blockchain and cryptocurrencies – Page 8

Outsourcing vertical integration: Distributed ledgers and the V-form organisation

With Sinclair Davidson and Jason Potts

Abstract: This paper introduces the V-form organisation, a new form of firm organisation where vertical integration is outsourced to a decentralised distributed ledger (a blockchain). V-form organisations rely on the coordination of a (trusted) third party. It looks specifically at two instances of V-form organisation being established on the IBM-Linux Foundation Hyperledger permissioned blockchain. The paper concludes with four recommendations for strategic management about how to adjust to a V-form world, and four recommendations for policymakers.

Available at SSRN

Should I use a blockchain?

With Sinclair Davidson and Jason Potts. Originally a Medium post.

Blockchain as a business model can be imagined in one of two ways. It can be thought of as being a new general purpose technology. This category of technologies includes electricity, transistors, computers, the internet, mobile phones, and so on. To this way of thinking a blockchain can be represented as the next generation of the internet.

But if this is how people come to think of a blockchain we believe that many are going to be disappointed. Here the blockchain would be — what economists call — a factor augmenting technology. This is the standard economic story about how technology drives economic growth. People adopt a new technology because it reduces the productions costs associated with producing a given output. Technology ‘economises’ on scarce resources. We do more with less. This is the better-stronger-faster-cheaper model that we have come to associate with new technology.

But there is a problem with this approach to blockchains.

It is not immediately obvious that a blockchain is better-stronger-faster-cheaper for many general purpose uses. If managers are looking for improvements to their back room operations they will likely be underwhelmed by what a blockchain has to offer. There are many existing database software solutions that will very likely outperform a blockchain.

Another way to think about blockchains is as an institutional technology. As The Economist magazine insightfully suggested some years ago the blockchain is a trust machine. We have argued that blockchains industrialise trust. This is where the gains to using blockchain technology originate — not that it economises on production costs, but that it economises on transactions costs — especially trust.

When Satoshi Nakamoto solved the Byzantine general’s problem he also provided a solution to what economists call the coordination problem. Historically economists have recommended the price system, bureaucracy and managerial hierarchy as solutions to coordination problems. Now we also have the blockchain.

That blockchains are fundamentally an institutional rather than a technological innovation is not mere semantics. This distinction matters because it focuses attention on what is actually driving the creative-destruction this innovation generates.

What has changed is the technology of economic coordination and governance.

In the real world there is a trade-off between the price system and bureaucracy and hierarchy. The price system provides clear incentives — prices and profits determine what should be produced, how it should be produced, and who will produce it. In bureaucracy and hierarchy, however, those high-powered incentives are missing. But large scale economic activity generates large transaction costs and a lack of trust means that prices and profits can’t weave their magic.

This is where blockchains have a competitive advantage — the decentralised ledger technology provides a platform for coordination where transactions costs are dramatically reduced and trust industrialised. In an environment of complex economic activity that previously relied on bureaucracy and management we can now have prices and profits doing their magic.

Those adopters who think blockchain is just another backroom business tool are missing the main game. The blockchain is going to be your business model.

Opportunities for crypto-havens to capture business

With Sinclair Davidson and Jason Potts.

Blockchain technology is set to drive a new era of global public policy competition. In May 2018, the premier of Bermuda, David Burt, announced to the 8,500 attendees of the Consensus blockchain and cryptocurrency conference his country’s new Digital Asset Business Act and Initial Coin Offering Act. This legislation is intended to establish Bermuda as a premier destination for blockchain business by providing regulatory certainty around new business models.

But Bermuda is hardly the only jurisdiction seeking to attract blockchain firms. Singapore, Switzerland, Dubai, Estonia, subnational jurisdictions and dependencies like Illinois, Zug, the Isle of Man and Gibraltar are all positioning themselves to capture blockchain services. In October 2017, the then prime minister of Slovenia, Miro Cera, declared the country was “setting itself up as a blockchain-friendly destination.”

What we are seeing right now is an aggressive policy-driven grab to become a world leader in blockchain technology, and to capture some of the enormous value that this can unlock. Where once we saw global tax competition – as small nations attracted investment with business-friendly tax and regulation policy – now we are able to watch the green shoots of global blockchain competition. Blockchains are a unique technology, and that uniqueness presents some unusual public policy challenges. They offer us a new platform to organize economic activity: to make trades, to arrange production processes, to store information about assets and property ownership. Blockchains provide an economic infrastructure on which parallel technological developments, such as artificial intelligence and machine learning, the Internet of Things, 5G, and automation, can be built.

