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.

International policy coordination for blockchain supply chains

With Darcy Allen, Sinclair Davidson, Mikayla Novak and Jason Potts. Published in Asia & The Pacific Policy Studies, 30 May 2019

Abstract: From the adoption of the shipping container to coordinated trade liberalization, reductions in trade costs have propelled modern globalization. In this paper, we analyse the application of blockchain to reduce the trade costs of producing and coordinating trusted information along supply chains. Consumers, producers, and governments increasingly demand information about the quality, characteristics, and provenance of traded goods. Partially due to the risks of error and fraud, this information is costly to produce and to maintain between dispersed parties. Recent efforts have sought to overcome these costs—such as paperless trade agendas—through the application of new technologies. Our focus is on how blockchain technology can form a new decentralized economic infrastructure for supply chains by governing decentralized dynamic ledgers of information about goods as they move. We outline the potential economic consequences of blockchain supply chains before examining policy. Effective adoption faces a range of policy challenges including regulatory recognition and interoperability across jurisdictions. We propose a high‐level policy forum in the Asia‐Pacific region to coordinate issues such as open standards and regulatory compatibility.

Available at Wiley Online.

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.

Forthcoming with Edward Elgar Publishing

Why Blockchain Technology Could Be the Key to Solving the Developing World’s Biggest Problems

With Darcy Allen

The core of the free market explanation for global poverty is simple and compelling: much of the world’s poor are poor because of institutional failure.

The court systems that service the bottom billion are unreliable or hard to access. The governments impose extractive taxation. The bureaucracies are corrupt.

And some institutions are simply missing in the developing world. A lack of reliable identity services makes it hard to access financial markets. A lack of property titles, as Hernando de Soto famously wrote, makes it hard to use the capital embodied in homes.

Corruption and Monopolies

These explanations are all true. But the free market response to global poverty is insipid to the point of uselessness. Faced with evidence that institutions in developing countries are corrupt, classical liberals respond: well, don’t be so corrupt.

There are other responses, of course. We sometimes adopt the Washington Consensus approach—use the levers of political globalization to force reform on unwilling populations. Or maybe we just hope for a revolution that might turn out liberal. Neither alternatives have good track records.

The problem here is that institutions tend to be monopolies. One country has one court system, one bureaucracy in charge of property titles, one authority giving out birth certificates. To get better institutions, we have to replace the corrupt old ones, and that’s hard to do, especially given the intransigence of rent-seekers who benefit from them.

Institution Innovation

What the developing world needs is a technology of institutions—a way not to replace institutions but to create more of them, experimentally and entrepreneurially.

This is what we see in the blockchain. Blockchain technology is an institutional technology that allows multiple institutions to operate in one place. It is perfectly suited to hostile institutional environments.

There’s been a lot of work, unsurprisingly, on individual blockchain applications that might be helpful for the world’s poor: supply chains, democratic governance, and identity management for example. With these applications, blockchain might allow poor countries to leapfrog some of the stages of development—a poor country might skip the creation of the centralized institutions characteristic of the rich world and instead adopt immediately decentralized ones.

These applications don’t need to replace their competitors, and they are virtually impossible for the beneficiaries of the old order to prevent.

But we think blockchain technology offers something more fundamental than these specific applications.

It offers the possibility of creating new institutions—new algorithmic legal systems, contract dispute resolutions systems, identity technologies, mutual welfare and insurance, and public goods provision—in competition with the existing set of institutions.

For instance, the invention of a smart contracting platform could compete with existing court systems, helping to overcome the problems of hold-up or counterparty risks. The contracting parties to decide which institutional structure they wish to use—the terrestrial one or a near-infinite number of new digital alternatives.

These applications do not need to replace their competitors to function. And they are virtually impossible for the beneficiaries of the old order to prevent.

Institutional Layering

We call this process institutional layering. Blockchain institutions co-exist with existing institutions, effectively layering on top.

Blockchain entrepreneurs in developing economies don’t require international aid agencies or development experts to define economic problems and try to solve them. Rather, they apply their entrepreneurial judgment and skills to define institutional problems and use blockchains to design and test new institutional solutions.

William Easterly famously outlined the distinction between “planners” and “searchers” in economic development. Development economics has been plagued by planners implementing top-down institutions that don’t match local conditions and have a raft of unintended consequences.

Instead of working within the existing institutions, entrepreneurs can use blockchain to operate more effectively.

