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.
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.
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.
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.
A review ofSir Joseph Carruthers: Founder of the New South Wales Liberal Party byZachary 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.
How much influence does libertarianism have on Australian politics? The first thing to know is that the Australian political system has very few libertarians in it.
The only federal member of parliament to self-describe as a libertarian is Senator David Leyonhjelm of the Liberal Democratic Party. Other candidates – like my former colleagues at the Institute of Public Affairs (IPA), Senator James Paterson and Tim Wilson – describe themselves as classical liberals.
Ideological classifications can get very tedious very quickly, but generally libertarianism is a variety of classical liberalism. Both philosophies believe that public policy should be designed to maximise free markets and civil liberties. That is, governments should get out of both the wallet and the bedroom. Libertarianism is generally seen as inhabiting the more radical end of the classical liberal spectrum.
A 2007 study published by the Centre for Independent Studies (CIS) estimated that 3–6% of the Australian electorate were classical liberals. So it is unsurprising they have little electoral influence on Australian politics.
The reason libertarians and classical liberals exercise some degree of influence is that they make up a disproportionate share of Australia’s policy wonks, think tank staff (especially at the IPA and CIS), and political commentators.
An extremely big tent
Australia’s right-of-centre political community is not so large as to have exclusively libertarian or conservative think tanks, as exist in the United States. Everyone works together. This co-mingling hasn’t generally been an issue because Australian political debate has tended to pivot around economic issues (taxation, regulation, privatisation) or basic shared liberty issues (like freedom of speech) rather than the thorny moral debates that might divide the two camps.
Occasionally there have been polarising issues. Same-sex marriage is one. Conservatives were generally opposed, while libertarians tended to be in favour. But there was also broad agreement that any change to marriage laws should also protect religious freedom.
Immigration – particularly asylum seeker policy – is another. Libertarians are inclined towards freer immigration, whereas conservatives want more control over the borders. Here the tiny number of libertarians have been completely ineffective against the policy stalemate.
For the most part, there is much agreement between conservatives and libertarians about the current state of Australian politics. Both think the Turnbull government is a disappointment, for much the same reasons. It failed on the campaign to repeal section 18C of the Racial Discrimination Act, which has become an iconic restriction on free speech. It has also repeatedly raised taxes, and been unable to drive any serious economic reform.
This may sound excessively Pollyanna-ish, as if everything is just swell between Australian conservatives and libertarians. Much has been said (almost all by commentators on the left) about a political split between libertarians and classical liberals on the one side and conservatives on the other. But I don’t really see it.
In the US, the fusion movement of the 1950s and 1960s was a deliberate project to build an alliance between these two distinct systems of political thought. The presidency of George W. Bush pushed that alliance to breaking point, and it seems the Trump administration has broken it.
By contrast, Australian politics has never been large enough to maintain such divergent streams. Every Liberal prime minister has for the most part maintained a sort of centre-right middle ground that kept everyone equally disappointed and dissatisfied. People are leaving the Liberal Party under the Turnbull government, not because it is too conservative or libertarian, but because it is too, well, nothing.
Liberal achievements and libertarian growth
The last quarter of the 20th century saw Australian public policy take major strides in a classical liberal direction. The economic reform movement that substantially liberalised the economy was matched with social reforms such as the decriminalisation of homosexuality and the repeal of obscenity laws.
I’ve argued in the past that Australian economic thought has had a distinct – even occasionally dominant – classical liberal tradition. There is no question that this tradition has driven policy debate and reform at a few key historical moments.
Though classical liberal efforts were often focused on economics rather than social policy, it’s worth pointing out that the IPA was one of the key voices against state overreaches such as the Hawke government’s ill-fated Australia Card, and more recently, mandatory internet data retention.
In recent years, there has been some notable growth of libertarianism as a self-aware and distinct group. A large part of that has been the Friedman Conference – named after Milton Friedman, David Friedman and Patri Friedman, who represent nearly the entire spectrum of classical liberal/libertarian thought in one family – which attracts hundreds of libertarians and fellow travellers to Sydney every year.
The Friedman Conference is in its sixth year, thanks to the organisational efforts of Tim Andrews (of the Australian Taxpayers’ Alliance) and John Humphreys (of the Australian Libertarian Society). The political success of the Liberal Democrats with David Leyonhjelm in the Senate is another factor in libertarianism’s modest gains.
