Cryptoeconomic Theory: Basics of Social Order

This is Part 1 of the weekly Cryptoeconomics series. The table of contents for this in-progress series can be found here.

The story of most all scientific disciplines today, are those composed of large groups of free things/objects gracefully coalescing into order. Chemists ask how elements can be joined together to create new ones; Biologists are fascinated with how cells organize to create complex lifeforms; and Doctors need to be keenly aware of how every independent section of your body coexists with one another to help keep you alive.

The organization of humans, however, is perhaps the most relevant to our daily lives’.

How can free-thinking humans actually come together to create nations, languages, and companies? How can social order exist?

• On one hand, people are inherently social creatures, and need others for our survival, as well as be happy and healthy.
• On the other hand, people are individuals — led by their own personal goals and desires.

The basis of all social order rests on two important concepts:

1) Coordination

People must be able to coordinate their actions.

2) Cooperation

People must cooperate in order to attain common goals.

These are the basics. In every example where humans have accomplished something great and wonderous, you will find these concepts: SpaceX building rockets, crisis relief after 9/11, and systems like Bitcoin and cryptocurrencies coming to their timely fruition.

A gridlock in American politics is a lack of both coordination and cooperation. Lack of coordination: different views about the role of government in the economy. Lack of cooperation: both Democrats and Republicans care about their own re-election, thus are unlikely to make hard decisions that are unpopular with their constituents.

But often times we find the interests of the individuals and the group are at odds. Individuals can fail to contribute to the group, or do things that impose harm on the group. Sometimes behaving cooperatively may impose a cost on the individual, too.

Bees and wasps have the highest known levels of social order- often altruistically sacrificing their lives on behalf of the colony. Their high genetic relatedness allows them to coexist in very large groups with no conflicts. This cooperation is not flexible, and is governed by rigid rules.

Animals that don’t all come from the same ‘Queen Bee’, exhibit much lower levels of genetic relatedness. Basically every other animal on the planet can only exhibit order when in much more constrained groupings (i.e. packs of wolves)

Therefore, in animals, either the cooperation happens in small groups (organically), or in large groups that have generic relatedness and they follow rigid rules (inorganically).

But social order in human societies is flexible, as well as varies drastically by genetic makeup. How can we explain this cooperation between large number of strangers in human societies?

Why is There Order?

The answer: Individuals need structures to act within. They need familiarity and some level of predictability in their social lives’, and some ability to make projections as there are consequences for each different action; this is all in order to be able to pursue goals, either individually or by cooperation with others.

But where do such structure and predictability originate? What makes society possible? What are the mechanisms that make cooperation between individuals for reaching common goals possible? Theories of order fall in either of two general categories: Made vs Spontaneous order

1st Category: Made Order

In these theories, order is the result of rational reasoning, planning, and intentions.

A clear example is the concept of companies, firms, and any other organizations. A social order of this kind transfers the same kind of logic from firms and organizations to the entire society. Order must originate with some sort of central authority (state/government, religious authority, central committees and so forth) and be imposed on society.

Historically there have been two prominent theories about the source of central authority:

“Divine Right” Theory: A political and religious doctrine of royal and political legitimacy. It asserts that a monarch is subject to no earthly authority, deriving his right to rule directly from the will of God.

“Social Contract” Theory: The order is the result of rational reasoning, planning & voluntary collective decision-making of individuals (i.e. Communism)

2nd Category: Spontaneous Order

Spontaneous order is not deliberately designed. Order emanates from actions of thousands of individuals without any coordination. It is the unintended consequence of actions taken by individuals. These theories claim that the most important human institutions have risen from such spontaneous cooperation.

• Markets, language, law, and money, are some examples of institutions where the deliberate and planned actions of a state are not the point of origin.
• Civil society- a complex network of voluntary and spontaneous associations, brings organization to society. But civil society itself isn’t an organization: it is not deliberately directed by someone for some grander purpose or scheme.

Spontaneous orders are not made, they are grown from within the context of social relations. It is self-generated or endogenous, as opposed to deliberately designed and exogenously imposed as is the case with made orders.

Read old books to understand old problems…

… is a valuable suggestion. Learning the evolution of social order historical thought will be helpful when building the future.

The State-Of-Nature

When theorizing social order from the ground up, an important theoretical exercise is to envision a hypothetical state of existence before society, a place where no political or economic institutions exist.

Ponder questions like:

• “What was life like before civil society?”
• “How did government first emerge?”
• “What are the hypothetical reasons for establishing a nation-state?”

This exercise is used partly to determine how humans behave at their core, and thus what kind of government should be built.

Thomas Hobbes (1588–1679)

The most famous formulation of a state-of-nature came in 1651 when Thomas Hobbes published his perennial classic Leviathan. Watching the English Civil War out his window, Hobbes came to a fairly bleak conclusion about human nature.

Rationality assumption:

• People have the capacity to reason. They weigh the costs and benefits., they consider the consequences of their actions.

Psychological assumption:

• People are self-interested, they seek to attain what they desire. Security (avoid death and injury), Reputation (status), Gain (Possessions)
• All men have a “relentless desire for power”. Because men want a happy life, they seek sufficient power to ensure that life.
• Everyone is pulled into a constant competitive conflict for a struggle for power. Or at least to resist being commanded by others

His state of nature conclusion was:

• People who want the same things will inevitably be enemies.
• They will use all means (including ‘force and fraud’) to attain their ends.
• Therefore, natural state of man is a war of all against all.

