The rational crypto-expectations revolution

With Sinclair Davidson and Jason Potts. Originally a Medium post.

Will governments adopt their own cryptocurrencies? No.

Will cryptocurrencies affect government currencies? Yes.

In fact, cryptocurrencies will make fiat currency better for its users — for citizens, for businesses, for markets. Here’s why.

Why do we have fiat currency?

Governments provide fiat currencies to finance discretionary spending (through inflation), control the macroeconomy through monetary policy, and avoid the exchange rate risk they would have to bear if everybody paid taxes in different currencies.

As George Selgin, Larry White and others have shown, many historical societies had systems of private money — free banking — where the institution of money was provided by the market.

But for the most part, private monies have been displaced by fiat currencies, and live on as a historical curiosity.

We can explain this with an ‘institutional possibility frontier’; a framework developed first by Harvard economist Andrei Shleifer and his various co-authors. Shleifer and colleagues array social institutions according to how they trade-off the risks of disorder (that is, private fraud and theft) against the risk of dictatorship (that is, government expropriation, oppression, etc.) along the frontier.

As the graph shows, for money these risks are counterfeiting (disorder) and unexpected inflation (dictatorship). The free banking era taught us that private currencies are vulnerable to counterfeiting, but due to competitive market pressure, minimise the risk of inflation.

By contrast, fiat currencies are less susceptible to counterfeiting. Governments are a trusted third party that aggressively prosecutes currency fraud. The tradeoff though is that governments get the power of inflating the currency.

The fact that fiat currencies seem to be widely preferred in the world isn’t only because of fiat currency laws. It’s that citizens seem to be relatively happy with this tradeoff. They would prefer to take the risk of inflation over the risk of counterfeiting.

One reason why this might be the case is because they can both diversify and hedge against the likelihood of inflation by holding assets such as gold, or foreign currency.

The dictatorship costs of fiat currency are apparently not as high as ‘hard money’ theorists imagine.

Introducing cryptocurrencies

Cryptocurrencies significantly change this dynamic.

Cryptocurrencies are a form of private money that substantially, if not entirely, eliminate the risk of counterfeiting. Blockchains underpin cryptocurrency tokens as a secure, decentralised digital asset.

They’re not just an asset to diversify away from inflationary fiat currency, or a hedge to protect against unwanted dictatorship. Cryptocurrencies are a (near — and increasing) substitute for fiat currency.

This means that the disorder costs of private money drop dramatically.

In fact, the counterfeiting risk for mature cryptocurrencies like Bitcoin is currently less than fiat currency. Fiat currency can still be counterfeited. A stable and secure blockchain eliminates the risk of counterfeiting entirely.

So why have fiat at all?

Here we see the rational crypto-expectations revolution. Our question is what does a monetary and payments system look like when we have cryptocurrencies competing against fiat currencies?

And our argument is that it fiat currencies will survive — even thrive! — but the threat of cryptocurrency adoption will make central bankers much, much more responsible and vigilant against inflation.

Recall that governments like fiat currency not only because of the power it gives them over the economy but because they prefer taxes to be remitted in a single denomination.

This is a transactions cost story of fiat currency — it makes interactions between citizens and the government easier if it is done with a trusted government money.

In the rational expectations model of economic behaviour, we map our expectations about the future state of the world from a rational assessment of past and current trends.

Cryptocurrencies will reduce government power over the economy through competitive pressure. To counter this, central bankers and politicians will rail against cryptocurrency. They will love the technology, but hate the cryptocurrency.

Those business models and practices that rely on modest inflation will find themselves struggling. The competitive threat that cryptocurrency imposes on government and rent-seekers will benefit everyone else.

It turns out that Bitcoin maximalists are wrong. Bitcoin won’t take over the world. But we need Bitcoin maximalists to keep on maximalising. The stability of the global macroeconomy may come to rely on the credible threat of a counterfeit-proof private money being rapidly and near-costlessly substituting for fiat money under conditions of high inflation.

A hardness tether

Most discussion about the role of cryptocurrency in the monetary ecology has focused on how cryptocurrencies will interact with fiat. The Holy Grail is to create a cryptocurrency that is pegged to fiat — a so-called stable-coin (such as Tether or MakerDAO).

But our argument is that the evolution of the global monetary system will actually run the other way: the existence of hard (near zero inflation, near zero counterfeit) cryptocurrency will tether any viable fiat currency to its hardness. No viable fiat currency will be able to depart from the cryptocurrency hardness tether without experiencing degradation.

This in effect tethers fiscal policy — and the ability of politicians to engage in deficit spending in the expectation of monetising that debt through an inflation tax — to the hardness of cryptocurrency.

The existence of a viable cryptocurrency exit tethers monetary and fiscal policy to its algorithmic discipline. This may be the most profound macroeconomic effect of cryptocurrency, and it will be almost entirely invisible.

Cryptocurrency is to discretionary public spending what tax havens are to national corporate tax rates.

Supply Chains on Blockchains

With Sinclair Davidson and Jason Potts

Blockchain technology is shaping up as one of the most disruptive new technologies of the 21st century, facilitating an entirely new decentralised architecture of economic organization. While still experimental, it is disrupting industry after industry, beginning with money, banking and payments, and now moving through finance, logistics, health, and across the digital economy. These waves of innovation are being driven by both new entrepreneurial startups as well as by industry dominant firms reimagining and rebuilding their business models and services to use blockchain technology. Trade platforms and supply chains are shaping up as the major use case for blockchain technology, and we explain here how this may lead to a second phase of globalisation.

Breakthroughs in the technology of trade can have far-reaching consequences. Sailing ships and steam ships, refrigeration and aircraft were all watersheds in the making of the modern world, but two technologies of trade delivered us the modern era of globalization: these are (1) the shipping container, and (2) the WTO (formerly known as the GATT).