My hope is that this sort of organisational effort fosters the idea in Australia of libertarianism as a distinct political philosophy, not just a quirky sub-category of the Australian right.
There is a need for this. The challenges we face now are not the same as they were in the over-mythologised 1980s. The combination of growth of the regulatory state, radical technological change, and the crisis of democratic trust require new ideas and new policy solutions. Libertarianism offers a framework to understand how these economic and social questions interact.
The Nobel laureate Oliver Williamson distinguishes between U-form companies and M-form companies.
Traditional U-form companies are unitary— their units are divided by business process (for instance, accounting, human resources, component manufacturing, assembly) and are not treated as separate cost centres.
M-form companies are multidivisional — their units are self-contained divisions that report profits and losses to an umbrella central body. They’re fully owned by a parent company, but they tend to have their own business services (accounting and human resources departments, for instance) and even market relationships.
But now we see a new corporate form — the V-form network — made possible because thanks to the application of distributed ledger technology to supply chain problems.
These V-form networks consist of a number of fully independent companies that effectively operate as one vertically integrated company through blockchain technology, coordinated and supplied by a third party.
This is a big change to the nature of the firm. We can already see V-form networks in the real world. They date as far back as January. It is surprising the economic community haven’t noticed them yet.
The IBM and Maersk TradeTech
Two weeks into 2018, IBM and the shipping giant Maersk announced a joint venture to develop a digital supply chain management system on their Hyperledger blockchain platform. Hyperledger is a private blockchain which requires permission to access.
In a previous Cryptoeconomics piece, we described how international trade is an information problem. As goods are shipped around the world, they are accompanied by information — really stacks of paperwork — that describe their provenance, destinations, regulatory and tax liabilities and so on.
In the IBM-Maersk system, each firm and bureaucracy in the supply chain — producers, shippers, port authorities, regulators, importers, retailers — will access and update a shared blockchain ledger containing all the information needed by each organisation.
And each organisation would have access to that information everywhere, ensuring complete visibility on where goods are in the world and which economic and regulatory hurdles they next need to overcome.
Before blockchains, there were only two basic ways to coordinate a supply chain: vertical integration, or regulation.
Vertical integration has problems. Large conglomerate firms struggle with the challenges of specialisation, and size tends to make firms less efficient.
Regulation has even worse problems. At the very minimum, regulation only works plausibly well within a single nation. The cost of multilateral harmonization — which includes things like treaties and global courts — is very high.
Blockchains can work to coordinate supply chains without the need for either (traditional) vertical integration or regulation. The vertical integration is outsourced to a distributed ledger. The blockchain provides the managerial service that coordinates each ‘unit’ (that is, firm) in the supply chain.
Regulators in any country can deal any firm in the supply chain as if it was a small unit of a larger, global company.
Each firm in the supply chain get the benefits of vertical integration through a network rather than a hierarchy.
The crucial role of IBM and Maersk
In this, the IBM and Maersk joint venture plays a novel economic role.
Imagine a supply chain with seven firms in it: primary producer, manufacturer, exporter, shipper, importer, wholesaler, retailer. Each firm has an established and trusted business relationship with the firms above and below them on the supply chain. But do they have a similar relationship with those one- or two-steps removed? Would the wholesaler in one country necessarily trust the primary producer in another?
A supply chain of two or three firms would be able to easily come to an agreement over shared digital systems. They wouldn’t even need a blockchain — market discipline would be enough to ensure stable coordination.
But firms which do not have direct market relationships with each other face a trust problem when they try to coordinate.
IBM-Maersk provide the trust. They are a large trusted firm that can broker a solution — get all parties around a table — and build the network.
This is a different sales and service model to the IBM of the 1960s. But not that different. With Hyperledger for supply chains, IBM is selling a single solution to multiple clients — just as they did with mainframes or do today with their Watson artificial intelligence machine.
It is only possible because IBM (and Maersk) has already built up deep client relations over past century or so. It is both trusted and has internal information and knowledge about client needs.
(A regulator has none of this information. Neither would a potential corporate raider attempting to vertically integrate through a merger and acquisition strategy.)
We expect to see competition between firms (IBM and and other full-stack technology/strategy/management consultants) to seek ongoing (that is, locked in) contracts for these sorts of services.
The innovative thing here is that they aren’t offering their services to individual firms. They are consulting to a group, or chain, or network of firms — a network that they may have themselves helped create. Economic coordination in the simplest sense of the term.
