Institutional Cryptoeconomics: A New Model for a New Century

While cryptoeconomics is already a vibrant research field, the study of the blockchain must not be left solely to computer scientists and game theorists.

The rollout of blockchain technology raises complex questions in economics, public policy, law, sociology and political economy. What we call “institutional cryptoeconomics” starts from a simple premise – the blockchain is not just a new general purpose technology, it is a new institutional technology.

This may sound like a pedantic distinction, but the difference between these two conceptions is profound. General purpose technologies allow us to do what we already do better, faster and cheaper. Economists understand general purpose technologies (like steam power or the semi-conductor) as great engines of economic growth.

There is no doubt that the blockchain is a general purpose technology, but it is much more.

Rather, the blockchain is a new mechanism to coordinate economic activity and to facilitate cooperation between individuals. It opens up new opportunities for exchange, for collaboration and for building communities that were previously closed off due to high information costs and transactions costs.

Old thinking

As a new institutional technology, we expect that blockchains will disrupt and transform both economic activity and social organization. Institutional cryptoeconomics is a new analytic framework to study that evolutionary process.

In the very first instance, we believe that the transaction costs approach of Oliver Williamson – who won the Nobel in economics in 2009 – is the ideal theoretical framework to understand the blockchain. Williamson was primarily interested in understanding the ‘make’ or ‘buy’ decisions that firms have to resolve.

Is it better the buy inputs on the open market or produce them in-house?

That choice defined the limits of the firm, which in turn determined the incentive structures that decision makers faced.

A key determinant of the limits of the firm is “opportunism” or “self-interest seeking with guile” as Williamson described human behavior.

The combination of opportunism and asset specificity (which refers to how easily an investment can be resold or repurposed for another use) meant that complex economic behavior had to take place in large corporations. This in turn implied the need for substantial financial capital investment.

Thus, we saw the dominance of shareholder capitalism in the 19th and 20th centuries.

New paradigm

The blockchain breaks this relationship between size, opportunism and asset specificity.

By substantially eliminating opportunism (that is, being a ‘trustless’ technology), the blockchain allows specific assets to be deployed in small businesses supported not by large amounts of financial capital but by large amounts of human capital. It allows market incentives to deeper penetrate into firm structures resolving problems of team production.

For many industries, the blockchain will radically redefine the boundaries of the firm, allowing individuals to trade their talents and skills in an environment devoid of big business.

The eclipse of the large public firm has been predicted before, of course, but this time we believe those predictions will eventuate for many, if not most, industries.

The decline of shareholder capitalism will have ricochet effects across the economy and society itself. It will put new pressures on employment, inequality, political power and the regulatory state. And it opens up vast new opportunities. The Williamson framework can also help us understand how the blockchain changes – and enhances – the provision of insurance, the provision of public goods, and the provision and protection of identity.

It is often said that we are at the start of a “blockchain revolution.” Institutional cryptoeconomics offers an exciting way to understand what features of the ancien régime we’re about to lose, and what might take its place.

Chris Berg, Sinclair Davidson and Jason Potts are with the RMIT Blockchain Innovation Hub in Melbourne, Australia. This op-ed was first published at CoinDesk.

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33 Responses to Institutional Cryptoeconomics: A New Model for a New Century

  1. pbw

    In the meantime, work continues, and continues, on quantum computing. Should QC ever realise its touted potential, the bricks on which blockchain institutions are built will crumble to dust, will they not?

  2. Bruce of Newcastle

    The ultimate blockchain is the 1st Law of Thermodynamics.
    That is my allowable profundity for the morning. (It’s also true!)

  3. Seza

    Is there a simple explanation of the blockchain? The more I read, the more my head hurts.

  4. C.L.

    I’d love to write an intelligent comment here but I have no idea what a blockchain is.
    I thought it was the kind of chunky necklace worn by cricketers in the 1970s.

  5. ACTOldFart

    I’m with CL on this. So far it is all waffle. Can someone give a specific example of how the “blockchain” will change things ordinary people do every day? And I don’t mean arm-waving generalisations like “allows specific assets to be deployed in small businesses supported not by large amounts of financial capital but by large amounts of human capital”. A real-life day-to-day example of how it’s done now, vs how it will be done in the magical kingdom of Blockchainia, and why the latter will be better.