Hobbes stated that since the state of nature is so negative, and people have a desire for social order, that must mean people’s liberty will need to be given up. He stated that agreements alone don’t have any force without some coercive power to back them up. That the only way to provide social order is for everyone to acknowledge a perpetual sovereign power.

Hobbes, interestingly enough, made the first moral and logical justification for authoritarian state regimes. These regimes existed in the past, yet they claim their power came from the gods via divine right. Hobbes stated that we’ll solve the problem of social order with an absolutist, coercive solution.

Ouch.

Yet he could not explain social order fully:

Why should rational egoists in the state of nature ever be willing to lay down their arms and surrender their liberty to a coercive ruler? If they do it out of concerns for social interest, how the rational egoists come to be concerned about the social interest rather than their individual interests and voluntarily give up (all or part of) their liberty for social order? As a result, we have to reconsider the view of human nature and consider that the humans might not only be motivated by self-interest.

In addition, very high levels of coercion would be required to produce social order. But

• Coercion is expensive
• Coercion is ethically unappealing

John Locke (1632–1704)

Some 40 years later, using the same state-of-nature thought experiments, Locke came to a different conclusion. Locke believed at the core, men are peaceful, and the government should be limited to preserve order and resolve conflicts. This limited state should simply keep the order that already exists i.e. a constitutional government. good will towards fellow men and mutual support.

• Man was equally created by God and endowed with the natural right of life, liberty and property (fruits of their labor). They are free to roam as they liked, utilizing their property without being conditioned by another’s will.
• However, there are bad apples even in this peaceful state nature. To flourish, man needs an impartial judge to resolve conflicts and an institutional framework that is fair and accepted by all.
• Like with Hobbes, man must enter a social contract which relinquishes some autonomy to a state which has as its task to protect life and property.
• Locke’s nation-state was, unlike Hobbes, necessarily limited in scope — the state was to uphold rights already existing in the state-of-nature, given to man by God, not to designate new rights or be a mechanism for shaping society according to some specific ideal.

Thankfully, Locke inspired much of our Declaration of Independence (1819) and not Hobbes.

Adam Smith (1723–1790)

We know Smith as the father of modern economics by his book “The Wealth of Nations” (1776), but before that, he was actually a moral philosopher and wrote about social order in his previous book — “The Theory of Moral Sentiments” (1759). This book laid out the initial theoretical underpinnings of the famous ‘Invisible Hand concept’.

He distinguished between a system of natural harmony and spontaneous order versus “the man of system”, who imagines himself moving people around like they were chess pieces, with the purpose of fulfilling some larger plan. Government, he concludes, is full of “men of system” who believe that society would run smoother if only individuals would cooperate with “the man of system’s” plan.

These individual chess pieces — people — have a principle of motion of their own, and altogether different from the master plan. If the motion of all the individual pieces should happen to coincide with the man of system’s plan, then society would run smoothly, but if they are of opposite minds, the chess game would proceed miserably.

Adam Smith was all about incentives — he pioneered many modern-day theories.

He stated order is pre-governmental and were a government to disappear, order would still be there because, according to Smith, order lay in “the principles of society and the constitution of man”.

With the publication of “An Inquiry into the Nature and Causes of the Wealth of Nations” in 1776 Smith elaborated on his idea of a harmonious and spontaneous order. He made a remarkable observation about commercial markets; they seem to operate under some self-generated, decentralized mechanism without any grander theme or purpose. He described this mechanism with his now so famous metaphor:

Economic actors are guided in their self-interested conduct to promote ends that were never part of their intentions as if moved by an Invisible Hand.

Spontaneous order was Adam Smith’s biggest contribution to modern society, and once again why he is considered the father of modern economics.

The Beginning of Spontaneous Order

The idea of spontaneous, non-directed social order isn’t new, but gets a huge boost by Adam Smith. He provides a foundational layer that more and more spontaneous order theories will build upon.

Friedrich Hayek (1899–1992)

The theory of spontaneous order in the twentieth century goes in-depth by Hayek. He’s responsible for increasing the complexity in the theory compared to previous thinkers.

He theorized that order exists when people are free to form accurate expectations. His account of how changing prices communicate information that helps individuals coordinate their plans is widely regarded as an important achievement in economics, leading to his Nobel Prize in Economics.

Hayek argued against the establishment of a Central Pricing Board by highlighting the dynamic and organic nature of market price-fluctuations, and the benefits of this phenomenon. He asserts that a centrally planned economy could never match the efficiency of the open market because what is known by a single agent is only a small fraction of the sum total of knowledge held by all members of society. A decentralized economy thus complements the dispersed nature of information spread throughout society.

Jimmy Wales in fact cites Hayek’s books as “central” to his thinking about “how to manage the Wikipedia project”. Hayek argued that information is decentralized — that knowledge is unevenly dispersed among different members of society — and that as a result, decisions are best made by those with local knowledge rather than by a central authority.

Rewriting Theory

Consider the historical progression…

From the rational justifications of authoritarian regimes by Hobbes to the “decentralization of knowledge” by Hayek, we have come a long way.

When designing social order, there was a time not so long ago when the simple answer was to create a dictatorship or monarchy, caste systems, and order peasants around.

It's often the more complex systems that are more efficient, albeit harder to understand.

What the Bitcoin network accomplished was incredible. This is the largest ever collaboration + coordination of humans without a ruling authority. The social order achieved was not only completely free-willed; but also efficient.

Questions for the future will be :

• How can decentralized protocols be used to incentivize social order?
• Is it now possible to ‘make’ spontaneous order?
• What will economic theories look like when money is programmable?

Next up: Market vs Planned Economies, why Communism fails, and importance of prices.

Edited by: Steven McKie

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