The invention of the shipping container in 1956 led to a revolution in international trade, birthing a new phase of globalisation. Blockchains, invented in 2009, promise a similar revolution. Blockchains offer a fundamental architectural change in the way firms and governments manage international trade, with enormous efficiency and productivity gains.

But, just as the shipping container required significant investment to bear fruit—and came up against the interests of the unions, regulators and ports—blockchain-enabled trade will require substantial upfront investment in new systems and will inevitably challenge existing interests. In the 1950s the shipping container was the solution to the problem of the high expense in money, time, and security to load cargo in and out of ships. Handling costs were high, operations were slow, and theft was rife.

Today the constraints on trade consist of the ever-increasing complexity of the data, records, payments and regulatory permissions that accompany goods as they travel across the world. Every good moving along a supply chain is accompanied by a data trail, often still as paperwork, to track bills of lading, invoices of receipt and payment, origin, ownership and provenance, as well as compliance with vast schedules of trade prohibitions and environmental regulation, taxes and duties.

The shipping container is a physical coordination technology, while the WTO is an institutional coordination technology. At the Blockchain Innovation Hub we believe that blockchain technology – as tradetech – is shaping up as the third great technology of trade.

The Cost of Information and Trust

Blockchain technology can solve a major and growing problem with the global trading order – namely the problem of information. Every time a good or service moves, information moves with it. The quantity of information associated with each product continues to grow, and the costs of dealing with this information, from compliance, auditing, verification – trust, in a word – is becoming a greater and greater share of the costs of the global trading system.

This information includes provenance and inputs – the information on a label. It includes trade-finance, bills of lading, shipping and handling information, security clearance – the commercial and administrative information. It includes the documentation of where it’s been and where it’s going, and who has handled it and who hasn’t. And it includes all the information that each country requires in relation to customs and duties, biosecurity, labour and environmental regulations, compliance with various treaties – a vast rigmarole of auditing and compliance, each of which is necessary, desirable and costly. With each day, the information burden increases, not decreases.

As the information cost of trade increases, it is not simply enough to digitize everything, because the real problem is that we need to be able to trust the information that is there.

Tradetech

Globalisation 2.0 will be built on tradetech, and the crucial infrastructural component of tradetech is blockchain. Blockchain technology, which is a distributed, append-only, peer-to-peer, trustless secure ledger, is almost custom-made for trade-tech. It provides an infrastructural platform upon which to build a new information architecture for globally tradable goods – and to do so in a way that is fully digital, tamper-proof, low-cost, end-to-end secure, verifiable, transparent, scalable and computable. What cryptocurrencies did for money tradetech will do for globalization.

Tradetech will integrate the benefits of fintech into trade networks. Crypto-based models of payments, trade finance, insurance and other risk management tools will be automated. Tradetech will integrate the benefits of regtech into trade networks. Verification and compliance with local regulations will be automated. Tradetech will power-up logistics technologies with blockchain affordances such as smart contracts, decentralized autonomous organisations (DAOs), and the full technology stack that includes AI integration.

So we think of blockchain as a next-generation infrastructural technology for the global movement of goods and services. Service exports have the same constraints with respect to compliance with certification, credential verification, and quality standards assurance. These same problems apply generally to the movement of people too. We are still yet to weave together a seamless global system of identity documents, education and trade certification and permissions, and taxation and other public liabilities.

Example: Benefits for Australia

Tradetech facilitated supply chains could to bring significant advantages to Australia, and her trading partners. This is win-win because there are both consumers and producers on each side.

For Australian exporters, there are at least two obvious advances. Tradetech facilitated Australian Agriculture will significantly boost the quality of provenance claims as to origin and quality of product. When this transparent verifiable information passes at much lower cost to final consumers, more of that assurance value passes back to suppliers, boosting primary producer income.

We are starting to see this already with start-ups in the primary export industry, for instance with Beef-ledger, Agridigital and Grainchain. We will also likely see the benefits of similar assurance in advanced manufacturing, such as in aerospace, medical devices, pharma and other high value bespoke manufacturing where quality is paramount and certification is costly. Or in other areas that rely heavily on intellectual property, such as creative industries.

Blockchain based tradetech will benefit producers and consumers by lowering the cost of providing and processing high value information that rewards legitimate quality production and minimizes
rent-extraction along the way.

Crypto Free Trade Zones

Blockchain-based next-generation trade infrastructure opens the prospect of a next generation of crypto free trade zones. These may overlay existing trade zones – within bilateral or multi-lateral zones – with a standard protocol for information handling. This would lower the transactions costs of trade, which economic theory predicts would increase the quantity of trade, and therefore value creation.

But blockchain trade areas could also build on private supply chains and infrastructure, as with consortia such as the IBM-Maersk-Walmart alliance, or with the recently announced adoption by FedEx of blockchain technology. This is the difference between say email (an open standard) and Facebook (a proprietary model). The strength of the closed network model is that it incentivizes investment. But it creates power, and invariably requires regulation to constrain that power. And regulation in turn stifles innovation.

We need to start thinking about how we want free trade to evolve in the blockchain era. Global open standards should be our ambition, because this brings the maximum prospect for growth and innovation. But open standard protocols are challenging to get started, because it can stumble on a coordination problem at the outset. This is why in order to build the next generation of globalization on blockchain infrastructure we will need to solve the open standards coordination problem.

The ABC, ‘Independent’ to a Fault

With Sinclair Davidson

It is appalling that a sitting government should have to complain that the ABC is repeating Labor lies as facts. The ABC itself should be ashamed to have received such a complaint. Yet that is precisely why the Labor Party supported the establishment of the ABC – to provide a forum for pro-ALP news and opinion. This points to questioning the precise meaning of what is meant by the ABC being “independent”.

The Charter describes the ABC as an “independent national broadcasting service”, and it is that independence which forms many arguments in favour of public broadcasting. But this notion of independence needs deeper examination. The ABC is a state-owned broadcaster, which is dependent on triennial funding arrangements drawn from the Commonwealth budget, which is set by the political discretion of the government of the day.

