The Blockchain Economy: A beginner’s guide to institutional crypto-economics (Part 2)
The evolution of the ledger
For all its importance, ledger technology has been mostly unchanged … until now.
Ledgers appear at the dawn of written communication. Ledgers and writing developed simultaneously in the Ancient Near East to record production, trade, and debt. Clay tablets baked with cuneiform script detailed units of rations, taxes, workers and so forth. The first international ‘community’ was arranged through a structured network of alliances that functioned a lot like a distributed ledger.
The first major change to ledgers appeared in the fourteenth century with the invention of double-entry bookkeeping. By recording both debits and credits, double-entry bookkeeping conserved data across multiple (distributed) ledgers and allowed for the reconciliation of information between ledgers.
The nineteenth-century saw the next advance in ledger technology with the rise of large corporate firms and large bureaucracies. These centralized ledgers enabled dramatic increases in organizational size and scope but relied entirely on trust in the centralized institutions.
In the late twentieth century, ledgers moved from analog to digital ledgers. For example, in the 1970s the Australian passport ledger was digitized and centralized. A database allows for more complex distribution, calculation, analysis, and tracking. A database is computable and searchable.
But a database still relies on trust; a digitized ledger is only as reliable as the organization that maintains it (and the individuals they employ). It is this problem that the blockchain solves. The blockchain is a distributed ledger that does not rely on a trusted central authority to maintain and validate the ledger.
Blockchain and the economic institutions of capitalism
The economic structure of modern capitalism has evolved in order to service these ledgers.
Oliver Williamson, the 2009 Nobel laureate in economics, argued that people produce and exchange in markets, firms, or governments depending on the relative transaction costs of each institution. Williamson’s transaction cost approach provides a key to understanding what institutions manage ledgers and why.
Governments maintain ledgers of authority, privilege, responsibility, and access. Governments are the trusted entity that keeps databases of citizenship and the right to travel, taxation obligations, social security entitlements, and property ownership. Where a ledger requires coercion in order to be enforced, the government is required.
Firms also maintain ledgers: proprietary ledgers of employment and responsibility, of the ownership and deployment of physical and human capital, of suppliers and customers, of intellectual property and corporate privilege. A firm is often described as a ‘nexus of contracts’. But the value of the firm comes from the way that nexus is ordered and structured — the firm is, in fact, a ledger of contracts and capital.
Firms and governments can use blockchains to make their work more efficient and reliable. Multinational firms and networks of firms need to reconcile transactions on a global basis and blockchains can allow them to do so near-instantaneously. Governments can use the immutability of the blockchain to guarantee that property titles and identity records are accurate and untampered. Well-designed permission rules on blockchain applications can give citizens and consumers more control over their data.
But blockchains also compete against firms and governments. The blockchain is an institutional technology. It is a new way to maintain a ledger — that is, coordinate economic activity — distinct from firms and governments.
Blockchains can be used by firms, but they can also replace firms. A ledger of contracts and capital can now be decentralized and distributed in a way they could not before. Ledgers of identity, permission, privilege, and entitlement can be maintained and enforced without the need for government backing.
This is what institutional crypto-economics studies: the institutional consequences of cryptographically secure and trustless ledgers.
Classical and neoclassical economists understand the purpose of economics as studying the production and distribution of scarce resources, and the factors which underpinned that production and distribution.
Institutional economics understands the economy as made of rules. Rules (like laws, languages, property rights, regulations, social norms, and ideologies) allow dispersed and opportunistic people to coordinate their activity together. Rules facilitate exchange — economic exchange but also social and political exchange as well.
What has come to be called crypto-economics focuses on the economic principles and theory underpinning the blockchain and alternative blockchain implementations? It looks at game theory and incentive design as they relate to blockchain mechanism design.
By contrast, institutional crypto-economics looks at the institutional economics of the blockchain and crypto-economy. Like its close cousin institutional economics, the economy is a system to coordinate the exchange. But rather than looking at rules, institutional crypto-economics focuses on ledgers: data structured by rules.
Institutional crypto-economics is interested in the rules that govern ledgers, the social, political, and economic institutions that have developed to service those ledgers, and how the invention of the blockchain changes the patterns of ledgers throughout society.
The economic consequences of the blockchain
Institutional crypto-economics gives us the tools to understand what is happening in the blockchain revolution — and what we can’t predict.
Blockchains are experimental technology. Where the blockchain can be used is an entrepreneurial question. Some ledgers will move onto the blockchain. Some entrepreneurs will try to move ledgers onto the blockchain and fail. Not everything is a blockchain use case. We probably haven’t yet seen the blockchain killer app yet. Nor can we predict what the combination of ledgers, cryptography, peer to peer networking will throw up in the future.
This process is going to be extremely disruptive. The global economy faces (what we expect will be) a lengthy period of uncertainty about how the facts that underpin it will be restructured, dismantled and reorganized.
The best uses of the blockchain have to be ‘discovered’. Then they have to be implemented in a real-world political and economic system that has deep, established institutions that already service ledgers. That second part will not be cost-free.
Ledgers are so pervasive — and the possible applications of the blockchain so all-encompassing — that some of the most fundamental principles governing our society are up for grabs.
Institutional creative destruction
We’ve been through revolutions like this before.
It is common to compare the invention of Bitcoin and the blockchain with the internet. The blockchain is Internet 2.0 — or Internet 4.0. The internet is a powerful tool that has revolutionized the way we interact and do business. But if anything the comparison undersells the blockchain. The internet has allowed us to communicate and exchange better — more quickly, more efficiently.
But the blockchain allows us to exchange differently. A better metaphor for the blockchain is the invention of mechanical time.
Before mechanical time, human activity was temporally regulated by nature: the crow of the rooster in the morning, the slow descent into darkness at night. As the economic historian Douglas W. Allen argues, the problem was variability: “there was simply too much variance in the measurement of time … to have a useful meaning in many daily activities”.
“The effect of the reduction in the variance of time measurement was felt everywhere”, Allen writes. Mechanical time opened up entirely new categories of economic organization that had until then been not just impossible, but unimaginable. The mechanical time allowed trade and exchange to be synchronized across great distances. It allowed for production and transport to be coordinated. It allowed for the day to be structured, for work to be compensated according to the amount of time worked — and for workers to know that they were being compensated fairly. Both employers and employees could look at a standard, independent instrument to verify that a contract had been performed.