  6. closeapproximation

    pbw: apparently quantum blockchains are a thing.

  7. old bloke

    Blockchain requires trust in technology, I think that this is where it will encounter resistance.

    People want to feel secure with their belongings, they want a paper title document to verify that they own a property, that a bank holds $x of their money, that they have x number of shares in ABC Ltd. They may trade online, they may engage in internet banking, but they want to hold paper which verifies their transactions.

    Blockchain is a concept, as best I understand it, of a central ledger of all transactions and nodes (items traded). This ledger resides somewhere in cyberspace, in reality on a server farm in some data centre possibly in a distant land. If I was to use it, my concerns would be how secure is it? A central ledger of any sort would be a hacker’s dream target, and what would happen to my transaction records if that data centre burnt to the ground, or if communications with that data centre were severed in some way?

    Blockchain is an interesting concept for one major reason, this is the speed of a transaction, i.e., no contracts, no invoices, etc. Nodes are ordered, and payment is processed immediately on delivery. Money moves faster through that process, and a business can do away with their accounts payable and receivable staff (no invoices to be paid and no creditors to chase up).

    But who will oversee the processes and the central ledger to guarantee its security? Blockchain is outside of government control so it will need a supra-national governing body to monitor the processes, who will they be?

  8. JohnA

    The eclipse of the large public firm has been predicted before, of course, but this time we believe those predictions will eventuate for many, if not most, industries.

    Hasn’t the practice of sub-contracting/out-sourcing already begun that fragmentation process?

    Tom Peters “Excellence” series of management books identified the twin problems of over-optimisation and sheer excessive size of large enterprises ie. dis-economies of scale for any business unit larger than 5000-10,000 employees.

  9. John Constantine

    The Australian economy is routinely devastated by our crony quisling political class, too bail out our too big to fail banking system.

    Block chain building societies, block chain cooperatives,

    The big banks sold out to Stalinist social engineers for a few more licks at the crony gravy train, now the most hated business executives in Australia are flat out trying to pack another five million in each others retirement payouts with their black hearts full of fear and loathing for the new tech.

  10. Blockchains, crypto watchmacallits…..there is far too much complication in economic theory me thinks.
    KISS is better.

  11. Procrustes

    Old bloke – your understanding about the block chain being a central ledger in one place is not right. It is the opposite. The ledger is distributed across many sites, all of which agree with one another on the details of the transactions.

    This is where the trust is built into the system – eg no one player (such as a government or a company with high market power) can control the records of the transactions on it. One application of this is land title in poorer countries with ill-defined property rights.

  12. hzhousewife

    How does blockchain work without electricity?

  13. BoyfromTottenham

    Sinc, as a semi-retired IT practitioner with experience of IT security including of course PKI, and previously being an economics / econometrics student, I admire your vision for what blockchain technology could potentially do to transform economics and business! (You have certainly got me interested – I have printed a few of the helpful sections of doco from the RMIT Hub, and look forward to reading them soon.)
    My first thought on reading this post, however, was concern re the technology’s scalability, rather than its security, but a quick read of some of the material indicates perhaps that closed (i.e. permissioned) blockchain implementations would scale far better than a public implementation, greatly expanding its potential market. Meanwhile I wish you and your team every success.

  14. BoyfromTottenham

    Sinc, a second thought from me – the very transparency of this technology may be its Achilles Heel – how many government or business organisations actually want all participants to know exactly what is going on, in near real-time? 😉

  15. old bloke

    #2500500, posted on September 18, 2017 at 10:48 am

    Old bloke – your understanding about the block chain being a central ledger in one place is not right. It is the opposite. The ledger is distributed across many sites, all of which agree with one another on the details of the transactions.

    Thank you for the correction but that still doesn’t resolve my concerns. A distributed (mirrored) ledger which is kept in data centres in countries A, B & C won’t be of use to me living in country D if communication links to country D are down.

    We still haven’t touched on who will monitor and guarantee the processes and transaction records. This would require something like a United Nations “department of commerce” or similar. Would Blockchain become the Gen X version of “global warming” to fund the UN?

    Colour me sceptical.

