A submission to the Senate Select Committee on Financial Technology and Regulatory Technology (‘Committee’) following the tabling of the Committee’s Interim Report and the publication of the Second Issues Paper, focusing on the regulatory implications of blockchain technology.
Abstract: Commitment voting is a mechanism for signalling intensity of preferences and long-term commitment to governance decisions in proof of stake blockchains. In commitment voting, the voting weight of a vote in any given election is determined by 1) the amount of tokens under a voters control and 2) the time that the voter is willing to lock their tokens up for that election. Winning votes are locked up for the nominated amount of time. Losing votes are released as soon as the election has results. Commitment voting requires voters to commit to the decisions they make while still allowing those who disagree with the majority to exit the community.
Abstract: What assets does a firm need to hold to develop a profitable business model? A ‘Hart asset’ is an asset that a firm cannot strategically afford a rival firm to own or control due to the risk of hold up, and therefore must be held within the firm, and upon which a profitable business model can be built. We tie the Hart asset to the problem of complementarities in profitable innovation, and conclude with an example Hart asset in digital platforms.
Donald Trump’s failure to win a second term as president isn’t just important for the future of the United States. It has significant implications for centre-right politics in Australia too.
At least since the Cold War the centre-right has been an alliance between conservatives and classical liberals. Sometimes this alliance has been awkward. But the result has been a balance between relatively free market economics and relatively conservative social policy that we broadly associate with John Howard, Ronald Reagan, and Margaret Thatcher.
The Trump administration represented for many on the right a sharp ideological break with the past. Out went conservative-liberal fusionism. In came working class populism and a suite of starkly different policy priorities: anti-trade, anti-immigration, anti-big business, and anti-tech.
Virtually the moment polls closed in 2016, conservatives around the world started talking excitedly about the virtues of populism, the opportunities of ‘conservative nationalism’, and building their own domestic version of Trump’s America First.
Electoral realignment has led to intellectual realignment. One influential manifesto was published in the conservative magazine First Things in 2019. Titled “Against the Dead Consensus”, it declared that the “pre-Trump conservative consensus” had collapsed and it was time to reject globalism and “warmed-over Reaganism”. A bunch of new think tanks and political magazines have been established with names like American Compass and American Greatness to capture the Trump-era zeitgeist.
On the other side, some traditional fusionist institutions like the Weekly Standard have collapsed, only to be replaced by Trump sceptical publications like The Dispatch and The Bulwark.
Perhaps we should not overstate the ideological change. The Trump administration enacted many traditional Republican policies – appointing those originalist judges, pursuing all that deregulation and the deep corporate tax cuts.
But they set up the two big debates we’re going to see in the centre-right for the next few years. First: could have any Republican president gotten these policies through, or could it only have been someone as confrontational and singular as Donald Trump?
Second: might the political capital spent on tax cuts and deregulation have been better spent on more working class-focused policies like infrastructure investment and paid family leave? Some are already claiming Trumpism didn’t fail – Trumpism was never really tried. If the conservative-liberal consensus is dead, did the Trump administration trip over its corpse?
The result of these debates will have ramifications in Australia. For the most part, the Morrison government has avoided major ideological realignment in the Trump era. The Prime Minister played around with Trumpy language last year when he warned about “negative globalism”. But there’s a big difference between opposing ‘negative’ globalism (by which our prime minister was criticising corrupt international institutions) and the sort of globalism that Donald Trump is opposed to (immigration, free trade, and the network of traditional alliances). Anyway, who could support “negative” globalism?
Ultimately the Morrison government has tried to paint a soft populist tint over its traditional policy agenda. It still claims its free trade agreements as an achievement, for instance (although it has been notably less talkative about those agreements since 2016).
Even if Morrison had wanted to explicitly follow the Trump path, he would have struggled to do so. A small, open, productive economy like Australia is highly dependent on free trade and migration for our prosperity.
One issue where we might say that the Australian right has been influenced by Donald Trump is on China. But these last four years have seen the heavy oppression of the Uyghur minority in Xinjiang, the loss of free Hong Kong, and Xi Jinping’s tightening grip on the Chinese state. It is hard to imagine an alternative history in which Australia was not aware of these events.
The big question for us is whether the old conservative-liberal alliance can be rebuilt. If the Trump administration has permanently severed that alliance, the deep interactions between centre-right intellectuals and activists across the Pacific Ocean mean it will inevitably be severed in Australia too.
And when that happens, we will be faced with a serious long-term challenge for our economic wellbeing.
Unless the Democratic Party or the Labor Party pick up the classical liberal agenda of free trade, deregulation, low taxes, and openness to immigration, then that policy mix – and the prosperity it has created – is at risk.