ABC supporters refer to the ABC’s independence in two senses. First, it has editorial independence from the government, insofar as it is a statutory agency that is self-managing and separated from the normal chains of political accountability. Second, it is independent of the interests of advertisers and private sector media moguls, providing the “independent information” that the commercial media might not.

Public broadcasting has always been defined against the evils of private broadcasting, and the theme of an independent bulwark against the commercial media (the moguls and monopolists) has been integral right from the start. In the early years it was claimed that a purely private media market would be simultaneously disorderly and monopolistic. In the debate over the 1932 bill, the Labor member for Kalgoorlie, Albert Green, warned of the “chains of newspapers … obtaining such a stranglehold over the eastern part of the Victoria, and disseminating its propaganda through the stations that it controls”. The private monopolisation of radio – “one of the most revolutionary additions to the pool of human resources” – was constantly invoked by Labor members throughout the early debates. This concern, they felt, was more than just theoretical. The 1931 election loss showed, they felt, that the private media was systematically biased against the Labor Party, and a public broadcaster would be able to right that wrong.

Control of the wireless was the high ground of the political contest. In New South Wales a few years earlier the Lang government had sought to establish a state government radio that would resist what Labor saw as the Nationalist Party-dominated private media. As Albert Green, the most forthright of the Labor members on this point in the 1932 debate, put it:

Some B class stations are controlled by newspaper combines, which use them to broadcast only one political opinion. I had hoped that the air would be free to all, and that at election time every party would be given an opportunity to express its opinions over the air. Unfortunately that has not been our experience. Certain newspaper combines are endeavouring to obtain a monopoly of B class stations, and I sound the note of warning that sooner or later some government will have to tackle the very difficult, but necessary task of dealing with the problem of metropolitan B class stations. Nothing short of a complete national scheme will do.

In this sense, independence was understood by the Labor Party as being pro-Labor – or, at least, not anti-Labor. The 1942 inquiry into wireless reiterated this concern, arguing that public broadcasting was needed “to prevent the service from being used for improper purposes”.

Similar concerns drove the introduction of television. The overwrought claims about the social and psychological power of television only intensified the concerns about the new technology’s political importance. The public position of the Labor Party and the ACTU emphasised the cultural good that public broadcasting television could bring, rather than its role countering political bias. But there is no doubt that politics was front of mind when the labour movement considered the significance of television.

A public disagreement between Arthur Calwell and H.V. Evatt as to whether Labor would nationalise the commercial television stations if they were returned to government pivoted on their different impressions of how sympathetic the ABC was to the Labor Party. Calwell, who had been Minister for Information during the Second World War, had a hostile relationship to the commercial press. He believed that Keith Murdoch, who controlled the Melbourne Herald and several other papers across the country, was “a fifth columnist”, “megalomanic”, and his network of papers “a law unto itself” and “Public Enemy No. 1 of the liberties of the Australian people”. Murdoch’s pernicious influence could not be let onto television. Evatt felt that if the hybrid system was maintained, at least the Labor Party would be able to buy a commercial station to air its views. For its part, the conservative parties were just as aware of the political significance of television, arguing in response to the Chifley government’s proposal to establish a monopoly broadcaster that Labor was “merely another milestone on the socialised road to serfdom”.

The modern ABC’s independence is often declared but in practice is hard to pin down. Unlike the BBC, the ABC was not established under a royal charter, and the 1948 move away from licence fees to funding through budget appropriations brought it more into the political window.

Yet how independent could the ABC be? Compared to private and non-government organisations, the fortune of any state authority is going to be closely tied to the government of the day. Public broadcasters have their budgets set by the same governments which they purport to keep a check on. Commercial broadcasters might be dependent on the goodwill of advertisers, but the fact that there are many potential advertisers is a protection against excessive advertiser influence. A public broadcaster has only one funder, and it is a funder whose interests are driven by political rather than commercial incentives.

Nor are commercial broadcasters required to constantly justify their activities to professional politicians. Public broadcasters are regularly brought in front of parliamentary committees to answer for editorial decisions, from the trivial to the significant. The Senate estimates committee procedure requires statutory agencies to present themselves in front of a committee of Senators three times a year. At her first Senate estimates hearing in May 2016, Michelle Guthrie was interrogated about the cancellation of livestock market reports on ABC regional stations, the ABC Fact Check program, how unionised the ABC’s workforce was, whether the ABC was too Sydney-centric, how many people it sent to the Cannes film festival and how long they were out of the office, and how much the ABC spent on a custom typeface to use across its brands. This sort of scrutiny is, of course, entirely appropriate for a state instrumentality. But the notion that independence is the ABC’s unique value as a media outlet is difficult to sustain.

It is not obvious that independence from a democratically elected government is desirable. The ABC is a state-owned organisation, and like any state-owned organisation it derives its legitimacy from its relationship to the democratic expression of voter preferences. Public broadcasters join a large number of other regulatory and bureaucratic agencies that have been deliberately separated from the normal lines of democratic accountability: rather than being the “arm of the minister”, in the classical Westminster bureaucracy formulation, they are protected from political interference and given independence. In an open market, private media organisations are subordinate to consumers and advertisers. In government, politicians and bureaucracies are subordinate to voters. Independent statutory agencies are, by intention, subordinate to neither. Even at their most benign, they are highly susceptible to capture by their employees and management.

Indeed, staff capture has been a longstanding concern of critics of public broadcasters. As Michael Warby writes, “‘Independence’ from government interference … comes to mean effective independence from whatever tenuous public controls over the ABC exist in practice—it amounts to independence from the direct legal owner”. One of the consequences of staff capture, of course, is political bias. The historical context shows that this political slant is a deliberate feature of public broadcasting, not a bug.