  16. duncanm

    Old bloke,.

    its not just ‘a few sites’ — the verified transaction is embedded in the block chain itself, which everyone uses.

    Once verified (a distributed function), subsequent transactions have a record of that transaction being valid.

    Communications will make it all fall apart — but only in the sense it’ll stop, not become invalid.

  17. BoyfromTottenham

    Procrustes, a couple of comments if I may:
    1. In your ‘data centres in 3 countries’ example, would not the organisation/s (e.g. a bank) simply host their own copy of the ledger, rather than using a 3rd party?
    2. Any business that uses a fully ‘online’ business model understands the need for reliable communications, whether via the Internet (which is replete with redundancy) or backup dedicated communications services.
    3. Regarding ‘who will monitor and guarantee the processes and transaction records’, IMO this is simply a business decision between the parties involved – my bank currently ‘guarantees’ my online banking transactions. If I don’t like this arrangement I can simply do without this arrangement and visit my bank in person. As a previous IT security practitioner, I know there is always a trade-off between security and convenience. Touch and Go credit cards are an example of this, easily mitigated by sensible users limiting the value of such transactions.
    4. Regarding your remark ‘blockchain is outside government control’ in your previous comment, my reply is that blockchain is merely a new enabling technology that has millions of potential uses, like say the underlying transmission protocols (TCP-IP) that enable the Internet, and the concept of ‘government control’ at this sub-sub-sub-sub-layer of the technology that enables the Internet seems just silly. However, maybe the government might ask the relevant Standards body to develop a Technical Standard for blockchain, compliance to which could then be made mandatory for certain types of distributed systems relying on blockchain technology – e.g. intergovernmental, banking, etc. I would have no problem with this.

  18. flyingduk

    How does anything work without electricity these days? If the planetary grid goes down, the last thing we have to worry about is what happened to our bitcoin

  19. Stephen Clively

    BoyfromTottenham – your questions are for old bloke, not me

  20. Arnost

    I do believe that blockchain has capacity to disrupt the financial giants of today to near oblivion. Big call – yes. But the core of blockchain is trust, and the financial giants are more and more lacking in that department.

    The key to blockchain is to see it as a verified right to property without the need to rely on third parties and without necessarily breaching privacy. Very libertarian.

    Currently we need to rely on trusted third parties like Banks, stockbrokers, regulators, courts, and a plethora of other institutions to guarantee ownership (of cash, stocks, instruments of trade, real estate etc). Think of these as each having / being a single ledger where that the ownership is registered. Blockchain essentially gets rid of these single ledgers by sharing the ownership data across multiple ledgers shared by many parties.

    And this means data and proof of ownership becomes more difficult to tamper with as it provides extremely reliable records on the history of asset ownership across multiple self checking ledgers.

    Another advantage is an increase in efficiency, where the middle men are not required assets and property can be transferred at faster speed – in real time even.

    And most importantly, can get rid of the vig that each middle man will take from any transaction that involves transfer of ownership.

    And that is its power and promise.

  21. Faye

    From a nobody – is it likely to become the power of a few and therefore dangerous?

  22. BoyfromTottenham

    Faye (being too modest, I’m sure): Was the invention of the steam engine or electricity dangerous? Is the Internet dangerous? IMO its very hard to tell about the future impact of innovations, but on the whole we would almost certainly be worse off without them. 😉

  23. Speedbox

    From a nobody – is it likely to become the power of a few and therefore dangerous?

    No. The design of the blockchain makes that scenario impossible. One person, or even a group of “like minded individuals” could not concentrate their power. And, as every day passes and the blockchain grows, any infinitesimally small potential for concerted action is further diluted. At present there are approximately 500,000 blocks each containing many tens of thousands of individual transactions.

    Moreover, the crypto market trades in over 900 crypto currencies and cumulatively many billions of dollars in every 24 hour period. (Bitcoin alone has traded $1.6Bn in the past 24 hours).

  24. Wal of Ipswich

    I have little idea of what this stuff means but having farted in the bath I know when a bubble is on the way.

  25. What John Constantine said…

    Watch out for Ethereum; roll your own smart contracts.

