BlockBytes |Byte 1|The Economic Problem
This is part 1 of a series of posts in a quest to understand blockchain and crypto-currency in its entirety. The why,what,when and how of the hot trend which started way back in 2009 when Satoshi Nakamoto published paper on crypto-currency whose famous variant,Bitcoin, is now valued at $16 bn .
One thing that predates even GOD is Market.
Markets and money involve matchmaking (bringing together buyer and seller), trust reduction (trusting in the self-interest rather than in the altruism of acquaintances and strangers), scalable performance (via money, a widely acceptable and reusable medium for counter-performance), and quality information flow (market prices). — Nick Sazabo.
To understand driver of human civilization, the market we need to break it down to its constituent artifacts.
Money
Money has been the most discussed topic in academia, yet most of us consider it to be that piece of paper which allows us to buy stuff. Our Primate forefathers first started exchanging economic surplus as a gesture of cooperation outside their immediate family in hope to get the favor returned later. However for that to happen there had to 3 coincidences
a.) Some one ready with surplus
b.) Some one else with a need for the surplus
c.)Mutual interest in sitting through the exchange.(Tripple Coincidence)However there were few problems
- How do i remember who provided favor and when? Facial recognition,capability to remember faces,works but has scalability problem both over quantity and time. You tend to forget faces over time and you will definitely tend to forget favor you have to return :)
- How much do i value the favor given by me compared to what i received? For example water provided in summer might be of more value than water provided in rainy season.
- What if i dont need the favor in the form which i sent out but the immediate beneficiary of my favor isn't capable of providing what i need. I gave you apples but you only have oranges but i need fish.
Hence we as animals first started to preserve value in precious commodities followed by writing it down first in clay, then coins followed by Paper to help store value of favor for future consumption at time and place of our choosing.
“money is a formal token of delayed reciprocal altruism” — Dawkins, Richard
Information
Our decisions in a situation are optimal when we assume to take them in context of all information present in universe about the problem. Money has a special capability to capture that information as explained well by Hayek in his essay “The Use of Knowledge in Society” and further comprehended by Nick. Each product/service at any given point aggregates data points regarding its cost of production at different raw material level, cost of transportation. Any sub part in this network if becomes expensive pushes the signal through an increase in overall price and hence reducing consumption. Price network of any item hence aggregates all possible information ,unless there’s a conscious effort to mask information. We will see how markets tackle that.
Social Scalability
For economies to scale people need to transact frequently with different set of circumstances ( location/people/commodity )and with minimum cost to the cycle. This brings to important question of social scalability. ( We will see social scalability and tech scalability pitched against each other in later posts)
Social scalability is the ability of an institution –- a relationship or shared endeavor, in which multiple people repeatedly participate, and featuring customs, rules, or other features which constrain or motivate participants’ behaviors — to overcome shortcomings in human minds and in the motivating or constraining aspects of said institution that limit who or how many can successfully participate. — Nick Sazabo
The key in the definition is multitude of people which can be included in the transaction with minimum cost. Imagine you in market to buy a pair of exotic shoes in Egypt. You need to have the following to commit to the transaction
- Information about the value of item : The price
- An acceptable payment medium which the other party can accept
- Capability to trust that item being sold is true to its said quality of “exoticism”/ “Quality”
- Capability of seller to trust on the payment mode you are providing.
For cost of transaction to come down, you need to trust the seller on his price quote and quality of his item to pay as much as he asks. Otherwise you would quote him very low for transaction to fail. Seller should trust your payment capacity and mode to ask you a high enough price for transaction to go through so that economic cost of transaction i.e the surplus at both end is minimized.
Another expense we incur daily is a cognitive one. In our daily life we often take decisions based on some hardwired logic built into our system based on assumptions which we take for granted. For example the Metro we take wont be blown up by the driver who is driving, or the food item that we are buying from local street vendor wont be poisoned to kill us. None of us understand how airplanes generate enough energy to travel continuously for 8 hours and not fall down out of sky yet we have complete trust on some people whom we don’t know or will never know. Or a simple example we don’t ask or explain proof“(A+B)² = A² + B² +2AB” every time we solve a mathematical problem. Now imagine our decision making speed if we had to compute everything from beginning.
I will take a bit of more time here as its imperative to understand the this objective in detail to make sense of cyrpto-currencies and the likes of it.
Social scalability tends to extend on two dimension
- Capability to know / remember / trust and communicate with as diverse individuals as possible
- Need for Trust to take decision collectively as fast as possible
Innovations which reduce our cognitive effort in conducting each transaction or take decision through a preset rules with predefined output help in scale transactions. We no longer have to worry about how different people will behave while involved in transaction with them as each is stipulated to behave in a predictable and calculable way.
To summarize
“We make constant use of formulas, symbols, and rules whose meaning we do not understand and through the use of which we avail ourselves of the assistance of knowledge which individually we do not possess. We have developed these practices and institutions by building upon habits and institutions which have proved successful in their own sphere and which have in turn become the foundation of the civilization we have built up.” — Friedrich Hayek
Markets
Money and markets directly benefit the participants in each particular trade by the market matching a buyer with a mutually beneficial seller and by a widely acceptable and standardized counter-performance (money).
Markets are basically one stop hub where we tend to fight away the triple coincidence mentioned previously. With multiple buyers and sellers they produce a competitive space rather than an individual monopolistic market. Price forms the information signal for the perfect match making. If any entity in open market wishes to manipulate price information, will be in-turn harming self either by losing out on the transaction ( by over pricing ) or lose money on transaction( by under pricing)
Hence Market amounts to :
Transaction = F(Money ,Information ,Contracts to build trust).
Markets = F(Transactions, Interested Parties)
However there are few things that are impeding our progress as human race to achieve the next frontier of scalability
- Money digitized is not scalable at its current form. If you want to pay to a merchant in Albania who is not hooked to current payment infrastructure you wont be able to. Even if he is hooked to, countless steps and commissions often make the transaction economically non viable.
- Information : This is one thing which internet has digitized to the best of its might. Internet since 1995 has democratized information. However the it suffers from mutability and trust problem. Anything digitized can be changed and any thing that can be changed ex-post is difficult to be trusted. #Fakenews
- Contracts digitized : Contracts digitized face a problem of being able to be easily copied. Also most of the contract are still designed and formulated on paper to gain advantage from the difficulty in copying it. Contracts during its formulation involve a huge amount of investment in terms of resource and money to iron all possible eventuality and the action hence taken. It takes human labor to interpret and apply these contracts transaction ex-post with an associated penalty to avoid malpractice. This leads to delay in closing of transactions and adds additional cost to transaction.
- Markets : Companies like Uber / Airbnb / FB have successfully digitzed one aspect of market to be the commercial match makers by bringing together and facilitating the negotiation of mutually beneficial commercial or retail deals. They from the central agency of building trust through buyer ,seller verification and ratings, payment intermediary and communication channel for transaction to take place. However the key here is “central agency” a single point of failure.
For any autonomous , scalable transaction platform we would need a scalable money with a robust framework which can build trust and react to market transactions pro-actively.
To end this posts would quote Nick’s thoughts
A blockchain can reduce vulnerability by locking in the integrity of some important performances (such as the creation and payment of money) and some important information flows, and in the future may reduce the vulnerability of the integrity of some important matchmaking functions. Trust in the secret and arbitrarily mutable activities of a private computation can be replaced by verifiable confidence in the behavior of a generally immutable public computation. — Nick Sazabo.
Next Topic :Trust & It’s Affect on Transaction cost.
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