Bretton Woods: A Lesson For Consensus Mechanisms
People visit Bretton Woods, NH, for two reasons: either to ski or to discuss global economic policy. Over the last four summers, business magnates, crypto experts, and financial policymakers have been doing the latter. This comes more than half a century after the first Bretton Woods conference in 1944, which is largely responsible for shaping the international
economic climate of the last three generations.
The most notable institutions that the 1944 Bretton Woods Agreement established — the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (now known as the World Bank) — have been largely responsible for the international economic strain that blockchain innovators have sought to correct. After World War II, the allied countries noticed two key things: first, all of the world’s wealth was concentrated in a handful of states; and second, even those states that held the concentrated power could collapse into depression in a world with unstable international trade policies. In short, there was no trust. After two devastating wars and a number of economic disasters, no country could be trusted to participate in trade without manipulating its currency and policies to pursue self-interest.
By now you should already be hearing echoes of 2018’s crypto-rhetoric. But before we make this parallel explicit, let me clarify one more thing about the products of the Bretton Woods agreement. In 1944 economists were split on how the IMF should bind together the different national economies and currencies. John Maynard Keynes and the U.K. argued that the only way
to do this was to create a world reserve currency, ultimately fixing all the currencies in the world to a common measure, like gold. The U.S., on the other hand, argued that because some countries have more capacity and responsibility to lend, and for that reason have a greater stake in the global system, other currencies should be pegged to the dollar. They came up with a
hybrid system: all currencies would be pegged to the dollar via the IMF, but could trade their dollars to the U.S. government for gold. That didn’t last long, though. The U.S. kept running trade deficits and eventually their supply of gold depleted, and so here we are in a fiat world economy.
Perhaps the greatest innovation of Satoshi’s white paper was the advent of an economic system “based on cryptographic proof instead of trust.” Blockchain, of course, has the potential to eliminate third party structures that facilitate trade between two countries that cannot implicitly trust themselves. This is especially attractive when those third party institutions act predatorily in
the expressed interests of the powerful few, as the IMF and the World Bank do.
The IMF and the World Bank have historically enacted policies of free trade that in practice have crystalized the power dynamics that exist between trade partners. For example, the World Bank might give a developing national economy a loan on the condition that it goes directly towards agriculture — prohibiting that the loan be used towards education or facilities in, say, engineering software or aerospace research, areas of production in which the rich countries specialize — cuffing the hands of nations like Uruguay and Mozambique to their soil. Even more explicitly, countries like the U.S. will refuse to contribute to IMF packages unless the beneficiary country
adopt trade policies that clearly benefit American interests.
Hodlers have been saying all this for years. But looking at trust and trustlessness specifically through the lens of BWIs sheds light on one of the most prominent debates in today’s crypto space. What is the right proof mechanism to replace the trusted intermediary institution?
Proof-of-Work (coins like Bitcoin, Litecoin, Monero) uses computing power as proof that a given node is a good actor can be trusted to write in the blockchain. The first drawback to Proof-of-Work is its high cost. It is incredibly expensive financial and uses massive amounts of energy
to support a Blockchain like bitcoin. The process takes a serious toll on the environment. And only certain people can afford to obtain the extremely expensive and specialized mining equipment. This leads to the second drawback, which is also the most flagrant for those in the crypto space: centralization. Only the wealthy can afford to mine. As I write this, something like 8 out of every 10 new BTC is being mine by a handful of factories in China. If in this situation, the mining superpowers decided to collude, there would be little hodlers could do to prevent the
network from being run by a production cartel.
The other most popular proof mechanism is Proof-of-Stake, which uses experience and equity in the network as a proof that a given node is a good actor and can be trusted to commit a block into the blockchain. Here the entity responsible and rewarded for producing a block is picked in a
kind of lottery, where the more equity and experience you have, the most likely you will be to produce the block. The logic here holds that if you have a lot of stock in a particular network, you will want to protect its value by ensuring that the blockchain continues to be valid. The drawbacks? There is what’s called the “nothing-at-stake” problem where you can spend little cost to attack the network. But perhaps the most philosophically central problem is that proof of stake can be seen as abandoning the goals of decentralization. Trustworthiness and your ability to write true history into the blockchain, in other words, comes from the amount of clout you have. In other words, might equals right.
This clearly mirrors the debate that they were having in 1944 in that small New Hampshire town. Do we want a currency that seems more democratic, albeit slower, more wasteful, less conducive to scalable growth? Or do we want to link the health of the system to the self-interest of its most powerful actors? At Bretton Woods, they agreed on we might call a hybrid: the IMF and World Bank would ensure that all international trading is bound to the dollar, while the dollar itself is bound to gold. When in 1971 the U.S. government uncoupled the dollar from gold, the world economy became governed largely by the will of powerful countries.
We should take of Bretton Woods to the Bretton Woods conferences that have resurfaced in recent years: do not abandon Proof-of-Work as the fundamental consensus mechanism of emerging blockchain technologies. We should not, and truly cannot, forget that decentralization is the focal point of the crypto economy. Instead, developers and champions of new crypto protocols should look to scale blockchain while maintaining its radical and democratizing methods of producing blocks. How do we make it so that at least a large chunk of the computing power and energy used to mine a block gets harvest by the blockchain, and not just wasted on the floor of goliath factor somewhere? How can we resist the view that powerful or wealthy actors define what it is to be a good actor in a financial system? This is precisely the kind of progress that makes Cypherium and Bitcoin NG the most exciting projects in the crypto space.