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

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.