Why economists might be the biggest winners of the blockchain revolution
Bubbles, regulatory shocks, incomplete contracts, game theory and mechanism design — in many ways the blockchain is better understood as an economic system than a software system.
I’ve been in the software industry for most of two decades now, but it wasn’t always clear that this is where I would end up. Back when I was a student, my other interest was economics. I found the subject fascinating, and still spend a good portion of my time reading about it, aided by the fact that economists embraced blogs and online communication, making it easy for laypeople to keep in touch with the debates of the day. I went into software and never looked back, but the interest in economics has remained.
Over time, I became more interested in it as a human discipline rather than a collection of problem-solving techniques or mathematical models. Economics is a high-stakes game — human livelihoods are greatly affected by it — and is also extremely contentious, politically sensitive, and divided between many competing schools of thought. Working out who these people are, why they think the way they do, and what the implications of their agendas are, became more interesting to me than how to model the effects of interest rates or optimal taxation. There would be occasional overlaps between this interest and my own work, but for the most part it remained an intellectual pursuit for its own sake.
The blockchain, and crypto-currency, finally allows me to indulge my two main interests at the same time. In many cases, what people mean by “the blockchain” is just “economics, on computers” (seriously, try it — any time someone says that the blockchain will solve a problem, substitute in “economics, on computers” for “the blockchain” and the statement generally makes way more sense). As someone with a combined interest in economics and computer science, this looks like fun.
If I had taken the other path, and been an economist instead of a software engineer, would I still find the blockchain to be relevant? I suspect that I would; in fact, I suspect that the blockchain might be one of the biggest things to hit economics in decades.
When people think of digitisation of a particular field or industry, they tend to think of automation — “robots taking the jobs”. But this is somewhat ahistorical. Digitisation of architecture in the form of Computer-Aided Design has not led to the robotisation of architecture, but to the creation of new concepts and better tools that enable new kinds of buildings. The architect is set free to consider new problems by the elimination of old ones. The same is true for graphic design, accountancy, aeronautics, biology and many other fields.
Digitisation gives us better information, and more of it, for a lower cost. It automates processes that would otherwise have been laborious and slow. One might think that this would reduce society’s expenditure on the activity in question — we can get the same amount of stuff for less money! — but in practice this tends not to be so. Make graphic design cheaper and we make graphic design more affordable to more consumers, with the result that many more instances of elaborate graphic design are created than before. Of course, none of this is news to economists — it’s known as the Jevons Paradox.
So does the blockchain do something like this for economics? There are a few ways in which this might be the case.
Firstly, the blockchain has helped to establish a new discipline known as “crypto-economics”. Although the terminology is not entirely settled, I regard crypto-economics as being the use of economic incentives and models in the service of building secure distributed systems (my definition is basically taken from Vlad Zamfir’s). Bitcoin is the paradigmatic example: it’s the payment of freshly-mined Bitcoin that incentivises the miners to participate and secure the network during its early growth phase. Proof-of-stake designs also employs economics in the same way — as an essential building block of the system.
Economists have plenty of tools for designing such systems — mechanism design, game theory, theories of asymmetric information, and models for economic constructs like auctions. The central insight of crypto-economics is that the design of a distributed computer system, with no central source of truth, is similar to the design of an economy with no central planner. As such, many of the tools of economics can now be applied to structuring collaborative distributed computer systems, not just people and firms. Thus, crypto-economics is about using economics to build and scale computer systems.
Secondly, there’s the “economics, on computers” (EOC, for brevity) work, which I would distinguish from crypto-economics on the basis that this activity occurs on top of the blockchain rather than as part of its foundational structure. For instance, there are economies running on top of Bitcoin, Ethereum, and other blockchains, that don’t have anything much to do with crypto-economics per se — the critical distinction is that they’d work pretty much the same way on top of a centralised system. We can apply economic reasoning to, say, Cryptokitties, without needing to apply crypto-economics just because we’re using a blockchain.
EOC is the study and design of economic interactions that occur entirely over computer systems. What this gives us is a real-time, high-fidelity set of accounts for entire digital economies. A complete transaction history of the Bitcoin blockchain exists, as does one for Ethereum and each of the other blockchains. As a tool for modelling and analysis, there has never been anything quite like it. And, as the blockchain slowly integrates with the real world, it becomes ever more useful as a tool for validating economic theories.
Phenomena that are hard to study in the offline world — regulatory shocks, supply/demand shifts, bubbles, responses to technological change and innovation — become much easier to measure in the blockchain economy. As tokens proliferate, we can measure their relative performance, their patterns of acquisition and use, how their structure and key economic drivers play out in the long-term. There has never been a better data set for many of these things.
Finally there is the political economy of the blockchain. Bitcoin is partly an ideological construct, encoding a set of beliefs about what money and value are, how they should be constructed, and how such beliefs can be sustained (or not) over time. The institutional structure of blockchains, of blockchain-native organisations, of DAOs and new forms of corporate entity, these are all fertile terrain for the deployment of institutional economics and political economy. You can’t fully understand Bitcoin with understanding its politics, and many of the alternatives differ more in their politics and economics than they do in their technology.
So the blockchain is great for academic economists, because it is a kind of living economic laboratory. Does it end there? No, because the blockchain does not evolve randomly but by attempts at designing new, and better, models for money, ownership, control, trade, lending, licensing, and investment. In other words, many of the key innovations of the blockchain are economic innovations, and that means we need economists to help design them.
There is precedent here in the field of video games. These days, Yanis Varoufakis is better known as the former Greek Finance Minister, whose battles with the Eurogroup were a pivotal part of the crisis of the Euro and the Greek economy. My first awareness of him came when he was appointed Economist-in-Residence at Valve, makers of Half-Life and Portal, amongst other video games, three years before returning to politics. There, he analysed the virtual economy that had grown up around the Steam platform, as well as Valve’s internal corporate structure.
Eyjólfur Guðmundsson has studied the economy of EVE Online, an economy worth millions of dollars in virtual spaceships. What he found was that the tools of economics were just as applicable to virtual economies as to physical-world ones, perhaps even more so. Moreover, those insights can be fed back into the decisions of the game’s designers, telling them how to price and structure new additions to the game world, or to tweak older ones.
If the blockchain is primarily an engine of economic innovation, this makes the skills, knowledge, and expertise of economists more valuable, because it is these skills that will be needed to create viable blockchain economies.
Is this already starting to happen? I’m an advisor at Sweetbridge, and one of the most impressive things about Sweetbridge’s design is the depth of economic thought behind it. From the micro-economics of interactions between actors in a supply chain to the macro-economics of stable currencies, innovation ecosystems, and new labour markets for rare talent, the Sweetbridge model is both deep and broad. Sweetbridge, of course, is advised by several experienced economists and employs economic modelling techniques throughout their product design.
For us at Mattereum, understanding our activities in relation to economic theory is crucial. The theory of incomplete contracts (for which Oliver D. Hart and Bengt Holmström received the 2016 economics Nobel prize) informs our thinking on smart contracts and how they relate to ownership structures; management of volatile assets is a major challenge in blockchain contract design; systems of price discovery that could previously only exist as thought experiments become possible with a globally shared ledger.
Of course, it’s all well and good to say that economists are important, but how about my revealed preferences? After all, Mattereum doesn’t have an economist on staff. This is true, and if you’re an economist who would like to get involved in shaping the future of the blockchain, global trade, and the new institutions of the 21st century, we’d certainly like to hear from you.
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