Jason Potts – Page 6

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.

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.

Supply Chains on Blockchains

With Sinclair Davidson and Jason Potts

Blockchain technology is shaping up as one of the most disruptive new technologies of the 21st century, facilitating an entirely new decentralised architecture of economic organization. While still experimental, it is disrupting industry after industry, beginning with money, banking and payments, and now moving through finance, logistics, health, and across the digital economy. These waves of innovation are being driven by both new entrepreneurial startups as well as by industry dominant firms reimagining and rebuilding their business models and services to use blockchain technology. Trade platforms and supply chains are shaping up as the major use case for blockchain technology, and we explain here how this may lead to a second phase of globalisation.

Breakthroughs in the technology of trade can have far-reaching consequences. Sailing ships and steam ships, refrigeration and aircraft were all watersheds in the making of the modern world, but two technologies of trade delivered us the modern era of globalization: these are (1) the shipping container, and (2) the WTO (formerly known as the GATT).

The invention of the shipping container in 1956 led to a revolution in international trade, birthing a new phase of globalisation. Blockchains, invented in 2009, promise a similar revolution. Blockchains offer a fundamental architectural change in the way firms and governments manage international trade, with enormous efficiency and productivity gains.

But, just as the shipping container required significant investment to bear fruit—and came up against the interests of the unions, regulators and ports—blockchain-enabled trade will require substantial upfront investment in new systems and will inevitably challenge existing interests. In the 1950s the shipping container was the solution to the problem of the high expense in money, time, and security to load cargo in and out of ships. Handling costs were high, operations were slow, and theft was rife.

Today the constraints on trade consist of the ever-increasing complexity of the data, records, payments and regulatory permissions that accompany goods as they travel across the world. Every good moving along a supply chain is accompanied by a data trail, often still as paperwork, to track bills of lading, invoices of receipt and payment, origin, ownership and provenance, as well as compliance with vast schedules of trade prohibitions and environmental regulation, taxes and duties.

The shipping container is a physical coordination technology, while the WTO is an institutional coordination technology. At the Blockchain Innovation Hub we believe that blockchain technology – as tradetech – is shaping up as the third great technology of trade.

The Cost of Information and Trust

Blockchain technology can solve a major and growing problem with the global trading order – namely the problem of information. Every time a good or service moves, information moves with it. The quantity of information associated with each product continues to grow, and the costs of dealing with this information, from compliance, auditing, verification – trust, in a word – is becoming a greater and greater share of the costs of the global trading system.

This information includes provenance and inputs – the information on a label. It includes trade-finance, bills of lading, shipping and handling information, security clearance – the commercial and administrative information. It includes the documentation of where it’s been and where it’s going, and who has handled it and who hasn’t. And it includes all the information that each country requires in relation to customs and duties, biosecurity, labour and environmental regulations, compliance with various treaties – a vast rigmarole of auditing and compliance, each of which is necessary, desirable and costly. With each day, the information burden increases, not decreases.

As the information cost of trade increases, it is not simply enough to digitize everything, because the real problem is that we need to be able to trust the information that is there.

Tradetech

Globalisation 2.0 will be built on tradetech, and the crucial infrastructural component of tradetech is blockchain. Blockchain technology, which is a distributed, append-only, peer-to-peer, trustless secure ledger, is almost custom-made for trade-tech. It provides an infrastructural platform upon which to build a new information architecture for globally tradable goods – and to do so in a way that is fully digital, tamper-proof, low-cost, end-to-end secure, verifiable, transparent, scalable and computable. What cryptocurrencies did for money tradetech will do for globalization.

Tradetech will integrate the benefits of fintech into trade networks. Crypto-based models of payments, trade finance, insurance and other risk management tools will be automated. Tradetech will integrate the benefits of regtech into trade networks. Verification and compliance with local regulations will be automated. Tradetech will power-up logistics technologies with blockchain affordances such as smart contracts, decentralized autonomous organisations (DAOs), and the full technology stack that includes AI integration.

