Trustless architecture and the V-form organisation

With Sinclair Davidson and Jason Potts

Abstract: Blockchain (distributed ledger technology) is an institutional technology that allows trust to be manufactured instead of being earned. Trust is an important component of business and trade and has previously been subsumed into information costs. It is only now that the importance of trust is being fully appreciated. Arun Sundarajaran has suggested that the creation of new forms of trust has driven the expansion economic activity throughout history. In this chapter we argue that the industrialisation of trust is going, again, to drive a massive expansion in economic activity through the emergence of new organisation forms that will deliver high-powered market incentives deep into what would appear to be hierarchical organisations. We are labelling these (as yet speculative) organisations forms the ‘V-form’ organisation. In this chapter we discuss the importance of trust, the evolution of trust, and the industrialisation of trust. We argue that current organisational forms have exhausted the levels of trust that have previously sustained them. Blockchain technology offers a new industrialised form of trust that can drive further economic activity.

Available in PDF or at SSRN.

Look at our history: protectionism doesn’t work

With Vijay Mohan

We rarely think about supply chains – those immensely complex networks of production and logistics that structure the economy. 

That has changed. Early in the COVID-19 crisis, we learned that Australia imports much of its basic medical equipment like facemasks and other protective gear. As borders were being closed importing this high-demand equipment got suddenly very hard.  

Now there is an unsurprising clamour for the government to take more of an interest in how our supply chains actually work, and to use the traditional tools of protectionism to encourage domestic production of medical equipment and pharmaceuticals.  

Prime Minister Scott Morrison said in April that “we need to look very carefully at our domestic economic sovereignty”. 

But neo-protectionism to secure Australia’s supply chains would be a grave mistake – and it fundamentally gets the supply chain challenge wrong. 

First, the obvious but necessary point. We actually had a protectionist economy for most of the twentieth century. And we didn’t build facemasks. We built cars. We built cars because cars had a certain romance in the twentieth century and Labor and the union movement wanted to lock in prestigious manufacturing jobs for their supporters. 

This has always been one of the central planks of the case against protectionism. The choice of what industries to protect is not made by all-knowing and benevolent leaders, but by self-interested politicians. They get to the top of their profession not because they are skilled production managers or supply chain coordinators, but because they’re great at navigating political factions and going on television. 

Of course, our national leaders will come out of this crisis more focused on the risk of future pandemics, and more motivated to prepare our economy for this now-known risk. But as they say in the military, generals too often prepare for the last war, not the next one. We don’t need an economic system that is prepared for a crisis that looks exactly like COVID-19. We need an economic system that is prepared for an unexpected crisis – which, definitionally, could be anything. 

Indeed, it is the fact that the pandemic was unexpected to most in government that makes the strongest case for free trade. The crisis has caused a lot of market disruption. But global supply chains have adjusted remarkably well to new demands and routed around new constraints. For example, airlines have been doing temporary conversions of passenger planes to cargo planes – particularly important because medical equipment, which in normal times would be leisurely transported by ship, needs to get to new COVID-19 hot spots urgently. 

Protectionism invariably makes the industries it protects brittle and highly politicised, not agile and adaptable to sudden economic shocks. And it is a fantasy to suggest that a small, wealthy, highly-educated nation like Australia could or should ever be self-reliant in the production of all low-value goods that might be needed in unexpected crises. 

There are things the government can do to be prepared for the next crisis. Rather than making essential products, we can buy them and store them. This requires no more foresight than full-blown protectionism and is a lot cheaper. The idea of keeping extensive national stockpiles of equipment for emergencies is uncontroversial. By all accounts, the National Medical Stockpile has been an immensely valuable asset during COVID-19. 

With our RMIT colleague Marta Poblet, we have been looking at the problems consumers had getting reliable information on supply chain security in the first weeks of the crisis.  

Before the pandemic, Australian industry was interested in using new technologies (such as blockchain, 5G communication, and smart devices) to better combat food fraud in export markets or to how to prove to their customers that their products were organic or fair trade certified.  

But the pandemic revealed a more basic problem with about supply chain information. Consumers were not worried about quality or fraud. They were worried there were not enough goods available to meet demand at all – hence the panic buying of toilet paper, hand sanitizer, and dried pasta.  

This panic buying looked a lot like the sort of panic withdrawals you see in a bank run. If depositors aren’t convinced their bank is solvent, they rush to be the first to get their money out. And as we saw, Scott Morrison was no better able to convince shoppers that there were adequate domestic supplies of toilet paper in March 2020 than South Australian premier Don Dunstan was able to convince the customers of the Hindmarsh Building Society that there were adequate funds to cover deposits October 1974 — despite standing in the street outside its headquarters with a megaphone.  