That’s why IBM is involved. But why is Maersk? The shipping company in this case is the firm with the most to gain from the adoption of the new technology and architecture — that is, which would benefit most from reducing the costs of the existing market architecture.
Vertical integration can be outsourced elsewhere
In the V-form network, the blockchain’s token establishes the consortium, and incentivizes cooperative behaviour.
The token also serves to move rents around the network. In this way, the blockchain provides a market mechanism to solve the sort of bargaining problems described by another Nobel laureate, Ronald Coase, that may occur as the network operates.
Outsourced vertical integration could be applied to many industries that are now integrated. Energy firms that currently integrate the exploration, production, generation, and retail of electricity might be better decomposed, with blockchains and tokens taking the place of head offices. The token economy, rather than energy regulators, could make decisions about the distribution of rents around the network.
We expect that a blockchain economy will have more, smaller firms linked together by protocols. One question — which we expect will preoccupy regulators for decades to come — is how just many protocols? It’s worth pointing out that these networks are inherently global, and any regulatory questions global as well.
Governments might be able to exploit the V-form network themselves. Instead of selling a vertically integrated state-owned asset to shareholders (and then controlling rents with price regulation) they could then privatise components directly on a blockchain network. Ports and airports might be privatised successfully in this way.
In that sense governments would provide the initial coordination now being provided by IBM and Maersk — a trusted third party to broker and establish a decentralised economic network.
As goods move between firms and across borders, information about the provenance, characteristics, and compliance liabilities (whether they are subject to taxes or tariffs) of those goods move alongside them.
Handling companies need to know which goods are going where.
Regulators and trade authorities need to know whether the goods crossing a national border are compliant with domestic regulations.
(Does a good need an import permit? Does it require any special documentation? In Australia the Minimum documentary and import declaration requirements policy is a 27 page document.)
And end-users increasingly demand information about where their goods came from and how they were produced.
(Consumers want to know where their food is grown, whether it was grown to organic standards, or was manufactured gluten-free or nut-free. Advanced manufacturing firms want assurances that components — such as aircraft or wind turbine parts — are of high quality. And everyone wants assurances that their goods have been looked after while in transit.)
The result is piles of documentation shipped alongside internationally traded goods.
And the demand for documentation is growing. Supply chains are getting more complex. Regulatory requirements are increasing. End-users want more information about what they’re buying.
FinTech is the application of new technology — particularly developments in computer science — to the financial services industry. RegTech does the same for regulatory compliance.
Now we have TradeTech — the application of information technology to reduce the information costs of international trade.
TradeTech can reduce transaction costs, increase transparency for firms, regulators, and consumers, facilitate trade finance, and significantly lower regulatory and tariff compliance burdens.
Tackling border costs
One TradeTech application, blockchains used to manage supply chains, have the potential to provide a new digital services infrastructure for international trade in goods.
Blockchains can store information about the provenance and distribution of tradable goods through the entire supply chain in circumstances where firms (and regulators) through the supply chain do not necessarily trust each other.
The invention of the shipping container in the 1950s radically transformed international trade by tackling the high cost — and unreliability — of getting goods on and off ships intact.
But in the 2010s, it isn’t the cost of transport that is the biggest burden on international trade. According to IBM and Maersk, the costs of bringing goods across borders are higher than the costs of transport costs.
In 2018 and 2019 we expect blockchains used in supply chains and to facilitate global trade will be one of the breakthrough blockchain use cases.
The impact of this sort of TradeTech will provide an enormous boost to the potential for global trade.
Facilitating trade flows
The information flows that facilitiate international trade are still to a remarkable degree governed and organised on a one-to-one basis and using paper. Each firm in a global supply chain passes off information relating to a tradeable good to each other one step at a time, vouchsafing that information until it can be passed to the next firm on the chain.
Furthermore, despite two decades of the digitisation of global commerce, it is still the case that international trade is a significantly paper-based process — which is slow, error-prone and raises fraud risks.
The growth of the regulatory state over the last thirty years has significantly increased the compliance costs of trade. While regulatory harmonisation and tariff reductions have encouraged larger volumes of trade, these have been matched by greater demands for information those goods travelling across borders.
New regulatory concerns about labour, environmental, chemical, and biosecurity standards are being reflected in international trade agreements and are translating into more regulatory requirements at the border.