With Darcy WE Allen, Aaron M Lane and Patrick A. McLaughlin. Published in Australian Journal of Public Administration, 18 September 2020
Abstract: The problem of regulatory accumulation has increasingly been recognised as a policy problem in its own right. Governments have then devised and implemented regulatory reform policies that directly seek to ameliorate the burdens of regulatory accumulation (e.g. red tape reduction targets). In this paper we examine regulatory reform approaches in Australia through the lens of policy innovation. Our contributions are twofold. We first examine the evolutionary discovery process of regulatory reform policies in Australia (at the federal, intergovernmental and state levels). This demonstrates a process of policy innovation in regulatory mechanisms and measurements. We then analyse a new measurement of regulatory burden based on text analytics, RegData: Australia . RegData: Australia uses textual analysis to count “restrictiveness clauses” in regulation—such as “must”, “cannot” and “shall”—thereby developing a new database. We place this “restrictiveness clauses” measurement within the context of regulatory policy innovation, and examine the potential for further innovation in regulatory reform mechanisms.
With Alastair Berg. Published in Cosmos + Taxis, Volume 8, Issue 8-9, 2020
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 eighteenth-century Britain. The New Australia settlement in Paraguay can be seen as an unsuccessful fork of nineteenth century Australia.
With Darcy W E Allen, Kiersten Jowett, Mikayla Novak, and Jason Potts. Published in in Cosmos + Taxis, Volume 8, Issue 8 + 9, 2020
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.
This essay follows an RMIT Blockchain Innovation Hub workshop on defi. Contributions by Darcy WE Allen, Chris Berg, Sinclair Davidson, Oleksii Konashevych, Aaron M Lane, Vijay Mohan, Elizabeth Morton, Kelsie Nabben, Marta Poblet, Jason Potts, and Ellie Rennie. Originally a Medium post.
The financial sector exists solely to smooth economic activity and trade. It is the network of organisations, markets, rules, and services that move capital around the global economy so it can be deployed to the most profitable use.
It has evolved as modern capitalism has evolved, spreading with the development of property rights and open markets. It has grown as firms and trade networks became globalised, and supercharged as the global economy became digitised.
Decentralised finance (defi) is trying to do all that. But just since 2019, and entirely on the internet.
Any business faces the question of “how do I get customers to pay for my product?” Similarly consumers ask the question, “Where and how can I pay for the goods and services I want to buy?” For the decentralised digital economy, defi answers this question. Defi provides the “inside” money necessary to facilitate transactions.
But what in traditional, centralised finance looks like banks, stock exchanges, insurance companies, regulations, payments systems, money printers, identity services, contracts, compliance, and dispute resolution systems — in defi it’s all compressed into code.
From a business perspective trade needs to occur in a trusted and safe environment. For the decentralised digital economy, that environment is blockchains and the dapps built on top.
And as we can see, defi doesn’t just finance individual trades or firms — it finances the trading environment, in the same way that taxes finance regulators and inflation finances central banks. If blockchain is economic infrastructure, defi is the funding system that develops, maintains and secures it.
These are heavy, important words for something that looks like a game. The cryptocurrency and blockchain space has always looked a little game-y, not least with its memes and “in-jokes”. The rise of defi has also had its own cartoonified vibe and it has been somewhat surreal to see millions of dollars of value pass through tokens called ‘YAMs’ and ‘SUSHI’.
Games are serious things though. A culture of gaming provides a point around which all participants can coordinate activity and experimentation — what we’re seeing in defi is the creation of a massive multiplayer online innovation system. The “rules” of this game are minimal, there are no umpires, and very little recourse, where the goal is the creation and maintenance of decentralised financial products, and willing players can choose (if and) to what extent they participate.
Because there is real value at stake, the cost of a loss is high. Much defi is tested in production and the losses from scams, unethical behaviour, or poor and inadequately audited coding are frequent.
On the other side, participation in the game of defi is remarkably open. There are few barriers to entry except a small amount of capital that players are willing to place at risk. Once fiat has been converted into cryptocurrency, the limit on participation in decentralised finance isn’t regulatory or institutional — it is around knowledge. (Knowledge is a non-trivial barrier, excluding people who could be described as naive investors. This is important for regulatory purposes.)
This is starkly different from the centralised financial system, where non-professional participants have to typically go through layers of gatekeepers to experiment with financial products.
The basic economics of defi
The purpose of defi is to ensure the supply of an ‘inside money’ — that is, stablecoins — within decentralised digital platforms and to provide tools to manage finance risks.
In the first instance defi is about consumer finance. It answers basic usability questions in the blockchain space: How do users of the platform pay native fees? Which digital money is deployed as a medium of exchange or unit of account on the platform?