Not our ABC

With Sinclair Davidson

The Australian Broadcasting Corporation is a $1.04 billion piece of public policy and we treat it as exactly that: a government intervention into the market for news, entertainment and communications. Policy interventions are financially costly. Policy interventions are also costly in a non-monetary sense. They can have unintended or counterproductive consequences. They can crowd out non-government activity, stifle entrepreneurship or technological innovation, distort the marketplace, systemically favour particular political interests and ideologies, and create fiefdoms of unaccountable bureaucrats.

The ABC was established in a moment of history significantly unlike our own, facing a cultural and political environment greatly different to our own, with technological and economic challenges completely opposite to those we now face. Over the course of eight decades the ABC has embedded itself in the Australian political system and public consciousness. But the original rationales for the ABC have long since expired. Technology has made the concerns of Australian policy makers in the 1930s – or even the 1990s, when the ABC was last subjected to a major review – redundant or anachronistic. Economic justifications for a state-owned media broadcaster simply do not fit the modern media landscape.

The arguments for public broadcasting in the twenty-first century are simply not compelling. It is certainly the case that the ABC has bound within it an enormous amount of cultural capital as a consequence of its eighty years of pre-eminence in the Australian media industry. But that should not be confused with either a claim that a publicly-funded broadcaster was necessary to build that cultural capital or that Australian culture would suffer in a world where the ABC had been reformed or privatised.

The ABC is an Australian ‘icon’ in the same sense that the Commonwealth Bank was an icon before its privatisation, and in the same anachronistic sense that Qantas, the ‘national carrier’, is imagined to be an essential part of the Australian psyche. We can celebrate the achievements of the ABC, its cultural significance, and its role in Australian history. But that should not prevent us from looking sceptically – as we should with all costly government interventions into the economy and society – at whether the ABC remains good public policy. Does it have a good reason to exist, now?

That question invites us to speculate as to the rationale for the ABC. The ABC itself denies that it is a market failure broadcaster, while the notion of it being independent is difficult to pin down. Independent of whom? It is publicly funded and its management are required to appear before parliament and answer questions posed by politicians. True, the ABC is independent of the demands of commercial reality, but it is not independent of its political paymaster. Of course that undermines the argument that the ABC is a bulwark of democracy. A free press may well be a necessary condition of democracy but that does not necessarily imply that the government should subsidise the press. To the contrary, many non-democratic nations have maintained very high levels of government ownership and subsidy in the media. A further argument undermining the ABC’s claim relates to the large and obvious political bias in its reporting and news coverage. A 2013 survey revealed that ABC journalists are almost five times more likely to be Greens voters than the average voter and twice more likely to vote Greens than the average journalist.

Other arguments for the ABC include quality programming, Australian content, and rural subsidy. What constitutes ‘quality’, however, is a value judgement. Australian content and rural subsidy can be provided for much less than $1 billion per annum. That is the challenge; the ABC is a massive government program with no clear objectives and no clear accountability.

Few Australians would realise that the ABC charter does not include the word ‘fair’ nor does it include the word ‘balanced’. The charter is at best only a loose guide to what the ABC does. Nor is it any constraint on ABC operations. While the charter is spelled out in legislation, section 6(4) explicitly states that ‘Nothing in this section shall be taken to impose on the Corporation a duty that is enforceable by proceedings in a court.’ Additionally, there is nothing in the charter that could be described as an enforcement mechanism, nor any penalties detailed for potential breaches. The charter is in law – insofar as it exists on the statute books – but it is not law that the ABC has to abide by.

What should be done about the ABC? It is certainly the case that doing nothing and muddling through is very much underrated as a government policy. Yet lower-cost alternative public policies are available and clear savings can be made. One possibility would be to refine the charter. In the first instance, the ABC could be redesignated to be a market-failure broadcaster. Alternatively, it could be required to be self-funding, i.e. commercialised. Here the ABC could be required to finance its activities through advertising revenue and then pay dividends to the government. A further option would be to reform the governance of the ABC.

Then there is privatisation. The ABC could be sold off to a single bidder or consortium. Or it could be listed on the stock exchange. Our preferred option would be for shares in the ABC to be given away, either to all Australians or to existing and previous staff. The staff are the best people to realise the value of the ABC – and they would pay for their shares over time through the capital gains tax as they sold their shares.

In this sense the privatisation of the ABC would proceed much like higher education is currently funded. ABC employees would receive their shares at zero-price and only pay for them when they disposed of the shares and only then if the shares had increased in value. The proceeds of the privatisation would be realised over time and would not constitute a ‘sugar-hit’ to the budget. Nor can the privatisation be characterised as a stunt to balance the Budget in the short term. Rather, it is a program to establish a newly-private ABC on a firm footing, vesting it with a cohort of new owners who have the most interest in making it a commercial success.

ABC is about partisanship not diversity

With Sinclair Davidson

The difference between the ABC and Fairfax and News Ltd is that the ABC is a $1 billion government program that provides media services to Australians. Fairfax and News Ltd are private entities that do so at their own expense and hope to earn a profit. Those small details were missing from Laura Tingle’s defence of the ABC published in Weekend AFR.

As such we can expect somewhat different behaviour from the national broadcaster than from the private sector. Indeed, holding the public sector to a different standard is commonplace in our society. The ABC, very often, wants to have it both ways. For example, paying its employees market rates of pay when they don’t have to compete in marketplace for income.

But some criticism of the ABC is unfair. Of course the ABC would send journalists to cover the recent royal wedding. As every other serious media organisation did. That, however, should not detract from the mounting criticism that is being levelled at the ABC.

For all its protestations of “independence” the ABC as a large and generously funded government program can and should be scrutinised by government, the Opposition, and ultimately the taxpayers who pay for it. Having embedded itself into the Australian psyche and culture the ABC has managed to avoid serious scrutiny for a long time. The ABC – like all government programs – should be an election issue at every election.

To justify its existence the ABC and its supporters posit a range of mostly overlapping rationales. We hear a lot about independence, quality and diversity. Less about being a market-failure broadcaster. Rural subsidy also appears to play a role in justifying the ABC’s existence – although it seems to be very Sydney-centric for a rural audience. It was the diversity argument that Laura Tingle emphasised at the weekend.