Longer and more complex supply chains as a result of globalisation has multiplied these compliance burdens.
Blockchains can provide a ‘rail’ on which all this information travels.
Blockchains are uniquely suited for an era of advanced globalisation, the regulatory state, and demand for information about product origins and quality.
But now Kodak is exploiting one of the most interesting characteristics of the blockchain (the technology behind Bitcoin) to reshape how we understand and manage intellectual property.
Just like Bitcoin demonstrated it was possible to have a digital currency that didn’t require third parties (banks or governments) to validate transactions, KodakOne hints at a future where intellectual property works without the need for third parties to enforce property rights.
Blockchains are a system of decentralised, distributed ledgers (think of a spreadsheet or database that is held on a number of computers at once). Transactions are verified and then encrypted by the system itself.
Kodak’s plan is to use the Ethereum blockchain to build a digital rights management platform for photographs. Photographers will register their photos on the KodakOne platform and buyers will purchase rights using the KodakCoin cryptocurrency.
The platform will provide cryptographic proof of ownership and monitor the web for infringement, offering an easy payment system for infringers to legitimise their use of photographs.
In one sense, KodakOne resembles one of the many supply chain (or “provenance”) applications for blockchain, which track goods and their inputs (think agricultural products or airplane parts).
But photographs are purely digital assets. In a sense, what we’re seeing is a new form of intellectual property.
In KodakCoin, the underlying asset – the thing that is being bought and sold, the thing that has the economic value – is no longer the photograph, per se. Rather, it’s the entry on the global blockchain ledger. Control of that entry constitutes ownership of the asset.
KodakOne only really gets halfway to this idea. Like so many blockchain applications, the question is how this elegant system will interact with the messy real world. It’s one thing to detect infringing uses of a photograph, it’s quite another to enforce terrestrial copyright law on unco-operative infringers. And KodakOne is hardly the only firm working on digital asset management on a blockchain.
A new kind of intellectual property
But there’s another, more pure example of what blockchains can do for intellectual property that is worth discussing – CryptoKitties.
CryptoKitties is a silly little blockchain game, but the economics are worth taking seriously. Players buy digital cats – cryptographically secure, decentralised, censor-proof digital cats – and breed them with each other. Each cat has a mix of rare and common attributes and the goal is to breed cats with the rarest, most-in-demand attributes.
That’s the game. But in fact what CryptoKitties has invented is a new form of intellectual property. Each cat is a completely unique, entirely digital good. And it is completely, cryptographically secure. It can’t be copied.
Usually the protection of intellectual property requires lawyers and courts. But with CryptoKitties, the intellectual property protection is part of the asset itself – it’s baked in.
This is what blockchains were invented to do. Before blockchains, digital goods could be easily duplicated. That’s a great feature – unless you want to create digital money. Digital money won’t work if everybody can just copy their money and spend it over and over again.
The creator of Bitcoin, known as Satoshi Nakamoto, solved this problemwith Bitcoin’s blockchain. Previous attempts to solve the double-spending problem had relied on trusted third parties like banks to validate transactions. Nakamoto managed to get the network to validate itself.
KodakOne (and CryptoKitties) show us that intellectual property has much the same problem as digital currency – and may have the same solution. There’s no need for trusted third parties (governments) to enforce property rights. The blockchain does that for us.
Of course, there’s a lot of work to be done before we see real benefits from this sort of blockchain-enhanced intellectual property. CryptoKitties is its own new form of intellectual property – but can we retrofit “traditional” cultural goods like photographs, music and movies onto the blockchain?
Digitisation has challenged the protection of intellectual property like never before. Cultural producers need to find some way to be paid for their work. This is the direction we should be looking.
Satoshi Nakamoto said Bitcoin would be “very attractive to the libertarian viewpoint”. The pioneers of cryptocurrencies were cypherpunks or crypto-anarchists who wanted to use this new invention to escape the state’s monopoly on money.
Not only are there many blockchain use-cases for government, but it is possible that positive government action could help the blockchain revolution along.
Just as the blockchain radically decentralises economic activity, the born-global nature of the blockchain can radically decentralise economic power.
Crypto-friendly governments — that is, governments that can rapidly adjust their regulatory frameworks to suit the blockchain economy — have a unique window to attract global investment.