We expect to see a great deal of economic activity that currently takes place in firms, in markets, even in government, to be displaced by distributed ledger technology. Blockchains will tie organizations together that have currently cooperated only through market exchange, or by the force of regulation. It will lead to demergers, as large firms realize that a decentralized ledger is an alternative to complex multidivisional corporate structures.

But we have spent hundreds of years building complex taxation and regulatory systems around these institutions. The dominance of large firms has led governments to impose anti-trust laws. Principal-agent problems between owners and firm managers has led to the introduction of complex schemes of directors duties and manager controls. Securities law is built around the dominance of the public offering, taxation law around a sharp distinction between currency and other assets, and labor law around the employer-employee divide.

As a new technology of governing economic activity, blockchain applications pull at the threads of all these traditional regulatory frameworks. Globally, there are still deep uncertainties over the most basic questions around cryptocurrencies, such as when they are taxed, and as what: currency or security? The initial coin offerings that have brought so much money into the industry exist in a legal gray area almost everywhere in the world.

Blockchains are an incredibly young technology – just ten years old. Distributed autonomous organizations, decentralized labor markets, blockchain-secured intellectual property assets and blockchain-enhanced international trade will raise complex issues about fundamental regulatory structures, like labor, competition, and companies law – structures which have been reasonably fixed for the better part of a century. As more applications around economic problems, such as identity management, charities, healthcare, finance and global trade, are developed and introduced into the real world, they will face a spiraling number of regulatory and policy barriers that will need to be overcome. We face decades of regulatory uncertainty and demand for reform.

This is where crypto-friendliness matters. Crypto-friendliness does not mean the government needs to subsidize, plan or control blockchain technology. The sector is awash with funds: a happy by-product of the enormous speculative investment in cryptocurrencies that has occurred over the last eighteen months. No government planner could predict how this technology is going to develop, and given its global nature, no regulator has a hope of controlling it.

But blockchains do require governments to facilitate adoption. Because of the many ways blockchain use cases interact with existing regulatory frameworks they will need the help – or at least the acquiescence – of public policymakers to reform those frameworks to suit. The biggest regulatory risk in the blockchain space is uncertainty. Right now, those uncertainties are about how crypto-assets will be taxed, how and when they will be treated as securities, and the levels of disclosure around anti-money laundering and know-your-customer rules.

Governments that want to attract blockchain firms to their jurisdictions need to be resolving those uncertainties as soon as possible.

A crypto-friendly government is one which is not only focused on resolving current uncertainties but is able to credibly commit to facilitating the sorts of regulatory reforms needed in the future. Technological change is unpredictable. We do not know what blockchain applications are going to be the most successful and disruptive. Consumer demand is unpredictable. Governments should ensure, as far as possible, that regulation is both predictable and adaptive, that shape-changes in regulatory regimes do not occur, and that yet there is adequate space for entrepreneurial experimentation.

Which governments are likely to be the most crypto-friendly? At the first instance, the governments which have already demonstrated themselves as business-friendly environments are obvious candidates for blockchain friendliness. The ingredients of long-run economic growth – liberal, responsive institutions, the rule of law, limited government, regulatory modesty, and low taxes – are as important for blockchain firms as they are for other industries. The Isle of Man, for instance, has long been an established global leader in gambling and e-gaming, thanks to a deliberate effort on its part to establish welcoming and certain public policy. The Isle of Man is now a thriving site of blockchain innovation. As this suggests, blockchain technology presents a historically significant opportunity for the Cayman Islands, and any other jurisdiction which has a reputation for business-friendly policy. The last few decades of global tax competition have shown that smart policy can shape the geography of global capitalism just as strongly as labor or natural resources. Blockchains are a decentralized network but their developers, entrepreneurs and users exist in a real world, subject to real laws. Crypto-havens can capture that business.

Blockchain: An entangled political economy approach

Abstract: This paper incorporates blockchain activities into the broader remit of entangled political economy theory, emphasising economic and other social phenomena as the emergent by-product of human interactions. Blockchains are a digital technology combining peer-to-peer network computing and cryptography to create an immutable decentralised public ledger. The blockchain contrasts vintage ledger technologies, either paper-based or maintained by in-house databases, largely reliant upon hierarchical, third-party trust mechanisms for their maintenance and security. Recent contributions to the blockchain studies literature suggest that the blockchain itself poses as an institutional technology that could challenge existing forms of coordination and governance organised on the basis of vintage ledgers. This proposition has significant implications for the relevance of existing entangled relationships in the economic, social and political domains. Blockchain enables non-territorial “crypto-secession” not only reducing the costs associated with maintaining ledgers, but radically revising and deconcentrating data-conditioned networks to fundamentally challenge the economic positions of legacy firms and governments. These insights are further illuminated with reference to finance, property and identity cases. Entangled political economy provides a compelling lens through which we can discern the impact of blockchain technology on some of our most important relationships.