In moments of high-stress consumers just don’t trust the political assurances they are given. Do we really blame them? 

Ultimately within a few weeks supply chains adjusted. Coles and Woolworths lifted their toilet paper sale limits. 

But the toilet paper panic symbolises the choice we now face when it comes to supply chain resilience. To go protectionist would be to trust our supply chains to the same political class that we simultaneously accuse of being underprepared for COVID-19. Or we could lean into free trade and open markets. We should encourage entrepreneurs to adapt rapidly to new circumstances, to experiment with new technology, and let them figure out how to operate in a disrupted global economy. 

Australia has a long history of protectionism. Let’s try to remember what we learned. 

Panic, Information and Quantity Assurance in a Pandemic

With Vijay Mohan and Marta Poblet

Abstract: During a pandemic or other disaster, public visibility of the supply chain can be useful for controlling the symptoms of coordination failure, such as panic and hoarding, that arise from the desire for quantity assurance by various sectors of the economy. It is also important for efficient coordination of the logistics required to tackle the disaster itself, with vital information flows to centralized agencies leading the response as well as to decentralized agents upstream and downstream in a supply chain. Publicly visible information about the supply chain at the time of a crisis needs to be secure, timely, possibly selective in terms of access and the nature of information, and often anonymous. Recent advances in distributed ledger technology allow for these characteristics to be met. Building digital infrastructure that permits visibility of the supply chain when needed (even if dormant during normal times) is essential for economies to be more resilient to black swan events.

Available at SSRN or in PDF here

The Cryptoeconomics of Cities, Data and Space

With Darcy W E Allen, Kiersten Jowett, Mikayla Novak, and Jason Potts. Forthcoming in Cosmos + Taxis

Abstract: We explore the connection between new decentralised data infrastructure and the spatial organisation of cities. Recent advances in digital technologies for data generation, storage and coordination (e.g. blockchain-based supply chains and proof-of-location services) enables more granulated, decentralised and tradeable data about city life. We propose that this new digital infrastructure for information in cities shifts the organisation and planning of city life downwards and opens new opportunities for entrepreneurial discovery. Compared to centralised governance of smart cities, crypto-cities are more emergent orderings. This paper introduces this research agenda on the boundaries of spatial economics, the economics of cities, information economics, institutional economics and technological change.

Preprint available at SSRN. (Previously titled ‘Spatial Institutional Cryptoeconomics’)

Blockchain Governance: What we can Learn from the Economics of Corporate Governance

With Darcy Allen. Published in The Journal of the British Blockchain Association, 31 March 2020

Abstract: Understanding the complexities of blockchain governance is urgent. The aim of this paper is to draw on other theories of governance to provide insight into the design of blockchain governance mechanisms. We define blockchain governance as the process by which stakeholders (those who are affected by and can affect the network) exercise bargaining powers over the network. Major considerations include the definition of stakeholders, how the consensus mechanism distributes endogenous bargaining power between those stakeholders, the interaction of exogenous governance mechanisms and institutional frameworks, and the needs for bootstrapping networks. We propose that on-chain governance models can only be partially utilised because of the existence of implicit contracts that embed expectations of return among diverse stakeholders.

Available at The Journal of the British Blockchain Association.

Age of currency disruption is here

With Sinclair Davidson and Jason Potts

It is unusual for the World Economic Forum’s Davos conference, held every year at the end of January, to be genuinely significant. But it seems this one was. Davos 2020 made clear that we are now living through a monetary reform era comparable to the great monetary events of the twentieth century.

The end of the gold standard, the creation of the Bretton Woods system in 1944, and that system’s collapse in the 1970s all brought about massive, structural economic changes. Our new age – the age of digital money competition – is likely to be just as disruptive.

At Davos the World Economic Forum announced a global consortium for the cross-border governance of digital currencies (including the class of cryptocurrencies stabilised against fiat money known as ‘stablecoins’) and a toolkit for the world’s central banks to establish their own digital central bank currencies.

The details of these Davos initiatives are less important than what they symbolise. Central banks have been experimenting with fully digital currencies for at least half a decade, ever since Bitcoin received its first big waves of press. But their experiments are suddenly urgent, for both commercial and geopolitical reasons.