Crypto-friendly governments: the state of play
A number of smaller countries and autonomous regions are trying to position themselves as crypto-friendly.
Both Great Britain and Australia have issued high-level government science reports on the prospects of the technology.
Other smaller countries (such as Estonia) and city-states (such as Singapore) have folded blockchain into a digital and e-government investment strategy.
City-states such as Dubai and states or cantons such as Zug in Switzerland and Illinois in the United States are trying to move many aspects of government services to the blockchain, or to create special crypto-economic zones.
Singapore and Australia have directed their financial regulators to issue detailed guidance about the regulatory, legislative and tax treatment of crypto-assets.
Political leaders in Japan and Russia have made multiple announcements broadly supportive of crypto-investment.
Those are the good news stories. However, most countries maintain a sort of benign neglect — either because of the relative small presence of the cryptoeconomy or lack of government interest or capability in the space.
And a small number of jurisdictions are outwardly hostile. New York adopted a hard line in terms of regulatory compliance when it introduced the BitLicense. China has banned initial coin offerings and cryptocurrency exchanges.
Global differences are going to matter
So far, the development of cryptocurrencies has been geographically concentrated in regions like Silicon Valley. But that won’t last. The blockchain is a distributed technology. The relationship between the regions that develop the technology and the regions that adopt the technology is unlikely to be strong.
In other words, the geography of invention is not the same as the geography of innovation.
The United States is highly successful in inventing blockchain technology. Yet it has been finding it hard to adopt blockchains because of American regulatory complexity.
Regulatory agility will be a significant factor determining which nations are able to successfully adopt blockchain technology.
This favors city-states (Singapore), smaller countries (Estonia, Australia) and subnational jurisdictions (Zug, Illinois).
The blockchain tax problem
How should cryptoassets be taxed? Are tokens money (taxed as spending)? Or are they debt or equity (in which case it would be treated as income or gains from a capital asset or investment vehicle)? We’ve argued that they cryptoassets are in fact the hypothetical asset class that Nobel laureate Oliver Williamson once called ‘dequity’. This means they should be taxed as capital assets, not as money.
But blockchain technology is not just another productivity enhancing technology that can be taxed at the point of adoption. Blockchains are actively associated with tax avoidance or tax shifting owing to the pseudonymous nature of transactions and the difficulty of establishing the correct jurisdiction for taxation.
are going to be harder to tax than the monolithic firms of the 20th century. We’ve published sceptically about the parliament’s efforts to prevent profit shifting by multinational firms. However, the born-global nature of blockchains will supercharge these trends. We do not believe there will be any easy regulatory solution to this, and parliament will need to rethink not just how it taxes, but what it taxes.
It’s not clear that the blockchain has this problem. This is in part because token sales incentivise early adoption. What some people are calling a ‘bubble’ we think is massive experimental investment.
Alternatively, governments could substitute blockchains for their own existing services like the provision of money or property registries.
Governments should pick specific use-cases — such as identity and asset registries, licenses and certification, open government data, reporting and management of government contracts and public assets — then estimate the marginal cost and benefits of investment and adoption of this technology.
These benefits could be huge. For instance, a Bank of England report estimates a 3 percent gain in GDP from issuing a government cryptocurrency.
Other potential government involvement could focus on public goods problems — such as the need for the network communications infrastructure upon which a cryptoeconomy operates (particularly in the developing world).
Governments could also create open access data regimes and registries that can be harnessed and used by cryptoeconomy businesses.
But most fundamentally, governments should invest in high quality legal institutions (regulators, courts, bureaucracies, democratic systems, etc) to provide the cryptoeconomy with the needed predictability, efficiency, transparency, accountability, and efficacy.
But then again…
Why might some countries fail to make the necessary reforms for the blockchain economy? Governments might not know about the benefits or might misunderstand them (bounded rationality or information constraints). Governments might not be able to afford the necessary public investment (financial constraints).
Or we might not trust government enough. There are huge efficiency gains to be made from moving government registries like identity, property titling, tax, voting, central bank coin to the ‘trustless’ blockchain. But to do so itself requires high levels of trust in the government making that change.
This is the paradox: it takes a lot of trust to get to trustlessness. Sweden and Australia will be able to move easily to distributed land title registries. Haiti (where the need for a distributed land title register is much greater) will find it harder.
Governments against blockchains
Radical decentralisation will not always be in the interest of centralised governments.