Author(s): Darcy W. E. Allen, Chris Berg, Mikayla Novak

Journal: Journal of Public Finance and Public Choice

Vol: 33 Issue: 2 Year: 2018 Pages: 105–125

DOI: 10.1332/251569118X15282111163993

Cite: Allen, Darcy W. E., Chris Berg, and Mikayla Novak. “Blockchain: An Entangled Political Economy Approach.” Journal of Public Finance and Public Choice, vol. 33, no. 2, 2018, pp. 105–125.

Blockchains and constitutional catallaxy: an EOS case study

With Alastair Berg. Originally a Medium post.

The EOS mainnet launched earlier this year.

In EOS we are witnessing the emergence of what Ludwig von Mises and Friedrich Hayek would recognise as constitutional catallaxy — open source constitutional orders in which participants are continually developing the rules of the game even after the game has started.

EOS operates under a Delegated Proof of Stake (DPoS) consensus mechanism, with 21 Block Producers (BPs) overseeing the validation of transactions. As an open source constitutional order, the jurisdiction of these BPs has been guided by de jure constitutional arrangements. In the pre-launch phase of EOS, documentation was drafted and debated outlining an EOS Constitution, while users were to include a hash of that document in their transactions to acknowledge their understanding and acceptance of it.

However, open source constitutional orders like EOS also have stakeholders who may exercise de facto authority in the absence of formal procedural rules or technical constraints.

The launch of the EOS mainnet provides examples of how de jure and de facto constitutional arrangements can diverge. While no token holder vote has taken place on the EOS Constitution (via their proxies — BPs), de factosovereignty was quickly exercised through the banning of seven (and later many more) accounts following a conference call between BP representatives and a body known as the EOSIO Core Arbitration Forum (ECAF).

As a result of this call, BPs chose to exercise de facto sovereignty and freeze these accounts. Only retroactively did this dispute resolution body ECAF issue a statement which indicated their support of the actions of BPs.

Similarly, 6 weeks after launch, an announcement was made to fundamentally change the way in which economic value is distributed across the EOS protocol. On July 28 Brendan Blumer, CEO of block.one (the organisation which developed the EOS mainnet), announced changes in the way EOS inflation is to be allocated. This will see new EOS tokens being distributed to users who stake tokens and vote for BPs, in addition to the rewards BPs receive for overseeing the validation of transactions.

These actions have drawn support as well as opposition. Some have called it a successful demonstration of off-chain governance, while some see it as jurisdictional overreach by emergent institutions.

In previous articles, we have argued that blockchains are a lot like countries. These (usually) open source protocols are constitutional orders which define how individuals interact and transact — complete with their own currencies, property, laws, corporations and security systems.

Blockchains, along with nation states, attempt to coordinate action in a world of incomplete information and opportunism — while computer scientists and economists have different vocabularies, Byzantine fault tolerance and robust political economy are the same thing.

Systems of governance for blockchain protocols are not new — the genius of Satoshi Nakamoto was to allow the Bitcoin network to reach consensus when two equally valid blocks are presented by miners, in effect solving the double-spend problem.

Yet now we can observe the emergence of — and have debate over — other governance arrangements in blockchain protocols. (Who writes and has permission to change the law (code), who enforces the rules, the role and method of voting, the role of developers and token holders, on-chain and off-chain governance etc).

What’s interesting is that these are analogous to the debates that individuals had during the emergence of nations. Consider the United States. With little to guide them but the musings of philosophers and radical thinkers, individuals grappled with a myriad of competing principles and interests as they set the ground rules for how their new constitutional order was to be governed.

Previously, constitutional orders emerged from revolution, civil war, conquest and other usually violent means — much like the constitutional order that emerged in the 13 American colonies.

In the real world, the emergence of institutions — as well as the jurisdiction which they exercise power over — can take many years after their formal establishment. The Supreme Court of the Unites States has the now familiar power of judicial review, evaluating the constitutionality of legislation and executive action. However it was only 16 years after it was established that the Supreme Court granted itself the power to declare acts of Congress unconstitutional as a result of Marbury v. Madison. Similarly, the role of the President has significantly expanded over time, with the term the Imperial Presidencyaccounting for the increased powers gradually vested in the US executive since the administration of George Washington.