In the second instance defi concerns itself with the operation of consensus mechanisms — particularly proof of stake mechanisms and their variants. The problem here is how to capture financial trust in a staking coin and then how to use that trust to generate “trust” on a blockchain. Blockchains need mechanisms to value and reward these tokens. Given the (potential) volatile nature of these tokens, risk management instruments must exist in order to efficiently allocate the underlying risk of the trading platform.
As we see it, the million yam question is whether the use of these risk management tools undermine trust in the platform itself. It is here that governance is important.
Which governance functions should attach to staking tokens and when should those functions be deployed? Should they be automated or should voting mechanisms be used? If so, which voting mechanisms and what level of consensus is appropriate for decision making.
Finally defi addresses the existence of stablecoin and staking tokens from an investor perspective. Again there are some significant questions here that the defi space has barely touched. How do these instruments and assets fit into existing investment strategies? How will the tax function respond? How much of existing portfolio theory and asset pricing applies to these instruments and assets?
Of course, we already have a complex and highly evolved centralised financial system that can provide much of the services that are being built from the ground up in defi. So why bother with defi?
The most obvious reason is that the blockchain space has a philosophical interest in decentralisation as a value in and of itself. But decentralisation addresses real world problems.
First, centralised systems can have human-centric cybersecurity vulnerabilities. The Canadian exchange QuadrigaCX lost everything when the only person with access to the cryptographic keys to the exchange died (lawyers representing account holders have requested that the body be exhumed to prove his death). Decentralised algorithmic systems have their own vulnerabilities (need we mention yams again?) but they are of a different character and unlike human nature they can be improved.
Second, centralised systems are exposed to regulation — for better or worse. For example, one of the arguments for UniSwap is that it is more decentralised than EtherDelta. EtherDelta was vulnerable to both hackers (its order book website was hacked) and regulators (its designer was sued by SEC).
Third, digital business models need digital instruments that can both complement and substitute for existing products. Chain validation instruments and the associated risk management tools presently do NOT have real world equivalent products.
Fourth and finally, the ability to digitise, fractionalise, and monetise currently illiquid real-world assets will require a suite of instruments and digital institutions. Defi is the beginning of that process.
In this sense, the defi movement is building a set of financial products and services that look superficially familiar to the traditional financial system using a vastly different institutional framework — that is, with decentralisation as a priority and without the layers of regulation and legislation that shape centralised traditional finance.
Imagine trying to replicate the functional lifeforms of a carbon-based biochemical system in a silicon based biochemical system. No matter how hard you tried — they’d look very different.
Defi has to build in some institutions that mimic or replicate the economic function provided by central banks, government-provided identity tech, and contract enforcement through police, lawyers and judges. It is the financial sector + the institutions that the traditional finance sector relies on. So, initially, it’s going to look more expensive, relative to “finance”. But the social cost of the traditional finance sector is much larger — a full institutional accounting for finance would have to include those courts and regulations and policymakers and central banks that it relies on.
Thus defi and centralised finance look very different in practice. Consider exchanges. Traditional financial markets can either operate as organised exchanges (such as the New York Stock Exchange) or as over-the-counter (OTC peer-to-peer) markets. The characteristics of those types of market are set out below.
Defi exchanges represent an attempt to combine the characteristics of both organised exchanges and over-the-counter markets. In the very instance, of course, they are decentralised markets governed by private rules and not (necessarily) public regulation. They aim to be peer-to-peer markets (including peer-to-algorithm markets in the case of AMM).
But at the same time they aim to be anonymous (in this context meaning that privacy is maintained), transparent, highly liquid, and with less counterparty risk than a traditional OTC market.
Where is defi going?
Traditional finance has been developing for thousands of years. Along with secure private property rights and the rule of law, it is one of the basic technologies of capitalism. But of those three, traditional finance has the worst reputation. It has come to be associated with city bros and the “Wolf of Wall Street”, and the Global Financial Crisis. Luigi Zingales has influentially argued that the traditional finance system has outgrown the value it adds to society, in part because of the opportunities of political rent seeking.
This makes defi particularly interesting. Defi is for machines. Not people. It represents the automation of financial services.
A century ago agriculture dominated the labour force. The heavy labour needs of farming are one of the reasons we were poor back then. As we added machines to agriculture — as we let machines do the farming — we reduced the need to use valuable human resources. Defi offers the same thing for finance. Automation reduces labour inputs.
Automation of course has been increasingly common in financial systems since at least the 1990s. But it could only go so far. A lot of the reason that finance (and many sectors, including government and management) resisted technological change and capital investment, was at the bottom, there had to be a human layer of trust. Now that we can automate trust through blockchains, we can move automation more deeply into the financial system.