The capacity of entrepreneurs to search, however, is constrained by the transaction costs they face and the technologies they have available. Rather than propelling institutional change through centralized planners (whether it be through conquest or special economic zones), blockchain enables a new decentralized process of search.

Rather than forming businesses within the existing institutions, entrepreneurs can use the blockchain to more effectively operate on the level of the institutions themselves. Blockchain enables institutional entrepreneurs to search by operating on the governance or “protective-tier” level of entrepreneurship.

Now entrepreneurs can search, discover, and deploy new governance mechanisms. They can attract users by better economizing on transaction costs than alternatives.

Polycentric Institutions

The process of institutional layering will also be more polycentric. Rather than having centralized institutions attempting to fit over broad groups of people within a geographical nation-state, entrepreneurs will, over time, discover the necessary levels of institutional rules within regions and across borders.

Another ongoing problem of institutional change in the developing world is aligning formal institutions with the underlying informal norms. Blockchain-based institutional layering—using governance approaches developed by local entrepreneurs—might better match the underlying norms, or what James C. Scott describes as metis.

New, digital, uncensorable, trustful institutional technologies open up enormous opportunities for decentralized economic development.

Because blockchain institutions are built from the bottom-up and draw on local entrepreneurial knowledge, we might see greater levels of institutional stickiness, where formal blockchain institutions better match underlying norms and therefore are embedded and longer-lasting.

Our argument risks techno-utopianism. We are confident that blockchain—or successor distributed ledger technologies not yet invented—might solve several institutional problems within the developing world. It will not, of course, solve all of them.

Nevertheless, the invention of a class of new, digital, uncensorable, trustful institutional technologies opens up enormous opportunities for decentralized economic development.

And it allows the same entrepreneurial creativity that has driven prosperity in the rich world to be turned to the causes of poverty in the developing world.

Byzantine political economy

With Sinclair Davidson and Jason Potts.

Abstract: For decades, computer science and economics have been working on the same questions in parallel. But each field has offered strikingly different answers. This paper examines the close relationship between what the study of distributed systems describes as Byzantine consensus and what the study of institutional economics describes as robust political economy. These parallels have become evident after the invention of distributed ledger technology (blockchain) via the Bitcoin cryptocurrency which provides a new technology for managing and coordinating knowledge about property rights. Blockchain is the instantiation of a new form of social infrastructure that securely decentralises property ledgers. As such it represents a shift in the role of government as a centralised property ledger.

Available at SSRN.

Blockchains and institutional layering as a new approach to economic development

With Darcy Allen.

Abstract: Since the mid-twentieth century, development economists have identified barriers to economic growth including financing a savings-investment gap, planning investments, and making lasting institutional change. Efforts to overcome these development barriers range from centralised planned intervention to decentralised entrepreneurial search. In this paper we analyse the impact of blockchain technologies on economic development. We propose that blockchains facilitate a more decentralised entrepreneurial process of economic development through institutional layering. This dynamic leads to a more permissionless, polycentric and institutionally sticky economic development process. Blockchains shift the entrepreneurial process by which development problems are defined and ameliorated through time.

Working paper available at SSRN.

Towards Crypto-friendly Public Policy

With Sinclair Davidson and Jason Potts. Published in Melanie Swan, Jason Potts, Soichiro Takagi, Frank Witte and Paolo Tasca, 2019. Blockchain Economics: Implications of Distributed Ledgers, World Scientific Publishing, Singapore, pp. 215-232.

Abstract: Distributed ledgers are institutional technologies that pose complex challenges regarding regulation and inter-jurisdictional competition. This chapter introduces ‘crypto-friendly’ public policy as a way to understand these challenges. Blockchains are relevant to public policy in at least three ways. First, they can be adopted by governments for the provision of public services. Second, many blockchain applications interact with existing regulatory frameworks and may provide new regulatory challenges. Third, they present the possibility of ‘crypto-secession’ as a form of privately provided public goods provision. The chapter applies an institutional theory of regulation to assess how blockchains effect relative institutional costs and guide public policy choices. Blockchain applications such as property rights and identity management are also considered. Finally the chapter considers the possibility of crypto-friendliness as a dimension for international regulatory competition.

Available at World Scientific.

The use of knowledge in computers: introducing nanoeconomics

With Sinclair Davidson, Jason Potts and Bill Tulloh. Originally a Medium post.