On the one side, the Facebook-led Libra digital currency project offers a vision of corporate-sponsored non-state private money. On the other side, China is fast-tracking the development of a fully digital yuan, with a barely disguised goal to challenge the American dollar’s domination through technological innovation. Both projects create enormous problems for the rest of the world’s central banks – let alone finance regulators and foreign policy strategists.

Libra has been faced with a concerted hostile attack from central banks and regulators – an attack that begun literally the day it was announced in June last year. Many of the Libra consortium have been pressured into withdrawing from the project.

Mastercard, Stripe and Visa withdrew after they received a letter from US Senators in October declaring that if they stayed in Libra they could “expect a high level of scrutiny from regulators not only on Libra-related payment activities, but on all payment activities”. The Bank of France chief declared last week that “Currency cannot be private, money is a public good of sovereignty”, and the French finance minister has warned that Libra is not welcome in Europe.

This mafia-like behaviour from American and European regulators is short-sighted – astonishingly so. Whether Libra ends up being a successful global corporate currency or not, it represents a powerful and competitive counterbalance to the Chinese digital yuan.

Details have been dribbling out about the digital yuan since it was revealed in August last year. Its key feature is that it is fully centralised. The People’s Bank of China will have complete visibility over over financial flows, including the ability to control transactions tied to an individual consumer’s identity. This offers China the digital infrastructure for a type of financial repression that is without historical parallel.

And adoption is basically assured. The Chinese government can coerce financial institutions to adopt the digital yuan, if necessary, and can exploit the remarkably strong hold that digital payments like WeChat Pay and AliPay have on Chinese commerce.

Let us hope there are some serious strategists thinking about what happens if this digital currency becomes part of China’s foreign policy toolkit – what the consequences of yuan-isation will be for those countries torn between the Chinese and American spheres of influence.

This is the context in which the many of the world’s central bankers came to Davos to spruik their own digital currencies. More than 50 central banks surveyed by the Bank of International Settlements are working on some form of digital currency, and half a dozen have moved to the pilot project stage. Our Reserve Bank told a Senate committee in January that it too has been secretly working on an all-digital Australian dollar.

And of course in the background to this monetary competition between the corporate sector and the government sector is the slowly growing adoption of fully decentralised cryptocurrencies – the decade-old technology that first sparked these waves of monetary innovation.

The global monetary system of 2020s will be a regulatory and financial contest between these three forms of all-digital money: central bank digital currencies, corporate digital currencies, and cryptocurrencies. The contest has profound significance for the ability for governments to control capital flows across international borders, for financial privacy, for tax collection, and obviously monetary policy.

China has the authoritarian power to force adoption of its central bank digital currency. Countries like Australia do not. So it is not obvious which form of money will eventually dominate.

National governments have had nearly absolute control over national currencies for at least a hundred years, in some cases much longer.

The end of the Bretton Woods system in the 1970s incited a generation of economic reform, as domestic policymakers discovered that Bretton Woods had been propping up all sorts of regulatory controls, trade barriers and even labour restrictions.

We’re about to discover what centuries of state monopoly over money has propped up.

Identity technologies: A transaction cost approach

With Sinclair Davidson and Jason Potts

Abstract: Identity is an input into economic exchange and contracting. The modern industrial economy has relies on cheap political identity to create trust and lower transaction costs. Market economies, however, have different identity needs than an administrative state. Economic efficiency in a digital economy requires high-quality economic identity to facilitate co-production of value on platforms, and to enable market competition through product-quality discrimination. Blockchain technologies and related advances are bringing innovation to economic identity technology. In this paper we explore state-produced identity and market-produced identity, the dynamics that exist in their demand and supply, how these categories are being shaped by technological change, the implications for privacy and secrecy, and the role of the state in market-produced identity.

Available at SSRN.

Blockchain and Investment: An Austrian Approach

With Darcy WE Allen, Sinclair Davidson and Jason Potts. Forthcoming in the Review of Austrian Economics

Abstract: Investment is a function of expected profit, which involves calculation of the cost of trust. Blockchain technology is a new institutional technology (Davidson et al 2018) that industrialises trust (Berg et al 2018). We therefore expect that the adoption of blockchain technology into the economy will affect investment and capital structure. Using a broad Austrian economic approach, we examine how blockchain technology will affect the cost of trust, patterns of investment, and economic institutions.

Working paper available at SSRN.

Proof of work as a three sided market

With Sinclair Davidson and Jason Potts. Published in Frontiers in Blockchain, 2020. doi: 10.3389/fbloc.2020.00002

Abstract: Blockchain technology is 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.

Available here.

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