Of course, this is in the future. Right now defi is building airplanes in 1902 and tractors in 1920. They’re hilariously bad and horses are still better. But that’s how innovation works. We’re observing the creation of the base tools for entrepreneurs to create value. Value-adding automated financial products and services comes next.
Economists have long warned that a great deal of regulation that is supposedly in the public interest acts in practice as a transfer of wealth from one private interest to another. Policy makers are usually demure enough to hide this. It is rare that rent-seeking is as explicit and open as the Australian government’s current attempt to expropriate money from Facebook and Google—money that will be directly paid to the traditional news outlets that these tech companies have disrupted.
This is much more than just a regional policy fight; what is happening in Australia tells us a lot about how the changing economics of media are feeding the bipartisan war on the tech industry in the United States and globally. Much of what is dressed up as populist anti-tech policy is in fact an attempt by legacy media companies to weaponize confused regulators against their competitors.
The Australian government wants Facebook and Google to sign onto what they call a “News Media Bargaining Code,” which will require tech companies to pay news organizations when news content is “included” on the digital platforms. The exact price to be paid is meant to be negotiated by media companies and digital platforms. The rationale offered by Australian antitrust regulators is that there is a “bargaining power imbalance” between tech and media companies, hence the need for government action to get negotiations started.
You may be tempted to read that paragraph again. Don’t bother. The government’s argument is euphemistic and its reasoning is obscure. The most obvious problem is that neither Facebook nor Google “include” news content on their platform. The dispute is not about intellectual property theft; all tech companies are doing is linking to news sites. Facebook allows users to share links. Google offers links through its general search function as well as its Google News search service. The upshot is that the Australian government wants Facebook and Google to pay news organizations for the privilege of linking to their content.
Much like the U.S., the Australian media sector is in economic freefall. And like the U.S., both Australian progressives and conservatives have been regarding tech companies with increasing skepticism. We usually think of anti-tech skepticism as ideological—conservatives are at odds with socially liberal Silicon Valley types while progressives look at Silicon Valley as the new robber barons. But in Australia, it is strikingly obvious how the economic collapse of traditional media causes anti-tech sentiment.
Throughout the 20th century, the newspaper business model was simple: Newspapers sought to match readers with advertisers. Advertising paid for journalism, which attracted readers, which then attracted more advertising, and so on. The more readers the better. So newspapers tried to appeal to the median reader.
The history of the media in the last two decades is the slowly unfolding consequences of advertising migrating from the print media to the internet. This creative destruction not only undermined business models that paid for mass-market journalism, but reshaped how public debate is conducted. The growth in media partisanship in recent years could be because media outlets no longer try to appeal to the median reader—they try to engage a passionate few who will stump up a subscription fee. That is, media partisanship has economic causes.
The other consequence is political backlash against the big tech companies.
For generations, the art of politics involved serenading the local press, getting an audience with the regional media mogul, or building a relationship with a sympathetic journalist who could be relied on to get a political message out.
Now those friendly moguls and journalists are on the backfoot, shocked by the extraordinary growth of the digital platforms that seem to have ripped both the economic high ground from under them. And the political class is starting to respond to the new media normal the best way they know how: with threats of regulation.
It is easy to laugh at the odd populist attempts to tame digital platforms, such as Sen. Josh Hawley’s (R–Mo.) 2019 proposal to ban autoplay videos and infinite scrolling. But the Australian experience shows that the greater threat to digital platforms comes from antitrust regulators, dressed up in bizarre claims about “bargaining power imbalances.”
Antitrust policy in the 21st century is particularly vulnerable to this sort of strange thinking. Antitrust was conceived in a world of monolithic corporate hierarchies—factories that built physical things and distributed those things using physical infrastructure like rails and ports. Digital platforms are hard to understand through the traditional antitrust lens.
The more users a digital platform has—the more it dominates a market segment—the more valuable that platform is to those users. We want to use the social media network that everyone else is using. And to get more users, platforms often provide access to one side of the market for free. For regulators used to hunting for predatory pricing, this just looks weird. At the same time these digital markets are highly dynamic; firms tend to dominate them, but not for long. This too leaves regulators in a bind. They’ve spent more than a century warning of the dangers of monopolies, but now they’re struggling to identify the actual harm these digital platform “monopolies” are causing.
Australian regulators are confused as to what to do and have proposed everything from regulating Facebook and Google’s algorithms, to enacting new privacy laws, to giving more money to public broadcasters.
It’s clear that U.S. regulators are confused too. In early September, The New York Times reported that while the Department of Justice plans to imminently bring an antitrust case against Google’s parent company, Alphabet, there is much internal disagreement about what the grounds of the government complaint should be.
As the Australian experience shows, this combination of confused regulators and aggrieved, politically connected industries is a dangerous thing.