The US Constitution has similarly been amended, challenged and otherwise interpreted in a myriad of different ways over its lifetime, demonstrating a real-world divergence and interaction of de jure and de facto constitutional arrangements.

Constitutional catallaxy

Likewise, blockchains are constitutional orders governed by social norms as well as technical constraints. The de jure constitutional order which governs how BPs represent EOS token holders, and the ways in which disputes are resolved, are ultimately subject to the exercise of authority by those who have the means.

What we are seeing is a process of constitutional entrepreneurism — constitutional catallaxy — in the establishment of new economies. The institutions that coordinate activity in these economies change and adapt to both the technological limitations built into the protocols, as well as the mutual expectations and power of interacting stakeholders.

Crypto Public Choice

With Alastair Berg and Mikayla Novak

Abstract: This paper presents ‘crypto public choice’ which examines the economics of collective decision making in the functioning of blockchain protocols and among related communities of users. We introduce the blockchain community to public choice theory and show how it can be applied to the study of this technology. Public choice offers an extensive literature that can be applied to blockchain design, can interpret the actions of different types of blockchain users, and can explain governance problems and challenges in each of the blockchain protocols. Blockchains are institutional technologies which provide new ways in which to produce public goods including consensus over shared facts and the security of property rights. Collective decision making by users of blockchain protocols relates to consensus over the contents of a shared ledger, as well as the initial design and subsequent upgrading of these protocols.

Working paper available at SSRN

Imagining the Blockchain Economy

With Sinclair Davidson and Jason Potts. Meanjin, vol. 77, no. 2 (winter)

For the first few years after its invention, the laser was described as ‘a solution in search of a problem’. Now lasers are everywhere. They’re used to scan barcodes, remove tumours and analyse chemical compounds. But initially no-one was quite sure what to do with this new technology. We have the opposite problem today. We’re facing down a wall of radical inventions and innovations that we can easily imagine will transform our world.

Take autonomous cars—the most public and obvious change that is now just years, perhaps months away. Autonomous vehicles are already being used across our transport networks. Driverless trucks shift iron ore out of mines. Driverless trains move minerals across the Pilbara. Pilotless cargo ships send goods across the planet. Self-driving vehicles for consumers will change the way we commute, how we travel, how we relate to distance, sprawl and density.

Institutional Discovery and Competition in the Evolution of Blockchain Technology

With Sinclair Davidson and Jason Potts

Abstract: Blockchains are an institutional technology for facilitating decentralised exchange. As open-source software, anybody can develop their own blockchain, ‘fork’ an existing blockchain, or stack a new blockchain on top of an existing one – creating a new environment for exchange with its own rules (institutions) and (crypto)currency. Since the creation of Bitcoin in 2008, blockchains have proliferated, each offering iterative institutional variation. Blockchains present a discrete space in which we can observe the process of institutional discovery through competition. This paper looks at the evolution of blockchains as a Hayekian discovery process. The public nature of blockchains – most blockchains offer public transaction – allows us to observe experimentation and competition at an institutional level with a precision previously unavailable compared to other instances of institutional competition.

Available at SSRN.

The rational crypto-expectations revolution

With Sinclair Davidson and Jason Potts. Originally a Medium post.

Will governments adopt their own cryptocurrencies? No.

Will cryptocurrencies affect government currencies? Yes.

In fact, cryptocurrencies will make fiat currency better for its users — for citizens, for businesses, for markets. Here’s why.

Why do we have fiat currency?

Governments provide fiat currencies to finance discretionary spending (through inflation), control the macroeconomy through monetary policy, and avoid the exchange rate risk they would have to bear if everybody paid taxes in different currencies.

As George Selgin, Larry White and others have shown, many historical societies had systems of private money — free banking — where the institution of money was provided by the market.

But for the most part, private monies have been displaced by fiat currencies, and live on as a historical curiosity.

We can explain this with an ‘institutional possibility frontier’; a framework developed first by Harvard economist Andrei Shleifer and his various co-authors. Shleifer and colleagues array social institutions according to how they trade-off the risks of disorder (that is, private fraud and theft) against the risk of dictatorship (that is, government expropriation, oppression, etc.) along the frontier.

As the graph shows, for money these risks are counterfeiting (disorder) and unexpected inflation (dictatorship). The free banking era taught us that private currencies are vulnerable to counterfeiting, but due to competitive market pressure, minimise the risk of inflation.

By contrast, fiat currencies are less susceptible to counterfeiting. Governments are a trusted third party that aggressively prosecutes currency fraud. The tradeoff though is that governments get the power of inflating the currency.

