Blockchain technology as economic infrastructure: Revisiting the electronic markets hypothesis

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

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

Available at Frontiers in Blockchain

The Crypto-Circular Economy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Capitalism after Satoshi

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

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

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

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

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

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

Available at Emerald Insight. Working paper version at SSRN.

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

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

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

Available at Research Policy. Accepted version available at SSRN.

Understanding the Blockchain Economy: An Introduction to Institutional Cryptoeconomics

With Sinclair Davidson and Jason Potts. Edward Elgar Publishing 2019

Blockchains are the distributed ledger technology that powers Bitcoin and other cryptocurrencies. But blockchains can be used for more than the transfer of tokens – they are a significant new economic infrastructure. This book offers the first scholarly analysis of the economic nature of blockchains and the shape of the blockchain economy. By applying the institutional economics of Ronald Coase and Oliver Williamson, this book shows how blockchains are poised to reshape the nature of firms, governments, markets, and civil society.

Available now from Edward Elgar Publishing

Spatial Institutional Cryptoeconomics

With Jason Potts, Darcy W E Allen, Mikayla Novak and Kiersten Jowett

Abstract: This paper explores the intersection of spatial economics, the economics of data markets, institutional cryptoeconomics, the application of blockchain to smart cities (a.k.a. cryptocities), and the economics of supply chains on blockchains. We weave this into a new field we call spatial institutional cryptoeconomics. This institutional cryptoeconomics analysis of space considers how blockchain-based proof of location services provide a new analytic conception of how cities self-organise through data markets to create economic value.

Available at SSRN

Cryptodemocracy: How Blockchain Can Radically Expand Democratic Choice

With Darcy WE Allen and Aaron M Lane. Lexington Books, 2019

This book investigates the theoretical and practical implications of blockchain and other distributed ledger technologies for democratic decision making. What new structures of democracy does blockchain technology enable? A cryptodemocracy is cryptographically-secured collective choice infrastructure on which individuals coordinate their voting property rights. Drawing on economic and political theory, a cryptodemocracy is a more fluid and emergent form of collective choice. This book examines these theoretical characteristics before exploring specific applications of a cryptodemocracy in labor bargaining and corporate governance. The analysis of the characteristics of a more emergent and contractual democratic process has implications for a wide range of collective choice.

Coming soon from Lexington Books

Facebook’s monetary revolution

With Sinclair Davidson and Jason Potts

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Blockchain and the manufacturing industry

With Darcy Allen and Jason Potts

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

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

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

What does blockchain mean for Australia’s manufacturing industry?

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

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

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

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

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

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

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

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

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

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

Blockchain and the New Economics of Healthcare

With Darcy W E Allen, Anastasia Pochesneva and Jason Potts

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

Available at SSRN