  26. Speedbox

    As one who is an active participant in the cryptocurrency market, I can relate to the various cynical comments about cryptocurrencies and the blockchain. When I first looked into “Bitcoin” and the whole process some 2 years ago, I was initially put off and shelved the idea of investing. It is now a matter of blockchain history that I could have made many millions of dollars had I invested then. (sigh).

    Fast forward to the current day and I have been happily riding the highs and lows of the crypto market for some time and continue to invest. IMO, crypto’s are the future of fiat money although I acknowledge that may seem absurd to most.

    For those who are curious about the market, I would make an important point – cryptos are wholly unregulated at the moment and the market is the “wild west” of investment. There are over 900 cryptocurrencies currently available globally (Bitcoin being the best known) and exchanges operate 24/7/365. In fact you and I can start our own cryptocurrency tomorrow with no Government or other regulatory oversight and, as time progresses, some of the cryptos will fail with their investors losing their money.

    As a demonstration of the volatility, a few days ago the Chinese Government ordered the three exchanges in China to close. (bah humbug, who cares). Cryptos operate without borders and the closures (if enforced) will not prevent the Chinese citizens from anonymously buying, selling or holding cryptocurrencies in the numerous other exchanges around the globe. The proclivity of Chinese to spirit away their money without Government approval will continue unabated.

    The traditional financial markets are generally dismissive and see cryptos as a bubble and Governments don’t know how to control the market, or more accurately, how to tax it. Globally, cryptocurrencies are a minnow in the world of money. But for me, I believe cryptocurrencies are the future of money and a means of global trade. Time will tell whether I am right or not.

  27. Howard Hill

    It all sounds so wonderful till you realize a couple of things. While government owns the wires that transfer the digits and government are beholden to those that control the money. Those that control the money control the wires and the digits. Both will never let go of their monopoly on the control of money and the serfs. Also those with the biggest guns get to control the lot; so unless you can get a bigger gun than everyone else or one big enough to scare the shit out of them all as in NK, then it’s back to business as usual, lube up!

    Blockchain will just allow them greater control over the flow of money.

  28. pbw,

    Quantum-secured blockchains? IIUC, these will require a new quantum-encrypted infrastructure, so it won’t secure the existing blockchains, like BitCoin, and all others built to date.

  29. DM OF WA

    How history does repeat herself!

    Lots of scepticism on display here; much of it quite obviously uninformed.

    If someone had told you back in 1993 that the HTTP and SSL protocols were going to revolutionise retail commerce and kill off the existing music, book selling and taxi industries, most of you would have ridiculed that man even though you did not know what those things were. That is similar to what we see here on this thread.

    That most posters have no understanding of what the blockchain and cryptocurrency are is evident from some of the predictions on this thread. For example that governments might seize control of Bitcoin: impossible even in principle!

    That technological progress in commerce is uneven in the short run is clear; we all remember the “dot com” bubble of the late 90s. Internet entrepreneurs are prone to overhyping their wares and gullible punters believe them. There are similarities between dot com bubble and the cryptocurrency bubble now. But that should not obscure the fundamental strength of the underlying technology.

    Blockchain and cryptocurrency (e.g. the Bitcoin implementation) solve an important set of theoretical problems around how to conduct efficiently and securely online commerce where there is no trust relationship between parties in a transaction. The successful solution of this problem is ultimately going to revolutionise finance. Like earlier technological revolutions, at the start we do not know where it will go, but it is surely going to be a wild and exciting journey: some people are going to get fabulously rich and many more going to lose their investment.

  30. Howard Hill

    For example that governments might seize control of Bitcoin: impossible even in principle!

    They don’t need to seize control of it, they just need to outlaw anyone transacting in it! Just like they’re want to get rid of cash. Just like they took peoples gold. Just like you’ll bend over and take it up the clacker when the shortfilth gets the top job, just like you’re taking it up the clacker now by Mr Gold in my Sacks – the potential greatness one!

  31. test pattern

    Did u vote Flux then? And will u in the future?

    Australia to Make Blockchain Voting App a Global Democratic Movement.

    ‘the Flux Party seeks to win enough seats at federal, state, and local levels enabling voters to directly influence the outcome of legislation that affects them, through the Flux app that has been built entirely on the blockchain.’

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