experimental phase. But they represent an early fundamental shift in how we organise information across the entire manufacturing supply chain.

Blockchain and the New Economics of Healthcare

With Darcy W E Allen, Anastasia Pochesneva and Jason Potts

Abstract: In this paper we outline the economics of healthcare as a problem of coordinating data and examine how blockchain technology might be applied as new economic infrastructure to govern those data rights. We argue that blockchain as a technology of trust pushes the economic organisation of healthcare data away from large, centralised hierarchical organisation towards decentralised, emergent platform organisation. The fundamental problem in healthcare is the coordination and governance of information around decision making (e.g. patient records, licensing of professionals, medical trial data, supply chains). The new economics of healthcare emphasises how this information is governed (e.g. through firms, governments, markets, blockchains) and how the most effective governance changes through time as new technologies of trust are developed. We examine the potential of blockchain as new healthcare data infrastructure (including ensuring the integrity of pharmaceuticals and devices, medical records and data markets). Our view is that blockchain fundamentally shifts healthcare data property rights away from centralised third parties (e.g. hospitals, companies, governments) towards decentralised data property rights held by individual patients. The future platform-based healthcare ecosystem will act as the foundational institutional infrastructure for new competitive solutions to healthcare problems (powered up through other technologies such as the Internet of Things and Artificial Intelligence), helping to solve a growing healthcare productivity crisis.

Available at SSRN

International policy coordination for blockchain supply chains

With Darcy Allen, Sinclair Davidson, Mikayla Novak and Jason Potts. Published in Asia & The Pacific Policy Studies, 30 May 2019

Abstract: From the adoption of the shipping container to coordinated trade liberalization, reductions in trade costs have propelled modern globalization. In this paper, we analyse the application of blockchain to reduce the trade costs of producing and coordinating trusted information along supply chains. Consumers, producers, and governments increasingly demand information about the quality, characteristics, and provenance of traded goods. Partially due to the risks of error and fraud, this information is costly to produce and to maintain between dispersed parties. Recent efforts have sought to overcome these costs—such as paperless trade agendas—through the application of new technologies. Our focus is on how blockchain technology can form a new decentralized economic infrastructure for supply chains by governing decentralized dynamic ledgers of information about goods as they move. We outline the potential economic consequences of blockchain supply chains before examining policy. Effective adoption faces a range of policy challenges including regulatory recognition and interoperability across jurisdictions. We propose a high‐level policy forum in the Asia‐Pacific region to coordinate issues such as open standards and regulatory compatibility.

Available at Wiley Online.

Why Blockchain Technology Could Be the Key to Solving the Developing World’s Biggest Problems

With Darcy Allen

The core of the free market explanation for global poverty is simple and compelling: much of the world’s poor are poor because of institutional failure.

The court systems that service the bottom billion are unreliable or hard to access. The governments impose extractive taxation. The bureaucracies are corrupt.

And some institutions are simply missing in the developing world. A lack of reliable identity services makes it hard to access financial markets. A lack of property titles, as Hernando de Soto famously wrote, makes it hard to use the capital embodied in homes.

Corruption and Monopolies

These explanations are all true. But the free market response to global poverty is insipid to the point of uselessness. Faced with evidence that institutions in developing countries are corrupt, classical liberals respond: well, don’t be so corrupt.

There are other responses, of course. We sometimes adopt the Washington Consensus approach—use the levers of political globalization to force reform on unwilling populations. Or maybe we just hope for a revolution that might turn out liberal. Neither alternatives have good track records.

The problem here is that institutions tend to be monopolies. One country has one court system, one bureaucracy in charge of property titles, one authority giving out birth certificates. To get better institutions, we have to replace the corrupt old ones, and that’s hard to do, especially given the intransigence of rent-seekers who benefit from them.

Institution Innovation

What the developing world needs is a technology of institutions—a way not to replace institutions but to create more of them, experimentally and entrepreneurially.