In the public choice model of government, both governments and citizens have distinct objectives that they seek to maximize.
Citizens trade votes for services. Governments seek to create benefits for themselves (subject to the constraint of getting elected). What citizens want and what governments conflict, resulting in political exchange.
Take blockchain-enabled identity. From the perspective of the government, each citizen ought to have one and only one identity. A single, centralised identity is useful for entitlements and taxation — or conscription.
These centralised identity registrations are co-opted for commercial uses of identity (e.g. to open a bank account, or to rent a car).
But from the citizen perspective this is inefficient, because as identity is owned and managed by the state, they have no control over it, and cannot choose how to permission and share this data. It also creates problems of trust and privacy (for example in health and criminal records).
A decentralized identity would be more efficient, facilitating variety of types of identity for specialized uses and enabling user control. Citizens might want this. Governments do not.
What will other governments do?
Ideally, the approach of governments to the blockchain economy would be both rationally optimal from the perspective of its own citizens, but also a best response to the expected moves of foreign governments — many of which will differ in size, level of economic development, and institutional quality.
For instance, there is no doubt that many tax bureaucracies would like to constrain or control the growth of the cryptoeconomy as it will make taxation harder.
But their success will depend on what other countries as well.Blockchains — and the wealth and relationships on the blockchain — are both everywhere and nowhere.
In this world, it is not obvious what most effective public policy settings will be. There will be heavy learning costs involved. Some governments might rationally decide to delay decision making in order to learn from first-movers who can then be expected to incur costly mistakes in the experimental process of policy settings.
It is possible that larger countries will be much more cautious in adopting cryptoeconomic policies that are significantly divergent from other competing countries.
In the classic federal model of local public goods, governments competitively provide public goods with different offerings and price points. If an individual prefers a different bundle of public goods, they move to another jurisdiction. If a group of individuals collectively prefers a different bundle of pubic goods, they secede. But to secede, they have to physically move somewhere else, which is costly.
Non-territorial secession allows individuals to choose a different bundle of public goods without having to move. They just opt out of all or part of the government bundle. Crypto-secession is when the new bundle of local public goods is organized, coordinated and delivered through blockchain technology.
What does this mean in practice? An example of such emergent private governance of local public goods might occur at a local or regional level where a group of citizens create a pooling mechanism of social insurance, energy grid, or asset titling management through smart contracts, decentralised applications and distributed autonomous organisations.
This is more likely at the local, regional or city level than that of a nation state because of set-up costs and self-selection. We expect that the adoption of blockchain technology for governance will be a bottom-up phenomenon beginning with small groups.
Blockchains and property rights
Blockchain technology may also disrupt the relationship between government and property rights.
A fundamental question in the economics of law is this: Do property rights originate from the state and are then used by market participants? Or do property rights arise from markets and economic activity, and are thenefficiently enforced by the state?
While the former view (legal-centrism) is the most widely held among law and government scholars, public choice and market institutional economists tend to defend the latter (evolutionary) view.
Cryptocurrencies and crypto-assets provide a test of these competing views. It is not obvious what role the state plays in either creating or enforcing the property right claims over these assets.
One argument is that cryptocurrencies and crypto-assets have emerged entirely outside state jurisdiction and instead occupy a new software-enforced constitutional governance realm. In this strong form view, these are native crypto-property rights from which there is a risk of government predation.
An alternative argument is superficially similar, but allows that this parallel crypto-property rights regime has emerged in-the-shadow-of state law and enforcement. Crypto-property rights will remain in the domain of private law only until there are irreconcilable disputes, at which point there will be a role for government enforcement and sanctions.
This distinction about the origins of property rights matters because while governments provide public goods and support property rights(emphasised by the legal-centric school), they also impose costs by accumulating power (emphasised by the evolutionary school). A crypto-property rights regime will test which of these is more significant.
Governments may also find themselves addressing the effects of creative destruction in a blockchain economy.
Past experience has shown that governments often end up supporting or compensating those negatively affected by new technology. They also end up making complementary investments such as education and workforce retraining.
The risk is that without such government action those who expect to be harmed by the adoption of a new technology may form political coalitions to block or raise the costs of developing the new technology.
Blockchain technologies face substantial hurdles from incumbents and vested interests that might lobby to slow or outright ban uses of the technology.
Governments may find themselves on both sides of creative destruction, seeking to promote the adoption of blockchains for social welfare maximizing reasons, while at the same time being captured by vested interests seeking protection.