In his 1945 essay “The Use of Knowledge in Society”, Friedrich Hayek first drew attention the knowledge problem. Information is distributed throughout an economy. No central planner can effectively bring it together.

Hayek, obviously, was talking about a human economy, where people exchange with people. But machines suffer from knowledge problems too. This is the domain of nanoeconomics — which we suggest is the study and evaluation of the economics of machine systems.

Hayek in the machine

Nanoeconomics is about human-machine exchange, and machine-machine exchange. It is the economics of distributed ledgers and artificial intelligence, of object-capability programming and cybersecurity, of ‘central planning’ in the machine, and of ‘markets’ in the machine.

As we’ve come to understand blockchains and other distributed ledger technologies as an institutional technology, we’ve also learned that not only can blockchains coordinate and govern decentralised human economies (as governments, firms and markets do) but they can coordinate and govern decentralised machine economies (or human-machine economies).

This extends what Hayek called catallaxy — the spontaneous order of the market — from the market coordination of human action to the coordination of human-to-machine and machine-to-machine economies.

Nanoeconomics is not a new idea. In their Agoric papers published in 1988, Mark Miller and K. Eric Drexler developed the idea of a computational system as a space for economic exchange. The development of object-oriented programming has created software agents, which vie for scarce resources in the machine. But right now, these agents are governed through planning, not markets. Miller and Drexler suggested an alternative: a market-based computation system. In this system:

machine resources — storage space, processor time, and so forth — have owners, and the owners charge other objects for use of these resources. Objects, in turn, pass these costs on to the objects they serve, or to an object representing the external user; they may add royalty charges, and thus earn a profit.

With global computers like the smart-contract platform Ethereum we now have the bones of such a market-based computational architecture.

Nor is the idea of an analytical layer below microeconomics a new idea. Kenneth Arrow used the word nanoeconomics for the study of single buying and selling decisions. But that line of research has been subsumed into behavioural and now neuroeconomics. Alternatively it is used to describe the economics of nanotechnology.

But in an age where we deploy digital, quasi-autonomous agents to act on our behalf, and where the traditional economic problems of opportunism, asset specificity and bounded rationality are intimately tied into cybersecurity and digital services, we have to drive our economic analysis — and our institutional choices — into the machine.

Nanoeconomics is the study of an economy of software agents, using market institutions and property rights to order computation and bid for computational resources. It is the study of choices and market exchange that occur between computational objects in object-oriented software architectures, and which are economically coordinated through blockchain infrastructure.

As Miller and his colleagues have pointed out, a key problem with ‘centrally-planned’ computation are the implications for computer security. A decentralised software economy would instead seek to operationalise tradable property rights for access to objects through the principle of least authority.

Contract theory, not choice theory

Nanoeconomics is not simply a new field of economics — it is a significant extension. Where the choice-theoretic branch of economics has managed to drive its analysis down into the brain, the contract-theoretic branch has stopped at the level of human-to-human exchange.

What do we mean by choice-theoretic and contract-theoretic? Choice theory studies why people make the choices they do. This branch has traditionally been split into macroeconomics (the study of the aggregate economy) and microeconomics (the study of individual market choices).

In recent decades many economists have sought to drive their analysis deeper into the brain. Why do they have different preferences? Behavioural economics applies psychology to economics, and even more recently neuroeconomics applies biology. The choice-theoretic branch of economics goes: macro, micro, behavioural, neuro.

The contract-theoretic branch is the economics of Ronald Coase, James Buchanan, Oliver Williamson, Friedrich Hayek, and Elinor Ostrom. This branch looks at exchanges (that is, contracts) and the human institutions we have devised to constrain or facilitate those exchanges. Firms, markets, governments, clubs and commons (and now blockchains) are institutional environments to make exchanges, sign contracts, and otherwise pursue economic goals.

Contract-theoretic economics starts with constitutional economics — the macro level structuring of political and economic choices. It applies a transaction cost approach to microeconomic analysis. And with nanoeconomics we can start look at machine agents as economic actors, making exchanges — and acting opportunistically.

As more and more of the economy becomes machine-mediated, we need to worry about the security and efficiency implications of centrally-planned machine economies. But the underlying knowledge problems are general.

We’ve previously argued that blockchains are constitutional protocols for catallactic ordering. Nanoeconomics is about how they can not only facilitate improved decentralised economic coordination for humans, but also for machines.