This is what we see in the blockchain. Blockchain technology is an institutional technology that allows multiple institutions to operate in one place. It is perfectly suited to hostile institutional environments.

There’s been a lot of work, unsurprisingly, on individual blockchain applications that might be helpful for the world’s poor: supply chains, democratic governance, and identity management for example. With these applications, blockchain might allow poor countries to leapfrog some of the stages of development—a poor country might skip the creation of the centralized institutions characteristic of the rich world and instead adopt immediately decentralized ones.

These applications don’t need to replace their competitors, and they are virtually impossible for the beneficiaries of the old order to prevent.

But we think blockchain technology offers something more fundamental than these specific applications.

It offers the possibility of creating new institutions—new algorithmic legal systems, contract dispute resolutions systems, identity technologies, mutual welfare and insurance, and public goods provision—in competition with the existing set of institutions.

For instance, the invention of a smart contracting platform could compete with existing court systems, helping to overcome the problems of hold-up or counterparty risks. The contracting parties to decide which institutional structure they wish to use—the terrestrial one or a near-infinite number of new digital alternatives.

These applications do not need to replace their competitors to function. And they are virtually impossible for the beneficiaries of the old order to prevent.

Institutional Layering

We call this process institutional layering. Blockchain institutions co-exist with existing institutions, effectively layering on top.

Blockchain entrepreneurs in developing economies don’t require international aid agencies or development experts to define economic problems and try to solve them. Rather, they apply their entrepreneurial judgment and skills to define institutional problems and use blockchains to design and test new institutional solutions.

William Easterly famously outlined the distinction between “planners” and “searchers” in economic development. Development economics has been plagued by planners implementing top-down institutions that don’t match local conditions and have a raft of unintended consequences.

Instead of working within the existing institutions, entrepreneurs can use blockchain to operate more effectively.

The capacity of entrepreneurs to search, however, is constrained by the transaction costs they face and the technologies they have available. Rather than propelling institutional change through centralized planners (whether it be through conquest or special economic zones), blockchain enables a new decentralized process of search.

Rather than forming businesses within the existing institutions, entrepreneurs can use the blockchain to more effectively operate on the level of the institutions themselves. Blockchain enables institutional entrepreneurs to search by operating on the governance or “protective-tier” level of entrepreneurship.

Now entrepreneurs can search, discover, and deploy new governance mechanisms. They can attract users by better economizing on transaction costs than alternatives.

Polycentric Institutions

The process of institutional layering will also be more polycentric. Rather than having centralized institutions attempting to fit over broad groups of people within a geographical nation-state, entrepreneurs will, over time, discover the necessary levels of institutional rules within regions and across borders.

Another ongoing problem of institutional change in the developing world is aligning formal institutions with the underlying informal norms. Blockchain-based institutional layering—using governance approaches developed by local entrepreneurs—might better match the underlying norms, or what James C. Scott describes as metis.

New, digital, uncensorable, trustful institutional technologies open up enormous opportunities for decentralized economic development.

Because blockchain institutions are built from the bottom-up and draw on local entrepreneurial knowledge, we might see greater levels of institutional stickiness, where formal blockchain institutions better match underlying norms and therefore are embedded and longer-lasting.

Our argument risks techno-utopianism. We are confident that blockchain—or successor distributed ledger technologies not yet invented—might solve several institutional problems within the developing world. It will not, of course, solve all of them.

Nevertheless, the invention of a class of new, digital, uncensorable, trustful institutional technologies opens up enormous opportunities for decentralized economic development.

And it allows the same entrepreneurial creativity that has driven prosperity in the rich world to be turned to the causes of poverty in the developing world.

Some Economic Consequences of the GDPR

With Darcy Allen, Alastair Berg, Brendan Markey-Towler, and Jason Potts. Published in Economics Bulletin, Volume 39, Issue 2, pages 785-797. Originally a Medium post.