>But it isn’t quite clear what is meant by the term “diversity”. The idea that media markets might lack diversity has its origins in a famous spatial economic model by the mathematical economist Harold Hotelling. In his model, firms, in a market with a small number of firms and not competing on price, would offer near identical products. Hotelling believed this explained the “excessive sameness” in capitalist markets. That is an interesting model but it does not explain the creation of public broadcasters in Australia and the UK.

To the contrary, public broadcasting in the UK was introduced explicitly to reduce diversity – the perceived cacophony and anarchy of radio broadcasting seen in the United States. The ABC was designed to follow the BBC model (albeit with a small commercial sector alongside). To argue that the ABC provides diversity where the private sector does not is entirely incorrect. What the ABC does is provide those very same services without having to attract an audience.

A generous interpretation of that feature is that there are some media services that should be provided that the private sector won’t provide. But it is difficult to imagine what those services might be. In any event, the ABC explicitly denies that it is a market-failure provider.

What the ABC does provide in excess, however, is partisanship. Any media organisation should be ashamed to be told that it is reporting political falsehoods as facts. Yet Mitch Fifield – the Minister for Communication and (very) nominally responsible for the ABC, did just that. No doubt he’ll be told something about consistency with “editorial standards”.

Those would be the same editorial standards that saw Emma Alberici publish Labor talking points on company tax cuts as if they were uncontroversial facts. The same editorial standards that saw two News Ltd journalists compared to a mass murderer just last week. Yet we are supposed to be fed up with News Ltd antics.

Let’s be blunt here: the ABC burns through $1 billion of taxpayers’ money every year. Not shareholder money, not a mogul’s money. Taxpayer money. The ABC is a not a blog run on a shoestring, or out of someone’s basement. To argue that being left-partisan is simply to compensate for right-partisanship in the commercial sector is to disfranchise all those coalition voters who pay for the ABC. Australians do not expect their government agencies – even nominally independent agencies – to exclude other Australians without excellent reason.

Blockchain is (now) a competitive industry

With Sinclair Davidson, Jason Potts and Ellie Rennie. Originally a Medium post.

With the anniversary of the Bitcoin whitepaper looming on October 31, it is remarkable how far and fast this industry has come since it was anonymously launched on a crypto bulletin board just ten years ago. Ethereum, which gave us smart contracts and ICOs, was only started in 2015. The Consensus conference, only in its fourth year, packed over 8500 attendees into the New York midtown Hilton with representatives from most major corporations and industries being present.

Blockchain is quickly becoming mainstream. The industry is entering the phase of industrial competition — and this is happening on a global scale.

Consensus is the centerpiece of Blockchain Week in New York City, and the main global industry conference for cryptocurrency and blockchain technology. It is also increasingly a platform for major industry announcements. Two clusters of announcements in particular are propitious markers of where we’re up to in the development of the industry.

In politics, David Burt, Premier and Finance Minister of Bermuda, announced his country’s Parliament had tabled the Digital Asset Business Act, staking an ambition and claim to be the world’s leading crypto-regulator. On Tuesday, Eva Kaili, Chair of European Parliament Science and Technology Options Assessment, announced the Blockchain Resolution had passed the European Parliament.

In enterprise, Fred Smith, CEO of FedEx called blockchain the next big disruption in supply chains and logistics with the potential to completely revolutionise the global trade system. Circle, a Goldman Sachs backed crypto finance company, announced it will be issuing a fiat stablecoin, which is to say a crypto-version of the $USD. And buried in the announcement by Kaleido — a blockchain business cloud — of a partnership with UnionBank i2i (a Philippines Bank specializing in rural banking), was a joint partnership with Amazon Web Services.

These announcements indicate that we have entered a new industry phase, moving well beyond the first entrepreneurial phase of highly speculative market-making start-ups operating entirely in a disruptive mode, and are now at the onset of a second phase of industrial dynamics, that of industrial competition. While still incredibly young, because of the speed and scale at which it has developed, the blockchain industry has now entered the phase of market competition.

The Bermuda announcement is a competitive response to the innovative regulatory frameworks built by jurisdictions such as Singapore, Zug (CryptoValley), Estonia, Gibraltar, Isle of Man, and other crypto-havens. The Bermuda announcement clearly signals that we’re now in the phase of global regulatory competition, and that crypto-regulation and legislation in countries such as the US and Australia will be held by the competitive pressure of exit-options from departing too far from the competitive equilibrium.

The announcement by Kaleido is in itself less significant than that of the AWS partnership, which signals the new shape of competition in cloud computing. Technology companies such as Microsoft, Oracle and IBM are competitively positioning themselves to provide foundational infrastructural services and standards in this new space, and the Fred Smith’s pronouncement signals that the logistics industry is about to be competitively disrupted again.

The difference between the first and second phase of industrial dynamics is that in the first phase entrepreneurs are inventing new technology, disrupting existing markets, and seeking to create new business models. It’s a process of de-coordination of an existing economic order. But this is not generally well described as a competitive market process, usually because markets themselves are still forming, and uncertainty is very high. Cooperation in networks and innovation commons is the predominant institutional form.

Competition emerges when uncertainty begins to clear as the outlines of how the technology works and what it will be used for, which markets are affected and how, and which firms will be involved, and a speculative game turns into a strategic game because it becomes clear who the players are and what they are doing. Investment is not just for R&D, for discovery of new technology; but is strategic investment to compete for market share, and ideally for market dominance.

This is where we are up to now: the phase of global market competition.And further evidence of this is that the main concern of industry participants is global regulatory uncertainty, which is to say the rules of the competitive game.

Now to be clear, crypto and blockchain is still an experimental technology. But we’re now past the early innovation phase — the start-up phase — and have investment is now a C-suite concern, and a parliamentary agenda item.

What does competition mean for Web 3.0?

So blockchain is being absorbed into the economy and global political system. But what does this mean for the future of the internet?

