Introduction to Blockchain for Economists
We are past the point in which armchair economists and visionary geeks can hope to create a cryptoeconomy that is fit for purpose. We need to bring in experience from professional economists.
We are past the point in which armchair economists and visionary geeks can hope to create a cryptoeconomy that is fit for purpose. We need to bring in experience from professional economists, so that they can positively contribute to this phase of blockchain development in which Investment Strategies and Monetary Tokenomics have taken a prominent place.
Please read this introduction to blockchain and cryptocurrencies if you are completely new to the topic, it explains all technology concepts required to understand this article.
Blockchain and cryptocurrencies spilt into the world of the general public only in the last few years, and during this process the complexity of the blockchain economy grew in a few distinct stages. In this document I give a timeline for the development of cryptocurrencies highlighting the different technological advances that in my understanding allowed the ecosystem to grow to higher and higher levels of economic complexity.
Although currencies that were not backed by governments existed with some success in the past, Bitcoin was successful at an unprecedented planetary scale. Much has been written on the origins of blockchain that doesn’t need to be repeated here.
From an economic point of view I think noteworthy that the first monetary decision of significance in Bitcoin was to have a fixed supply. For any real world currency its controlling government can print more at will, but in Bitcoin the rate at which the supply is increased is very rigid, and the maximum amount of Bitcoins that can ever exist is fixed somewhere around 21 million. This decision was ostensibly taken to control inflation and perhaps incidentally gave credibility to Bitcoin as a store of value.
The success and limitations of Bitcoin resulted in the creation of Ethereum, which could be described as a more general version of Bitcoin. Ethereum allows any developers to implement cryptocurrencies like Bitcoin, as well as any other idea that can be coded as a computer program. In blockchain lingo computer programs stored on a blockchain are called smart contracts.
The impact of Ethereum was enormous, allowing thousands of new ideas to be implemented and explored. Admittedly some of them were as hare-brained as in the days of the dot-com bubble, but from an economic point of view this transformed the economic discipline by providing the means to test economic theories with real people without the risk of crashing the livelihoods of millions.
All these new cryptocurrencies were thought of as Utility Tokens that would fuel some private marketplace bringing service providers and consumers together around some arbitrary concept. The possibility of trading these utility tokens in crypto exchanges led to discussions about what the value of such a token is, and the factors that need to be taken into account such as speculation, productive uses, taxes and minting and burning tokens to control supply.
The rapidly increasing valuations of Bitcoin and a few high-profile blockchain solutions attracted a large amount of capital available to cryptocurrencies. Combined with the complete lack of regulation, many blockchain applications were proposed with utility tokens barely disguising their purpose as investment vehicles, and many of these proposals were little more than pump and dump schemes.
The usefulness of blockchain as an investment vehicle remained as regulators moved in to provide certainty to investors. The result of regulated cryptocurrencies that would act solely as security certificates were STOs — Security Token Offerings. STOs are being introduced as investment vehicles backed by blockchain technology and safely regulated.
Where STOs encapsulate the speculative use of cryptocurrencies, Stable Coins are being proposed to safely allow for utilitarian uses of cryptocurrencies, without having to fight with the volatility caused by investors.
Most of the stable coins proposed are a form of currency pegging as happens in the physical world with the currencies of some countries with vulnerable economies. The mechanisms proposed would be recognised by any economist and are based on using collateral assets such as government-backed currencies or commodities. A collateralised reserve account is used to buy and sell those tokens trying to keep them in a price band.
Further research into stable coins leads to thinking about alternative mechanisms to provide trust in the capacity of cryptocurrencies to resist speculation efforts, as well as the relationship between a healthy market economy and currency value.
In this article I tried to tend some bridges to professional economists by giving a history of blockchain development along with the economic concepts that I perceive related to the issues that blockchain engineers and architects grapple with.
I’m sure I’ve made some questionable assertions and I hope that by being publicly corrected a healthy dialogue will start between the engineering and economics community. It is my belief that both fields stand to benefit enormously from a closer cooperation and exchange of ideas.
Thanks to Dr. Lucy Firth, a best friend and for whom this article is written.
If you liked this article and like me are also itching to put build actual products that put economic theories to the test, we are hiring!
Originally published on the TechHQ blog.