So we think of blockchain as a next-generation infrastructural technology for the global movement of goods and services. Service exports have the same constraints with respect to compliance with certification, credential verification, and quality standards assurance. These same problems apply generally to the movement of people too. We are still yet to weave together a seamless global system of identity documents, education and trade certification and permissions, and taxation and other public liabilities.

Example: Benefits for Australia

Tradetech facilitated supply chains could to bring significant advantages to Australia, and her trading partners. This is win-win because there are both consumers and producers on each side.

For Australian exporters, there are at least two obvious advances. Tradetech facilitated Australian Agriculture will significantly boost the quality of provenance claims as to origin and quality of product. When this transparent verifiable information passes at much lower cost to final consumers, more of that assurance value passes back to suppliers, boosting primary producer income.

We are starting to see this already with start-ups in the primary export industry, for instance with Beef-ledger, Agridigital and Grainchain. We will also likely see the benefits of similar assurance in advanced manufacturing, such as in aerospace, medical devices, pharma and other high value bespoke manufacturing where quality is paramount and certification is costly. Or in other areas that rely heavily on intellectual property, such as creative industries.

Blockchain based tradetech will benefit producers and consumers by lowering the cost of providing and processing high value information that rewards legitimate quality production and minimizes
rent-extraction along the way.

Crypto Free Trade Zones

Blockchain-based next-generation trade infrastructure opens the prospect of a next generation of crypto free trade zones. These may overlay existing trade zones – within bilateral or multi-lateral zones – with a standard protocol for information handling. This would lower the transactions costs of trade, which economic theory predicts would increase the quantity of trade, and therefore value creation.

But blockchain trade areas could also build on private supply chains and infrastructure, as with consortia such as the IBM-Maersk-Walmart alliance, or with the recently announced adoption by FedEx of blockchain technology. This is the difference between say email (an open standard) and Facebook (a proprietary model). The strength of the closed network model is that it incentivizes investment. But it creates power, and invariably requires regulation to constrain that power. And regulation in turn stifles innovation.

We need to start thinking about how we want free trade to evolve in the blockchain era. Global open standards should be our ambition, because this brings the maximum prospect for growth and innovation. But open standard protocols are challenging to get started, because it can stumble on a coordination problem at the outset. This is why in order to build the next generation of globalization on blockchain infrastructure we will need to solve the open standards coordination problem.

Blockchain is (now) a competitive industry

With Sinclair Davidson, Jason Potts and Ellie Rennie. Originally a Medium post.

With the anniversary of the Bitcoin whitepaper looming on October 31, it is remarkable how far and fast this industry has come since it was anonymously launched on a crypto bulletin board just ten years ago. Ethereum, which gave us smart contracts and ICOs, was only started in 2015. The Consensus conference, only in its fourth year, packed over 8500 attendees into the New York midtown Hilton with representatives from most major corporations and industries being present.

Blockchain is quickly becoming mainstream. The industry is entering the phase of industrial competition — and this is happening on a global scale.

Consensus is the centerpiece of Blockchain Week in New York City, and the main global industry conference for cryptocurrency and blockchain technology. It is also increasingly a platform for major industry announcements. Two clusters of announcements in particular are propitious markers of where we’re up to in the development of the industry.

In politics, David Burt, Premier and Finance Minister of Bermuda, announced his country’s Parliament had tabled the Digital Asset Business Act, staking an ambition and claim to be the world’s leading crypto-regulator. On Tuesday, Eva Kaili, Chair of European Parliament Science and Technology Options Assessment, announced the Blockchain Resolution had passed the European Parliament.

In enterprise, Fred Smith, CEO of FedEx called blockchain the next big disruption in supply chains and logistics with the potential to completely revolutionise the global trade system. Circle, a Goldman Sachs backed crypto finance company, announced it will be issuing a fiat stablecoin, which is to say a crypto-version of the $USD. And buried in the announcement by Kaleido — a blockchain business cloud — of a partnership with UnionBank i2i (a Philippines Bank specializing in rural banking), was a joint partnership with Amazon Web Services.

