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Theoretical Foundation of Token Economics in Nobel Prize in Economic Science

Abstract

Since Coase was awarded the Nobel Prize in Economic Science in 1991, there are more than 11 theories in Nobel Prize in Economic Science related to token economics in two major directions. One is game theory and the other is Coase theorem.

In token economics, the direction of research is not just the theory of private money, which has drawn attention as a result of the Bitcoin. That was a research topic in the age of Blockchain 1.0. Since the birth of Ethereum, scholars have not paid enough attention to,Smart contract, is an embedded contract which can execute code automatically without a fair independent third party or guarantee and can be automatically executed as long as certain conditions trigger. Under the condition that in execution level, the trust cost is almost zero, how the contract theory will develop has not been discussed thoroughly yet.

Moreover, the public chain technology gradually matured, the cross-chain technical map became more and more clear. Blockchain 3.0 gradually has been sprouted. In this case, how does the token economy work, the governance of community, the game between development team, miners and the currency holders, the game and alliance between the super nodes of public chain and Consortium chain, the Incentive compatibility of token system design. Those issues are all very necessary to discuss. Not to mention that how to combine the valuation of tokens with the traditional valuation theory (the valuation model is not covered by this article yet because it is not clear).

As the most famous prize in economics, the Nobel Prize in Economic Science brings together the most important theories in economics. This article summarizes the previous Nobel Prize Laureates and their main theories, which may be the theoretical foundation of token economics. It is not a rigorous academic literature review, but an attempt to summarize and focus on possible research directions. The development of token economics needs joint efforts of all economic scholars.

I. Token economics related Noble Prize laureates and their theories

As mentioned above, there are roughly two lines from the theoretical perspective. One is Game Theory — Mechanism Design — Neoinstitutional Economics — Incentive Compatibility line, which is used to study the eco-design of the economy of certification and the community. The other is the smart contract research line of Coase theorem — contract theory — property rights theory — transaction cost theory. traditional valuation theories and models may also be useful in value estimate. They are not listed here because the technical path is not yet clear..

This report has collected and summarized previous Nobel Prize winners related to the blockchain and their theories since 1991:

II. Mind Map

III. Brief Introduction

1991, Ronald H. Coase

Relevance *****

The definition of property, enterprise boundary and transaction costs in Coase’s theory forms the theory basis of blockchain and smart contract. Coase theorem was never raised or stated clearly by Ronald Coase himself, it was summarized by neoinstitutional economists from Coase’s work The Nature of the Firm, published in 1937. The most popular expressions are as below:

1) When there is no transactions cost, all negotiations between parties will lead to Pareto Optimality, no matter how rights are allocated at the beginning.

2) When there are transaction costs, different allocation of rights will lead to different distribution of resource.

3) Because of the existence of transaction costs, different rights allocation will bring resources with different benefits, thus the setting of property system is the basis for optimizing resource allocation (or reaching Pareto Optimum).

Coase was rewarded the Nobel Economics Prize in 1991 for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy. Coase’s two most well-known works are The Nature of the Firm (1937) and The Problem of Social Cost (1960). Of the two, the first explains enterprise scale with transaction costs. Coase said in the article, “Because of the difficulties in forecasting, the longer the contractual period for the supply of goods or services are, the more impossible and more inappropriate for the buyer to specify what the other party should do.” This has exposed two points: First, Coase has been understanding transactions from the perspective of the contracts; Second, Coase has suggested that the less complete a contract is, the more likely the market is replaced by companies. The second work (The Problem of Social Cost) proposes that external problems can be solved by the perfection of property demarcation. Please notice the second point mentioned above, as Coast has prospected in 1937, that the less complete a contract is, the more likely the market is replaced by companies; In turn, the more complete a contract is, the less value the firms has. The complete contract theory holds that there is no essential difference between firms and the market and that both are contracts; Principals and agents can foresee all possible situations and formulate the optimal risk sharing and income transfer mechanism to achieve suboptimal efficiency under constraint conditions. Coase proposed that “the nature of the firm is an alternative to the market.”

Under the background of Token economics, Coase’s first work enlightens us that since the cost of trust in transaction costs has been greatly reduced by blockchain technology, the existence of firms has become less and less necessary. The second tells us that the external problem can be well solved because the blockchain technology is very clear about the division of various low-order and high-order rights.

From the Coase Theorem, we can see two criteria for the design of the Token economic system:

1. The clearer the division and definition of rights, the more efficient the allocation of resources to the entire economy;

2. All designs contributing to reducing information asymmetry are good.

1993, Douglass C. North

relevance ****

Douglas North’s property rights theory is the theoretical basis for the delimitation of “property rights enhances economic efficiency” in Token economics. The main contents of the theory are:

Property rights theory is the most important theoretical pillar of North’s institutional change theory. North thinks that efficient property rights play a very important role in economic growth. He once mentioned that “the fact that growth is rarer than stagnation or depression indicates that ‘efficient’ property rights are not common in history”. Obviously, economic growth is often influenced by inefficient property rights. Efficient property rights help promote economic growth because on one hand, the basic functions of property rights are related to the efficiency of resource allocation, and on the other hand, efficient property rights have made the economic system an incentive mechanism. The incentive effect of this mechanism is reflected three aspects: reducing or reducing costs, guarantying people’s expected benefits, and, from the whole society, individual investment income fully close to social benefits (when the cost to exercise property rights is 0, the well-defined property rights make individual investment income equal to social benefits). Thus North believes that the definition, adjustment, revolution, and protection of property rights are necessary.