Abstract: The EU General Data Protection Regulation (GDPR) is a wide ranging personal data protection regime of greater magnitude than any similar regulation previously in the EU, or elsewhere. In this paper, we outline how the GDPR impacts the value of data held by data collectors before proposing some potential unintended consequences. Given the distortions of the GDPR on data value, we propose that new complex financial products—essentially new data insurance markets—will emerge, potentially leading to further systematic risks. Finally we examine how market-driven solutions to the data property rights problems the GDPR seeks to solve—particularly using blockchain technology as economic infrastructure for data rights—might be less distortionary.

Available here.

Byzantine political economy

With Sinclair Davidson and Jason Potts.

Abstract: For decades, computer science and economics have been working on the same questions in parallel. But each field has offered strikingly different answers. This paper examines the close relationship between what the study of distributed systems describes as Byzantine consensus and what the study of institutional economics describes as robust political economy. These parallels have become evident after the invention of distributed ledger technology (blockchain) via the Bitcoin cryptocurrency which provides a new technology for managing and coordinating knowledge about property rights. Blockchain is the instantiation of a new form of social infrastructure that securely decentralises property ledgers. As such it represents a shift in the role of government as a centralised property ledger.

Available at SSRN.

Blockchains and institutional layering as a new approach to economic development

With Darcy Allen.

Abstract: Since the mid-twentieth century, development economists have identified barriers to economic growth including financing a savings-investment gap, planning investments, and making lasting institutional change. Efforts to overcome these development barriers range from centralised planned intervention to decentralised entrepreneurial search. In this paper we analyse the impact of blockchain technologies on economic development. We propose that blockchains facilitate a more decentralised entrepreneurial process of economic development through institutional layering. This dynamic leads to a more permissionless, polycentric and institutionally sticky economic development process. Blockchains shift the entrepreneurial process by which development problems are defined and ameliorated through time.

Working paper available at SSRN.

Submission to the Australian Competition and Consumer Commission’s Digital Platforms Inquiry

With Gus Hurwitz.

Executive summary: The analysis in the Australian Competition and Consumer Commission’s Preliminary Report for the Digital Platforms Inquiry is inadequate in several ways, most notably:

  • It mischaracterises the relationship between changes in the economics of media advertising and the rise of digital platforms such as Facebook and Google.
  • Its analysis of the dynamics of media diversity is misguided.
  • Its competition analysis assumes its results and makes unsupportable claims about the division of advertising markets.
  • It is recklessly unconcerned with the freedom of speech consequences of its recommendations.
  • It fails to recognise, and proposes to supplant, the ongoing social negotiation over data privacy.
  • It provides a poor analytic base on which to make policy recommendations, as it applies a static, rather than dynamic, approach to its analysis.

There is a real danger that if the policy recommendations outlined in the preliminary report were to be adopted, Australian consumers would be severely harmed.

Available here.

Towards Crypto-friendly Public Policy

With Sinclair Davidson and Jason Potts. Published in Melanie Swan, Jason Potts, Soichiro Takagi, Frank Witte and Paolo Tasca, 2019. Blockchain Economics: Implications of Distributed Ledgers, World Scientific Publishing, Singapore, pp. 215-232.

Abstract: Distributed ledgers are institutional technologies that pose complex challenges regarding regulation and inter-jurisdictional competition. This chapter introduces ‘crypto-friendly’ public policy as a way to understand these challenges. Blockchains are relevant to public policy in at least three ways. First, they can be adopted by governments for the provision of public services. Second, many blockchain applications interact with existing regulatory frameworks and may provide new regulatory challenges. Third, they present the possibility of ‘crypto-secession’ as a form of privately provided public goods provision. The chapter applies an institutional theory of regulation to assess how blockchains effect relative institutional costs and guide public policy choices. Blockchain applications such as property rights and identity management are also considered. Finally the chapter considers the possibility of crypto-friendliness as a dimension for international regulatory competition.

Available at World Scientific.