These announcements indicate that we have entered a new industry phase, moving well beyond the first entrepreneurial phase of highly speculative market-making start-ups operating entirely in a disruptive mode, and are now at the onset of a second phase of industrial dynamics, that of industrial competition. While still incredibly young, because of the speed and scale at which it has developed, the blockchain industry has now entered the phase of market competition.

The Bermuda announcement is a competitive response to the innovative regulatory frameworks built by jurisdictions such as Singapore, Zug (CryptoValley), Estonia, Gibraltar, Isle of Man, and other crypto-havens. The Bermuda announcement clearly signals that we’re now in the phase of global regulatory competition, and that crypto-regulation and legislation in countries such as the US and Australia will be held by the competitive pressure of exit-options from departing too far from the competitive equilibrium.

The announcement by Kaleido is in itself less significant than that of the AWS partnership, which signals the new shape of competition in cloud computing. Technology companies such as Microsoft, Oracle and IBM are competitively positioning themselves to provide foundational infrastructural services and standards in this new space, and the Fred Smith’s pronouncement signals that the logistics industry is about to be competitively disrupted again.

The difference between the first and second phase of industrial dynamics is that in the first phase entrepreneurs are inventing new technology, disrupting existing markets, and seeking to create new business models. It’s a process of de-coordination of an existing economic order. But this is not generally well described as a competitive market process, usually because markets themselves are still forming, and uncertainty is very high. Cooperation in networks and innovation commons is the predominant institutional form.

Competition emerges when uncertainty begins to clear as the outlines of how the technology works and what it will be used for, which markets are affected and how, and which firms will be involved, and a speculative game turns into a strategic game because it becomes clear who the players are and what they are doing. Investment is not just for R&D, for discovery of new technology; but is strategic investment to compete for market share, and ideally for market dominance.

This is where we are up to now: the phase of global market competition.And further evidence of this is that the main concern of industry participants is global regulatory uncertainty, which is to say the rules of the competitive game.

Now to be clear, crypto and blockchain is still an experimental technology. But we’re now past the early innovation phase — the start-up phase — and have investment is now a C-suite concern, and a parliamentary agenda item.

What does competition mean for Web 3.0?

So blockchain is being absorbed into the economy and global political system. But what does this mean for the future of the internet?

The other big question arising from the Consensus 2018 announcements was the extent to which the involvement of incumbent internet platforms, such as Microsoft and AWS, will affect the distributed nature of the emergent blockchain ecosystem.

Joseph Lubin, co-founder of Ethereum, argued that the technological foundations for a distributed future have been built and that the essential task now is to achieve scalability. Data storage is an important aspect of scalability that will be essential to the success of decentralised applications (dapps), and more radical solutions (such as the InterPlanetary File System, IPFS) are apparently not ready for widespread adoption.

The involvement of AWS in Kaleido enables enterprise participation in the Ethereum blockchain whilst ensuring that the data (including oracles) are housed securely. While numerous self-sovereign identity dapps are available (as displayed through Civic’s identity-checking beer vending machine at the conference), common standards are necessary for those providing verified information.

Microsoft’s partnership with Blockstack and Brigham Young University is a development towards these standards that is potentially significant for this new approach to online privacy.

Neither development necessarily threatens Web 3.0, but this is now being driven by a competitive logic of market forces.

Crypto constitutionalism

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

Blockchains are constitutional orders — rule-systems in which individuals (or firms, or algorithms) can make economic and political exchanges.

In this sense, blockchains look a lot like countries. They have currencies (tokens), property (digital assets), laws (protocols), corporations (DAOs), and security systems (proof-of-work, or proof of stake, or delegated byzantine fault tolerance, etc.).

And like countries, blockchains have systems of governance.

Satoshi built one system of governance into Bitcoin: how the network comes to a consensus when miners announce two equally valid blocks to the network. The protocol (the constitution) resolves this problem by incentivising nodes to prefer the chain with the most work.

But this is a tiny fraction of the governance questions that just surround Bitcoin. How should the Bitcoin network be upgraded? Who decides? How should the various interests be accommodated — or compensated?