The other big question arising from the Consensus 2018 announcements was the extent to which the involvement of incumbent internet platforms, such as Microsoft and AWS, will affect the distributed nature of the emergent blockchain ecosystem.

Joseph Lubin, co-founder of Ethereum, argued that the technological foundations for a distributed future have been built and that the essential task now is to achieve scalability. Data storage is an important aspect of scalability that will be essential to the success of decentralised applications (dapps), and more radical solutions (such as the InterPlanetary File System, IPFS) are apparently not ready for widespread adoption.

The involvement of AWS in Kaleido enables enterprise participation in the Ethereum blockchain whilst ensuring that the data (including oracles) are housed securely. While numerous self-sovereign identity dapps are available (as displayed through Civic’s identity-checking beer vending machine at the conference), common standards are necessary for those providing verified information.

Microsoft’s partnership with Blockstack and Brigham Young University is a development towards these standards that is potentially significant for this new approach to online privacy.

Neither development necessarily threatens Web 3.0, but this is now being driven by a competitive logic of market forces.

Crypto constitutionalism

With Sinclair Davidson and Jason Potts. Originally a Medium post.

Blockchains are constitutional orders — rule-systems in which individuals (or firms, or algorithms) can make economic and political exchanges.

In this sense, blockchains look a lot like countries. They have currencies (tokens), property (digital assets), laws (protocols), corporations (DAOs), and security systems (proof-of-work, or proof of stake, or delegated byzantine fault tolerance, etc.).

And like countries, blockchains have systems of governance.

Satoshi built one system of governance into Bitcoin: how the network comes to a consensus when miners announce two equally valid blocks to the network. The protocol (the constitution) resolves this problem by incentivising nodes to prefer the chain with the most work.

But this is a tiny fraction of the governance questions that just surround Bitcoin. How should the Bitcoin network be upgraded? Who decides? How should the various interests be accommodated — or compensated?

In these blockchain governance debates — disputes about whether governance should be on-chain or off-chain, who writes the rules, who can be a node, the role of voting, and the relative position of protocol developers, miners, block producers, HODLers and third party applications — we’re seeing the history of thinking about political economy being rediscovered.

Happily there exists an enormous body of thinking on governance, constitutions, the function and efficiency of voting and voting mechanisms, and how power is allocated in a political and economic system.

Blockchains as constitutional experiments

Historically, experimenting with new constitutions has involved things like civil war, secession, conquest, empire, and expropriation. The English fought civil war after civil war to limit the power of the monarch to tax. Expanding the franchise involved protest and violence.

In the real world, constitutional experimentation is costly and slow: limited by the rights and preferences of real populations and the real endowments of physical land and property.

By contrast, blockchains offer a space for rapid, hyper-experimentation. New constitutional rules can be instantiated by a simple fork. New protocols can be released in months or weeks.

Blockchains are an environment for institutional innovation — a place to apply hundreds of years of thinking about political governance.

Why vote?

For instance, networks such as Decred, NEO and EOS use voting to manage their decentralised consensus mechanisms. Vitalik Buterin and Vlad Zamfir have argued that on-chain governance is overrated.

What this debate is missing is an understanding of the economics of politics. Blockchain developers aren’t writing protocols — they’re writing constitutions. And we know a great deal about constitutional design and voting mechanisms.

The first thing we know is that choosing the rules of a voting system is effectively choosing the result of the vote.

The eighteen-century mathematician the Marquis de Condorcet found that a three cornered vote using a simple majority rule might not come to a clear consensus on the winner. A might beat B, B might beat C, but C might beat A. The ‘ultimate’ winner of this cycle will depend on how the votes are ordered.

Kenneth Arrow generalised this into his impossibility theorem: there’s no unique procedure that reliably comes up with a stable ordering of aggregated preferences. A set of quite reasonable institutional assumptions — such as no dictator, the independence of irrelevant alternatives and so forth — can’t be combined.

The lesson economists have taken from all this is: tell me what you want, and I’ll design you a mechanism to get it. What matters is how we decide how to decide.

Public choice scholars have focused on problems how political agents shape their policy positions to suit median or marginal voters. Retrospective voting models suggest that voters assess how happy they are (in general, not just with politics) at the time of voting and vote for or against incumbents on that basis.

Other scholars have focused on why people even bother to vote — given there is a miniscule chance that they can change the outcome of a vote. This had led scholars to the theory of ‘expressive voting’, where voting is effectively a form of consumption or signalling.

This is a rich body of political and economic theory that has been absent from the blockchain governance space. For instance, is voting a positive or negative externality?

It depends on what the purpose of the voting is. If preference aggregation is your goal, ‘low-information’ voting is a problem — it introduces noise. Blockchains should then tax voting.

However, if simple legitimation is the purpose of voting (as Vlad Zamfir argued at the Ethereal conference) then even low-information voters add value. Ideally the mechanism would subsidise all voting.

The incentive design problem for blockchain voting depends on what you think the purpose of the voting is.

And it turns out that this question has been one of the over-riding concerns of economists, philosophers and political scientists for hundreds of years.

Only A Flesh Wound

With Sinclair Davidson

Howls of outrage from the ABC and its fans on social media over the most mild of cuts to the broadcaster’s budget ignore the fact of an institution that has drifted far away from its charter’s demands for objectivity.

Judging by the howls of outrage echoing through twitter it seems that the Turnbull government has destroyed our democracy, if not Australian civilisation itself. But no. The Turnbull government has frozen ABC operational funding for three years. That translates to a ‘funding cut’ of some $83 million.

Not $83 million per year, mind you. Over three years.

Not quite a rounding error, but hardly a crisis.

The ABC only has itself to blame. In the pre-budget period it went well out of its way to annoy the government. The prime minister – a former communications minister – is something of a fan. Yet the ABC chose to publish a highly opinionated and factually challenged analysis by the ABC’s Chief Economics Correspondent of the government’s centrepiece economic policy. Then there was the small matter of pooh-poohing the current communications ministers’ complaint about a conservative politician being pointlessly abused in a comedy skit.

