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.
Abstract: Distributed ledger technology emerged in 2009 as the protocol behind bitcoin, a cryptocurrency with origins in the ‘cypherpunk’ community who sought to use cryptography to secede from government control of money. Bitcoin’s pseudonymous inventor, Satoshi Nakamoto said Bitcoin would be “very attractive to the libertarian viewpoint” and many in the crypto-anarchist community saw, and still see, cryptocurrencies as a means to free citizens from the monetary depredations of governments. But from these revolutionary secessionist origins, it has become apparent that not only are there many possible use cases of distributed ledger technology for government, but that government action through both regulation, legislation, and public investment might be a key factor in the adoption and development of this technological innovation. Governments can use blockchain technology to exploit the service efficiencies they may bring. But also, and perhaps counter-intuitively given their revolutionary origins, blockchain applications are likely to need government cooperation to facilitate adoption and the development of the blockchain economic system.
With Darcy Allen. Published in New Perspectives in Political Economy (2017), Vol 13, no. 1-2, pp. 19-40.
Abstract: We extend the Institutional Possibility Frontier (IPF) – a theoretical framework depicting the institutional trade-offs between the dual costs of dictatorship and disorder – by incorporating the notion of subjective costs. The costs of institutional choice are not objectively determined or chosen by a society; rather, they are subjective to the political actor that perceives them. Our methodologically individualist approach provides a new, highly adaptable extension of the IPF enabling examination of the political bargaining process between dispersed actors, the bounds and evolution of institutional innovation and discovery, and follower-leader dynamics in long-run institutional changes. Our new Subjective Institutional Possibility Frontier (SIPF) helps to integrate ideas into the economics of political systems, creating the foundations for a more subjective political economy.
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.
Abstract: A blockchain is an institutional technology—a protocol—that allows for economic coordination between agents separated by boundaries of possible mistrust. Blockchains are not the only technology in history to have these characteristics. The paper looks at the role of the diplomatic protocol at the very beginning of human civilisation in the ancient near east. These two protocols—diplomatic and blockchain—have significant similarities. They were created to address to similar economic problems using similar mechanisms: a permanent record of past dealings, public and ritualistic verification of transactions, and game-theoretic mechanisms of reciprocity. The development of the diplomatic protocol allowed for the creation of the first international community and facilitated patterns of peaceful trade and exchange. Some questions about a generalised ‘protocol economics’ are drawn.
Abstract: This paper offers a new framework to understand institutional change in human societies. An ‘institutional fork’ occurs when a society splits into two divergent paths with shared histories. The idea of forking comes from the open-source software community where developers are free to copy of a piece of software, alter it, and release a new version of that software. The parallel between institutional choice and software forking is made clear by the function and politics of forking in blockchain implementations. Blockchains are institutional technologies for the creation of digital economies. When blockchains fork they create two divergent communities with shared transaction ledgers (histories). The paper examines two instances of institutional forks. Australia can be seen as a successful fork of the United Kingdom. The New Australia settlement in Paraguay can be seen as an unsuccessful fork of Australia.
Abstract: Blockchains are the distributed, decentralised ledger technology underlying Bitcoin and other cryptocurrencies. We apply Oliver Williamson’s transactions cost analysis to the blockchain consensus mechanism. Blockchains reduce the costs of opportunism but are not “trustless”. We show that blockchains are trust machines. Blockchains are platforms for three-sided bargaining that convert energy-intensive computation into economically-valuable trust.
Abstract: Identification forms a key part of all but the least sophisticated economic and political transactions. More complex or significant transactions demand more formal identification of the parties involved. In this paper we develop an institutional economics of identity. We distinguish between a Demsetzian evolutionary view of identity institutions and a ‘legal-centric’ view of identity institutions. In the former view, identity is a contextual, fluid and subjective, and evolved for market, social and political exchange. In the latter, identity is uniform and permanent, and created (imposed) by governments. Governments have an interest in identity insofar as identity is used in the process of tax collection, entitlements, and conscription. Private organisations free ride off state-provided identification services. The paper concludes with a discussion about technological change and identity management. We characterise two possible futures: one in which new technologies enable states to create more comprehensive uniform identities, and one in which new technologies enable identities to be ‘federated’ and transferred to citizens.
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.
With Sinclair Davidson. Published in the Journal of Behavioral Economics for Policy (2017), Vol. 1, special issue, pp. 50-52.
Abstract: In this paper we provide a critique of behavioural economics or nudging as a basis for practical policy making purposes. While behavioural economics operates as a plausible critique of standard neoclassical economics, it suffers from the same methodological errors inherent within that tradition. Just as socialist planners lacked the information (and incentives) to allocate resources across an entire economy and economists lack the information to optimally correct externalities, so too libertarian paternalists lack the information to second guess consumer preferences and opportunity costs.