In these blockchain governance debates — disputes about whether governance should be on-chain or off-chain, who writes the rules, who can be a node, the role of voting, and the relative position of protocol developers, miners, block producers, HODLers and third party applications — we’re seeing the history of thinking about political economy being rediscovered.

Happily there exists an enormous body of thinking on governance, constitutions, the function and efficiency of voting and voting mechanisms, and how power is allocated in a political and economic system.

Blockchains as constitutional experiments

Historically, experimenting with new constitutions has involved things like civil war, secession, conquest, empire, and expropriation. The English fought civil war after civil war to limit the power of the monarch to tax. Expanding the franchise involved protest and violence.

In the real world, constitutional experimentation is costly and slow: limited by the rights and preferences of real populations and the real endowments of physical land and property.

By contrast, blockchains offer a space for rapid, hyper-experimentation. New constitutional rules can be instantiated by a simple fork. New protocols can be released in months or weeks.

Blockchains are an environment for institutional innovation — a place to apply hundreds of years of thinking about political governance.

Why vote?

For instance, networks such as Decred, NEO and EOS use voting to manage their decentralised consensus mechanisms. Vitalik Buterin and Vlad Zamfir have argued that on-chain governance is overrated.

What this debate is missing is an understanding of the economics of politics. Blockchain developers aren’t writing protocols — they’re writing constitutions. And we know a great deal about constitutional design and voting mechanisms.

The first thing we know is that choosing the rules of a voting system is effectively choosing the result of the vote.

The eighteen-century mathematician the Marquis de Condorcet found that a three cornered vote using a simple majority rule might not come to a clear consensus on the winner. A might beat B, B might beat C, but C might beat A. The ‘ultimate’ winner of this cycle will depend on how the votes are ordered.

Kenneth Arrow generalised this into his impossibility theorem: there’s no unique procedure that reliably comes up with a stable ordering of aggregated preferences. A set of quite reasonable institutional assumptions — such as no dictator, the independence of irrelevant alternatives and so forth — can’t be combined.

The lesson economists have taken from all this is: tell me what you want, and I’ll design you a mechanism to get it. What matters is how we decide how to decide.

Public choice scholars have focused on problems how political agents shape their policy positions to suit median or marginal voters. Retrospective voting models suggest that voters assess how happy they are (in general, not just with politics) at the time of voting and vote for or against incumbents on that basis.

Other scholars have focused on why people even bother to vote — given there is a miniscule chance that they can change the outcome of a vote. This had led scholars to the theory of ‘expressive voting’, where voting is effectively a form of consumption or signalling.

This is a rich body of political and economic theory that has been absent from the blockchain governance space. For instance, is voting a positive or negative externality?

It depends on what the purpose of the voting is. If preference aggregation is your goal, ‘low-information’ voting is a problem — it introduces noise. Blockchains should then tax voting.

However, if simple legitimation is the purpose of voting (as Vlad Zamfir argued at the Ethereal conference) then even low-information voters add value. Ideally the mechanism would subsidise all voting.

The incentive design problem for blockchain voting depends on what you think the purpose of the voting is.

And it turns out that this question has been one of the over-riding concerns of economists, philosophers and political scientists for hundreds of years.

Some economic consequences of the GDPR

With Darcy Allen, Alastair Berg and Jason Potts.

At the end of May 2018, the most far reaching data protection and privacy regime ever seen will come into effect. Although the General Data Protection Regulation (GDPR) is a European law, it will have a global impact. There are likely to be some unintended consequences of the GDPR.

As we outline in a recent working paper, the implementation of the GDPR opens the potential for new data markets in tradable (possibly securitised) financial instruments. The protection of people’s data is better protected through self-governance solutions, including the application of blockchain technology.

The GDPR is in effect a global regulation. It applies to any company which has a European customer, no matter where that company is based. Even offering the use of a European currency on your website, or having information in a European language may be considered offering goods and services to an EU data subject for the purposes of the GDPR.