These hostilities have not come cheap.

There may well be a market for ‘edgy’ humour, but the ABC’s efforts tend to boorishness. Reproducing flawed ALP and Greens talking points on company tax cuts as being ‘independent’ and ‘trust worthy’ is arguably a greater problem. These are not minor lapses in editorial policy – the ABC is politically biased and incapable of self-regulation.

Rather than viewing the ABC as a ‘trusted’ news source we should recognise it as being a political actor in its own right. Not just any sort of political actor. Journalists, as David Marr has suggested, are usually ‘vaguely soft-left’ and sceptical of authority.

The ABC, however, is not so vague and not so soft. A 2013 survey of journalists revealed that 41.3% of ABC journalists intended to vote Greens at the 2013 election. That compares with 19.8% of journalists at both Fairfax and News and just 8.7% of the electorate.

ABC journalists are well to the left of journalists in general, and nearly five times more likely to vote Greens than the general public.

To be fair – there is nothing wrong with voting Greens or being left-wing. Journalists are citizens too. But the ABC claims to be a bulwark of our democracy. While nearly 80% of Australians claim to believe that the ABC is balanced and even-handed there is a huge drop off in actual audience numbers. There are three to four times as many Australians who claim to trust the ABC than who actually watch the ABC. Sure 86% of Australians value to ABCs service to the community, but that probably reflects its status as an emergency broadcaster.

Generally there is no reason why political opinion should cloud professional performance. Coalition voting journalists are a minority even at News. Yet none of the mechanisms that crowd out personal preference operate at the ABC. It does not have to please advertisers, it does not have to earn a profit, nor does it not have to explain itself to controlling shareholders.

To claim that the ABC Charter constrains it is laughable. The Charter is written in legislation but it is not law. It doesn’t require anyone to do anything, it contains no penalties for non-compliance, and it has no enforcement mechanism. If only the Tax Act worked on the same principles.

The ABC pleases itself; in practice that means it pleases its staff. To the extent that many ABC journalists are professional in their activities that is a personal preference and not institutional discipline.

Unsurprisingly the ABC does as it pleases and largely it gets away with doing as it pleases.

Being stripped of a mere $83 million over three years is a very mild rebuke from an otherwise indulgent government. Yet the ABC seems to have chucked a temper tantrum in response. Threats to bully the government into restoring funding indexation should be resisted.

Rather than simply restore indexation after three years the Turnbull government should be looking at innovative market solutions to commercialise and professionalise the ABC. Expecting value for money from the ABC is not an attack on its independence but rather a minimum expectation of any government program that costs the taxpayer $1 billion per annum.

Some economic consequences of the GDPR

With Darcy Allen, Alastair Berg and Jason Potts. Originally a Medium post.

At the end of May 2018, the most far reaching data protection and privacy regime ever seen will come into effect. Although the General Data Protection Regulation (GDPR) is a European law, it will have a global impact. There are likely to be some unintended consequences of the GDPR.

As we outline in a recent working paper, the implementation of the GDPR opens the potential for new data markets in tradable (possibly securitised) financial instruments. The protection of people’s data is better protected through self-governance solutions, including the application of blockchain technology.

The GDPR is in effect a global regulation. It applies to any company which has a European customer, no matter where that company is based. Even offering the use of a European currency on your website, or having information in a European language may be considered offering goods and services to an EU data subject for the purposes of the GDPR.

The remit of the regulation is as broad as its territorial scope. The rights of data subjects include that of data access, rectification, the right to withdraw consent, erasure and portability. Organisations using personal data in the course of business must abide by strict technical and organisational requirements. These restrictions include gaining explicit consent and justifying the collection of each individual piece of personal data. Organisations must also employ a Data Protection Officer (DPO) to monitor compliance with the 261-page document.

Organisations collect data from customers for a range of reasons, both commercial and regulatory — organisations need to know who they are dealing with. Banks will not lend money to someone they don’t know; they need to have a level of assurance over their customer’s willingness and ability to repay. Similarly, many organisations are forced to collect increasingly large amounts of personal data about their customers. Anti-money laundering and counter-terrorism financing legislation (AML/CTF) requires many institutions to monitor their customers activity on an ongoing basis. In addition, many organisations derive significant value from personal data. Consumers and organisations exchange data for services, much off which is voluntary and to their mutual benefit.

One of the most discussed aspects of the GDPR is the right to erasure — often referred to as the right to be forgotten. This allows data subjects to use the government to compel companies who hold their personal data to delete it.

We propose that the right to erasure creates uncertainty over the value of data held by organisations. This creates an option on that data.

The right to erasure creates uncertainty over the value of the data to the data collector. At any point in time, the data subject may withdraw consent. During a transaction, or perhaps in return for some free service, a data subject may consent to have their personal data sold to a third party such as an advertiser or market researcher. Up until an (unknown) point in time — when the data subject may or may not withdraw consent to their data being used — that personal data holds positive value. This is in effect a put option on that data — the option to sell that data to a third party.

The value of such an option is derived from the value of the underlying asset — the data — which in turn depends on the continued consent by the data subject.

Rational economic actors will respond in predictable ways to manage such risk. Data-Backed Securities (DBS) might allow organisations to convert unpredictable future revenue streams into one single payment. Collateralised Data Obligations (CDO) might allow data collectors to package personal data into tranches of varying risk of consent withdrawal. A secondary data derivative market is thus created — one that we have very little idea of how it will operate, and what any secondary effects may be.

Such responses to regulatory intervention are not new. The Global Financial Crisis (GFC) was at least in part caused by complex and rarely understood financial instruments like Mortgage-Backed Securities (MBS) and Collateralised Debt Obligations (CBS). These were developed in response to poorly designed capital requirements.