Blockchain public policy
The blockchain is an extremely new technology. There is substantial uncertainty associated with its future uses, adoption levels — even its basic economic properties.
But it will be disruptive. And despite the libertarian, secessionist ethic of the blockchain community, government will be involved, for better or worse.The goal for the blockchain community and for crypto-friendly governments ought to be ensuring that this technology can be adopted in a way that benefits citizens, not rent-seekers.
For more than three decades economists and cryptographers have been working on the same problem.
Neither species has recognised their own work in the other.
But it turns out that the question of how to coordinate a society and how to ensure communication can be trusted is the same question differently phrased.
Our argument in this essay is simple: What cryptographers call byzantine fault tolerance and economists call robust political economy is the same thing.
This observation turns out to have some significant consequences for understanding the history of economic thought and the directions of institutional cryptoeconomics.
But to explain why, let’s quickly revisit one of the most important debates in the history of economics.
The socialist calculation debate
Economists from Adam Smith on have sought to explain the wealth of nations — why some nations are prosperous and others are not. By the twentieth century this debate had coalesced into a debate about which of two economic systems (communist central planning or capitalist decentralised markets) were more likely to bring prosperity.
Smith argued that market societies were characterised by spontaneous orders. Social order came from market incentives.
Karl Marx objected that the state (or some central coordinating authority) could produce superior outcomes to the market through conscious, deliberate planning.
Before the socialist calculation debate the liberal critique of socialism focused on the problem of incentives — how could a socialist community convince people to work hard if the product from their labour was redistributed? (See, for example, the discussion of socialism in Bruce Smith’s 1887 book Liberty and Liberalism.)
How would [a socialist planner] decide whether to send rubber to Tyre Factory 12 or Hose Factory 7? In a market economy, the factory that needed the rubber most would be willing to pay the highest price. But there is no natural price system in socialism — consumer prices are decided by the planner, and rubber allocated according to their diktat.
Mises’ critique of socialism was extended and elaborated by Lionel Robbins and Friedrich Hayek. Hayek turned this argument into one of the greatest essays in economics: ‘The Use of Knowledge in Society’, where he described prices as a decentralised knowledge network.
Centralised computer socialism
The Mises and Hayek argument today is well known, particularly after they seemed to be proven right by the fall of the Berlin Wall. By contrast, their opponents in the debate are less read today.
Mises and Hayek’s criticism was answered by the Polish economist Oskar Lange and extended by Hayek’s Russian-born student Abba Lerner.
Lange and Lerner accepted the importance of the price system in organising economic activity. But they argued that this system could be simulated mathematically.
Working firmly in the equilibrium economics school Vilfredo Pareto and Léon Walras, they imagined the price system as computational machine. In On the Economic Theory of Socialism, published first in 1936 and 1937, Lange concluded that a socialist economy could simulate the effect of the price system by trial and error.
Lange revisited his argument 30 years later. “Were I to rewrite my essay today my task would be much simpler”, wrote Lange:
My answer to Hayek and Robbins would be: so what’s the trouble? Let us put the simultaneous equations on an electronic computer and we shall obtain the solution in less than a second. The market process with its cumbersome tâtonnements appears old-fashioned. Indeed, it may be considered as a computing device of the pre-electronic age.
Not only could computers simulate the market but the computer could conduct long range planning and implement that plan — “a function which the market never was able to perform”.
How decentralised is Hayek’s market, really?
It is typical to cast these two visions of the economy as Lange’s centralised planned economy and Hayek’s decentralised market.
But Hayekian decentralisation still has a lot of centralisation in it.
Here the Marxists are right. Free markets have an awful lot of state involvement in them. Property is private but its enforcement relies heavily on public authorities — the legal system courts, sheriffs, police.
But what both the Hayekians and the Marxists missed is that property rights are not only about enforcement. They’re about the identification and verification of property rights. And (right now) the state does most of that.
As we argued in our previous essay,so much of what the modern state does is endorse, manage, and verify ledgers of social relations. The state manages the property titles register. It manages ledgers of social security entitlements. It manages the ledgers of who is a citizen and who can therefore participate in political bargaining.
This is a very big, important, and largely unappreciated function that the state fulfills. The state does is in charge of these crucial ledgers because it is a large ‘trusted’ entity. But of course how much we can trust the state is questionable.