The remit of the regulation is as broad as its territorial scope. The rights of data subjects include that of data access, rectification, the right to withdraw consent, erasure and portability. Organisations using personal data in the course of business must abide by strict technical and organisational requirements. These restrictions include gaining explicit consent and justifying the collection of each individual piece of personal data. Organisations must also employ a Data Protection Officer (DPO) to monitor compliance with the 261-page document.

Organisations collect data from customers for a range of reasons, both commercial and regulatory — organisations need to know who they are dealing with. Banks will not lend money to someone they don’t know; they need to have a level of assurance over their customer’s willingness and ability to repay. Similarly, many organisations are forced to collect increasingly large amounts of personal data about their customers. Anti-money laundering and counter-terrorism financing legislation (AML/CTF) requires many institutions to monitor their customers activity on an ongoing basis. In addition, many organisations derive significant value from personal data. Consumers and organisations exchange data for services, much off which is voluntary and to their mutual benefit.

One of the most discussed aspects of the GDPR is the right to erasure — often referred to as the right to be forgotten. This allows data subjects to use the government to compel companies who hold their personal data to delete it.

We propose that the right to erasure creates uncertainty over the value of data held by organisations. This creates an option on that data.

The right to erasure creates uncertainty over the value of the data to the data collector. At any point in time, the data subject may withdraw consent. During a transaction, or perhaps in return for some free service, a data subject may consent to have their personal data sold to a third party such as an advertiser or market researcher. Up until an (unknown) point in time — when the data subject may or may not withdraw consent to their data being used — that personal data holds positive value. This is in effect a put option on that data — the option to sell that data to a third party.

The value of such an option is derived from the value of the underlying asset — the data — which in turn depends on the continued consent by the data subject.

Rational economic actors will respond in predictable ways to manage such risk. Data-Backed Securities (DBS) might allow organisations to convert unpredictable future revenue streams into one single payment. Collateralised Data Obligations (CDO) might allow data collectors to package personal data into tranches of varying risk of consent withdrawal. A secondary data derivative market is thus created — one that we have very little idea of how it will operate, and what any secondary effects may be.

Such responses to regulatory intervention are not new. The Global Financial Crisis (GFC) was at least in part caused by complex and rarely understood financial instruments like Mortgage-Backed Securities (MBS) and Collateralised Debt Obligations (CBS). These were developed in response to poorly designed capital requirements.

Similarly, global AML/CTF requirements faced by financial institutions have caused many firms to simply stop offering their products to certain individuals and even whole regions of the world. The unbanked and underbanked are all the poorer as a result.

What these two examples have in common is that they both have good intentions. Adequate capital requirements and preventing money from being cleaned by money launderers are good things, but good intentions are not enough. Secondary consequences should always be considered and discussed.

Self-governance alternatives, including the application of blockchain technology, should be considered. These alternatives use technology to allow individuals greater control over the personal data they share with the world.

Innovators developing self-sovereign identity solutions are attempting to provide a market based way for individuals to gain greater control over — and derive value from — their personal data. These solutions allow users to share just enough data for a transaction to go ahead. A bartender doesn’t need to know your name or address when you want a drink, they just need to know you are of legal age.

Past instances of regulatory intervention should make us cautious that even well-meaning regulation will achieve its stated objectives with no negative effects. Self-sovereign identity, and the use of blockchain technology is a promising solution to the challenges of data privacy.

Identity as Input to Exchange

With Alastair Berg, Sinclair Davidson and Jason Potts

Abstract: Identity is an integral part of all but the most trivial economic, social and political transactions. Using transaction cost economics, we determine that identity costs are a distinct and measurable subset of transaction costs. In certain transactions, such as credit arrangements, identity costs are incurred at considerable expense for commercial and compliance based reasons. Vertical integration can be seen through the lens of identity cost economising, including in the financial sector, due to high costs of complying with KYC regulations as well as commercial risk management. Such organisational structure is also contingent on available identity technologies. The introduction of blockchain and distributed ledger technologies in identity applications may see new models of institutional structures develop.

Working paper available at SSRN.