Similarly, global AML/CTF requirements faced by financial institutions have caused many firms to simply stop offering their products to certain individuals and even whole regions of the world. The unbanked and underbanked are all the poorer as a result.

What these two examples have in common is that they both have good intentions. Adequate capital requirements and preventing money from being cleaned by money launderers are good things, but good intentions are not enough. Secondary consequences should always be considered and discussed.

Self-governance alternatives, including the application of blockchain technology, should be considered. These alternatives use technology to allow individuals greater control over the personal data they share with the world.

Innovators developing self-sovereign identity solutions are attempting to provide a market based way for individuals to gain greater control over — and derive value from — their personal data. These solutions allow users to share just enough data for a transaction to go ahead. A bartender doesn’t need to know your name or address when you want a drink, they just need to know you are of legal age.

Past instances of regulatory intervention should make us cautious that even well-meaning regulation will achieve its stated objectives with no negative effects. Self-sovereign identity, and the use of blockchain technology is a promising solution to the challenges of data privacy.

Sober liberal

A review of Sir Joseph Carruthers: Founder of the New South Wales Liberal Party by Zachary Gorman, Connor Court, Qld, pp.425, $59.95

Australia has a rich heritage of nineteenth century classical liberalism. But that history has been almost completely lost in the flood of historical work focusing on either federation or the labour movement. Zachary Gorman’s new biography of Sir Joseph Carruthers, the nineteenth century free trade liberal and founder of the Liberal party of New South Wales, helps balance the ledger – recovering the tradition of free market liberalism that has been so significant in Australian history.

In many ways, Joseph Carruthers embodies that tradition, with its strengths and flaws. In the colonial era liberal political thought was one of the dominant strands of public life, and Carruthers’ career reflected its dominance. Born in 1857, he entered NSW politics in 1887. Carruthers was a father of federation, a minister under Henry Parkes and George Reid, and after the establishment of the Commonwealth became premier of New South Wales. He only left politics when he died in 1932.

Like his university friend George Reid, Carruthers was a great admirer of William Gladstone. He believed in balanced budgets, individual liberty, and that ‘we should encourage commerce in its freest sense’ (as he once informed a branch meeting of the Labour Electoral League).

Carruthers was a liberal, but not a radical one by the standards of the time. Gorman positions him as a moderate, or pragmatic liberal within the free trade movement. On one side was Bernard Wise, whose support for free trade was matched with a pro-government intervention and regulation program. On the other side was the radical free market liberalism of Bruce Smith, whose 1887 book Liberty and Liberalism was a full-frontal attack on the left-liberalism advocated by people like Wise. A working politician has to satisfy multiple constituencies. Carruthers was no exception, balancing both liberal and conservative supporters, as well as managing coalitions with the progressives.

Histories of political life can sometimes be a little deadening. Much drama in politics consists of a stream of legislation and amendment, which can be both complex and (in the hands of poor biographers) dull. Gorman does not fall into this trap: he is able to very clearly explain the significance of each well-chosen controversy in a way that makes the relevance to liberalism and Carruthers’ life obvious.

Gorman is also sensitive to instances of where Carruthers’ thought deviated from classical liberal ideas. These are worth detailing, because classical liberals have not always lived up to their underlying belief in the inherent equality and political dignity of all people. One philosophically minor but historical significant example was temperance. His father had struggled with alcohol and was ultimately involved in the temperance movement. Likewise many of the Liberal party voters were motivated by temperance. Gorman writes that Carruthers believed ‘liberalism could bend on this issue’. Carruthers ended up supporting the so-called ‘local option’ which handed the regulation of liquor licences to electorates and municipalities – not always a win for liberty.

More serious to modern readers was Carruthers’ opposition to female suffrage, for which he believed the case had not yet been made. His was perhaps a half-hearted opposition, and he later supported the suffragette movement in Britain when he visited there in 1908. But his stance compares poorly with some contemporaries like Bruce Smith, who actively called for universal suffrage in Australia.

Carruthers’ attitude to immigration presents a similar story. While being supportive of high immigration levels, he also backed the white Australia policy on the grounds that a multiracial society could harbour ethnic tensions. This view changed when he began to visit Hawaii, as he did regularly late in life. He saw there a society in which Americans, native Hawaiians, Japanese and Filipinos coexisted prosperously, helped in no small part by American free trade relationships.

Carruthers’ views were more admirable when it came to the relationship between colonists and the Indigenous population. As a child growing up in Macleay he had spent much time playing with Aboriginal children, and he maintained a sympathy with Indigenous people his whole life. He wrote later of the ‘ruthless indifference [of] the whites, who have invaded their homelands, bringing with them new diseases and vile habits, and sometimes unspeakable cruelties that have unnecessarily wiped out millions of so-called inferior and backward peoples’. Carruthers’ language often betrayed a paternalistic or patronising mindset but he was more wide-eyed than most about who bore the costs of colonialism.

For the most part, Carruthers was a needed defender of liberal values. During the First World War he refused to get too caught up with the anti-liberal sentiment of wartime Australia, and opposed the NSW government’s sedition bill (which had been mainly targeted at the labour movement).

This is not the first full length biography of Carruthers. Beverly Earnshaw published One Flag, One Hope, One Destiny: Sir Joseph Carruthers and Australian Federation in 2000, which as its title suggests finds interest in Carruthers because of his federation role. (Carruthers’ own memoirs also received commercial publication in 2005.) But for Gorman, Carruthers’ greatest legacy is the New South Wales Liberal party, which he views as one of the crowning organisational achievements of nineteenth century liberalism. While it has repeatedly changed its name, the NSW Liberal Party is still, organisationally, the same entity today as the one Carruthers established as the Liberal and Reform Association in 1902.

For modern classical liberals the post-Federation decade has a somewhat melancholy tone. The rise of the Labor party led to an alliance, and then fusion, between the free traders and protectionists under the banner of anti-socialism. Gorman’s book both adeptly navigates this history, and, with his picture of nineteenth century liberalism, underlines just what we lost.