The invention of the blockchain presents us with new institutional choices.
A new typology of political economy
In our new typology of political economy, political ideas are arranged in a grid of centralised and decentralised economies, and decentralised and decentralised ledgers.
In Lange’s computer socialism, the economy is centralised and the ledger is centralised — the state is a planning machine, both managing the ledger and executing a global plan.
In pre-Marxist communalism, such as the scheme devised by the Welsh utopian socialist Robert Owen, economic planning is centralised but the relevant jurisdiction — that is, the ledger-providing authority — consists of subnational groups of voluntary, socialistic communities.
Hayekian distributed capitalism has a decentralised economy — planning is done by individuals rather than the state — yet the state still organises, records, verifies and updates the ledgers of identities, rights, obligations, and entitlements.
By contrast, in a cryptoeconomy both the economy and the ledgers are decentralised. Blockchains take the state out of both planning and verification.
Information and incentives
Markets work because they align incentives into productive work and they harness distributed information productively.
In the second half of the twentieth century the public choice school extended the incentives critique to encompass the incentives of the planners themselves. How could a socialist commonwealth ensure that planners worked in society’s interest, rather than their own personal interest?
Today, what scholars now call a ‘robust political economy’ (see Mark Pennington’s book and this paper by Peter T. Leeson and J. Robert Subrick) is an economic system structured to deal with the twin problems of information and incentives. How can we coordinate action — make exchanges, build relationships and communities — in a world of incomplete information and potential rentseeking?
Turns out, cryptographers and computer scientists have been working on these two problems as well.
The Byzantine Generals’ Problem
Distributed computing systems have to deal with what is known as the Byzantine Generals’ Problem.
Illustration from the 12th century Madrid Skylitzes, a history of Byzantium between 811 and 1057
The army consists of divisions, each headed up by a general, and they need to establish a consensus about when exactly to launch their attack on the city.
Centralised command is out of the question. No individual general has line of sight to all the generals — or the authority to impose consensus on the whole army at once. They can only communicate by messenger.
So there’s an information problem. The generals need a system — an algorithm — that allows all generals to agree on a consensus.
The problem is made even harder because it’s not certain that all generals are loyal. Some have been paid off by the enemy, and are actively trying to disrupt the plan. The traitorous generals don’t want the loyal generals to come to a consensus.
Thus Byzantine Generals’ Problem describes the challenge of a) achieving consensus in distributed, decentralised systems b) when information flows imperfectly, and c) in the presence of adversaries.
Blockchains achieve Byzantine fault tolerance in part by treating it as an incentive problem. The Bitcoin proof-of-work mechanism incentivises good behaviour, makes it extremely expensive to attack the network, and reduces the payoffs for a successful attack.
The so-called ’51 per cent’ attack on Bitcoin — the possibility that a majority of hashing power could coordinate and then undermine the network — is what would happen if more than half the generals were traitors. (Of course, that itself would be hard to coordinate.)
Two fields together
A decision to attack a city simultaneously is just a narrow slice of the general economic problem: how to coordinate activity in when information is incomplete, communication is imperfect, and people can be lazy, opportunistic, and self-interested.
What computer scientists have been trying to solve algorithmically, economists have been trying to solve constitutionally.
Where cryptographers have found their solutions in public key cryptography and proof of work mechanisms, economists have found solutions in markets, regulation, and institutions.
Blockchains bring these two fields together. They turn constitutional questions into algorithmic questions, and algorithmic questions into constitutional ones.
Byzantine political economy
One way to see this is as a curious historical instance of two largely unrelated fields (computer science and economics) somewhat simultaneously working on a structurally similar problem (decentralised coordination) and arriving at the same type of solutions (consensus protocols and market institutions).
But a more interesting perspective is that blockchain technology actually joins these worlds together in reality. Blockchains can provide the secure fault tolerant decentralised layer for property rights information and its verification and updating whenever that information changes, which can support a decentralised economic layer of markets.
The socialists were wrong in their hopeful quest that (centralised) computers would replace markets. Actually, it is decentralised computers (blockchains) than can replace governments.
Markets always need governance, and the limits of a market society were always the ability of the state to provide those services of record keeping, validation and verification of transactions in property rights. In return, the state levied taxation to fund these services.
Blockchains are a new technology of fault tolerant governance that can furnish the governance to underpin a market economy and society.