The fact that fiat currencies seem to be widely preferred in the world isn’t only because of fiat currency laws. It’s that citizens seem to be relatively happy with this tradeoff. They would prefer to take the risk of inflation over the risk of counterfeiting.

One reason why this might be the case is because they can both diversify and hedge against the likelihood of inflation by holding assets such as gold, or foreign currency.

The dictatorship costs of fiat currency are apparently not as high as ‘hard money’ theorists imagine.

Introducing cryptocurrencies

Cryptocurrencies significantly change this dynamic.

Cryptocurrencies are a form of private money that substantially, if not entirely, eliminate the risk of counterfeiting. Blockchains underpin cryptocurrency tokens as a secure, decentralised digital asset.

They’re not just an asset to diversify away from inflationary fiat currency, or a hedge to protect against unwanted dictatorship. Cryptocurrencies are a (near — and increasing) substitute for fiat currency.

This means that the disorder costs of private money drop dramatically.

In fact, the counterfeiting risk for mature cryptocurrencies like Bitcoin is currently less than fiat currency. Fiat currency can still be counterfeited. A stable and secure blockchain eliminates the risk of counterfeiting entirely.

So why have fiat at all?

Here we see the rational crypto-expectations revolution. Our question is what does a monetary and payments system look like when we have cryptocurrencies competing against fiat currencies?

And our argument is that it fiat currencies will survive — even thrive! — but the threat of cryptocurrency adoption will make central bankers much, much more responsible and vigilant against inflation.

Recall that governments like fiat currency not only because of the power it gives them over the economy but because they prefer taxes to be remitted in a single denomination.

This is a transactions cost story of fiat currency — it makes interactions between citizens and the government easier if it is done with a trusted government money.

In the rational expectations model of economic behaviour, we map our expectations about the future state of the world from a rational assessment of past and current trends.

Cryptocurrencies will reduce government power over the economy through competitive pressure. To counter this, central bankers and politicians will rail against cryptocurrency. They will love the technology, but hate the cryptocurrency.

Those business models and practices that rely on modest inflation will find themselves struggling. The competitive threat that cryptocurrency imposes on government and rent-seekers will benefit everyone else.

It turns out that Bitcoin maximalists are wrong. Bitcoin won’t take over the world. But we need Bitcoin maximalists to keep on maximalising. The stability of the global macroeconomy may come to rely on the credible threat of a counterfeit-proof private money being rapidly and near-costlessly substituting for fiat money under conditions of high inflation.

A hardness tether

Most discussion about the role of cryptocurrency in the monetary ecology has focused on how cryptocurrencies will interact with fiat. The Holy Grail is to create a cryptocurrency that is pegged to fiat — a so-called stable-coin (such as Tether or MakerDAO).

But our argument is that the evolution of the global monetary system will actually run the other way: the existence of hard (near zero inflation, near zero counterfeit) cryptocurrency will tether any viable fiat currency to its hardness. No viable fiat currency will be able to depart from the cryptocurrency hardness tether without experiencing degradation.

This in effect tethers fiscal policy — and the ability of politicians to engage in deficit spending in the expectation of monetising that debt through an inflation tax — to the hardness of cryptocurrency.

The existence of a viable cryptocurrency exit tethers monetary and fiscal policy to its algorithmic discipline. This may be the most profound macroeconomic effect of cryptocurrency, and it will be almost entirely invisible.

Cryptocurrency is to discretionary public spending what tax havens are to national corporate tax rates.

Cryptodemocracy and its institutional possibilities

Abstract: Democracy is an economic problem of choice constrained by transaction costs and information costs. Society must choose between competing institutional frameworks for the conduct of voting and elections. These decisions over the structure of democracy are constrained by the technologies and institutions available. As a governance technology, blockchain reduces the costs of coordinating information and preferences between dispersed people. Blockchain could be applied to the voting and electoral process to form new institutional possibilities in a cryptodemocracy. This paper analyses the potential of a cryptodemocracy using institutional cryptoeconomics and the Institutional Possibility Frontier (IPF). The central claim is that blockchain lowers the social costs of disorder in the democratic process, mainly by incorporating information about preferences through new structures of democratic decision making. We examine one potential new form of democratic institution, quadratic voting, as an example of a new institutional possibility facilitated by blockchain technology.

Author(s): Darcy W. E. Allen, Chris Berg, Aaron M. Lane, Jason Potts

Journal: Review of Austrian Economics

Year: 2018

DOI: 10.1007/s11138-018-0423-6

Cite: Allen, Darcy W. E., Chris Berg, Aaron M. Lane, and Jason Potts. “Cryptodemocracy and its Institutional Possibilities.” Review of Austrian Economics, 2018.