1994 John Nash, John C. Harsanyi, Reinhard Selten

relevance **

The three received the 1994 Nobel Prize for their contribution to game theory. Game theory can be used to analyze community governance issues in Token economy, such as the game between super-nodes, development teams, and big coin holders.

1996 James Mirrlees, William Vickrey.

relevance *****

The two people’s incentive theory in information economics, especially under asymmetric information, can be applied as theoretical basis for the design of Token system.

2001, Michael Spence, George A. Akerlof, Joseph E. Stiglitz

relevance ***

The three has exerted a great impetus to the research in the branch of information economics, related theories of which is helpful in the study of moral hazards and adverse selection under information asymmetry.

2005 Robert J. Aumann, Thomas C. Schelling

relevance **

The contributions of the two are based on the game theory of Nash, Harsanyi and Selten in 1994. Their contributions can be used to study the non-cooperative continuous game equilibrium of agents in Token economy.

2007 Leonid Hurwicz, Eric Maskin, Roger B. Myerson

relevance****

The “mechanism design theory” was first proposed by Hurwicz, and further developed by Maskin and Myerson. This theory can be used in the design of Token economy, and how to achieve “incentive compatibility” through mechanism design. An important goal of the “mechanism design theory” is to explain which system or distribution mechanism can minimize economic losses.

Hurwicz’s article entitled Optimization and Information Efficiency in Resource Allocation Processes kicked off the “mechanism design theory.” Hurwicz is thus known as the “father of mechanism design theory.”

In 1973, Hurwicz published Optimization and Information Efficiency in Resource Allocation Processes in the most famous American Economic Review magazine. The article has solved two core issues in the theoretical framework of mechanism design: the incentive compatibility principle and the principle of display, and laid the framework of the mechanism design theory. The incentive compatibility principle can be briefly explained as making individual rationality and collective rationality compatible to each other, which is to say that policies can achieve an effect subjectively self-benefiting and objectively benefiting others. Information asymmetry leads to market failure, so we may design a certain incentive mechanism to guide economic men to display real information. In fact, incentives systems are everywhere. They can be used in science, sociology, and even marriage and family studies. The principle of display can make participants tell the truth, so as to eliminate information asymmetry and thus achieve sub-optimal results. Hurwicz’s mechanism design is more from the perspective of the central planner, while the most prominent contribution Maskin makes is the introduction of game theory into mechanism design. His research on the election system and the auction system and Myerson’s research on the voting system can be used in the field of Token economy and community governance. Meyerson’s game theory research on oligopoly is very suitable for the study of events like the election of EOS super nodes. In the 1980s, the power reform in California was to break the monopole, but the power industry is impossible to form a perfect competition and oligopoly is the best solution. Myerson designed a power reform program for Clifornia with “mechanism design” and game theory, the effect of which is proved to be satisfying.

2009, Elinor Ostrom, Oliver Williamson

relevance*****

Ostrom’s research on social organization relation can be used to study the organizational system in Token economy. Williamson’s relevance is even higher. He summarized and developed the “Coase Theorem”, detailed transaction costs, and created “New Institutional Economics.” It was his contributions and admiration that revived the “Coase Theorem” and pushed it back to the top. The new institutional economics, including a great number of interdisciplinary and academic innovation about organizational theory, law, economics, gradually developed into a new branch of contemporary economics

2012, Alvin E. Roth, Lloyd S. Shapley

relevance***

The two won the Nobel Prize for stable distribution theory and market design practices. Both theories can be used in designing the system of Token economy.

2014, Jean Tirole

relevance****

Tirole held achievements in many aspects of economics. He has a keen insight. His theoretical contributions to corporate theory, regulation and incentives, and game theory can be used to Token economy. His new industrial organization theory is also helpful in the study of the organizational operation of Token economy

2016, Oliver Hart, Bengt Holmstrom

relevance*****

The two men won the Nobel Prize in Economics for their contributions to the contract theory. Contract theory is naturally fit with smart contract and is ideally for researching it. Holmstrom’s measure of information under a full contract is actually of great importance. He has a key theory in the design of incentive contract: suppose two variables, one measurable and one not, if the measurable one is given a strong incentive, the non-measurable one will not be incented. The simplest application of this theory is education. There are two variables: one is easy to measure, such as papers or college entrance examination results, and the other is not, such as educating people, cultivating human qualities and creativity. When providing particularly strong incentives only to easy-to-measure college entrance examination results or paper publication, education incentives will be destroyed. In this case, it is necessary to deliberately weaken the incentive to variables easy to measure and make it less strong. This theory is truly insightful, it shows that incentives are not always better to be stronger but depend on their observability and the relationship between them. I devote myself to education these years. I found a prominent problem in our education that the incentive differences between the education and publication papers and between creativity cultivation and performances in exams has caused a malformation. (See: Qian Yingyi: The Chinese Meaning of Contract Theory) Holmstrom’s theory has a realistic significance. Things are the same in governing Token economy. If measurable variables, such as workload, holding time, and frequency of code contribution, are given too strong incentives when designing a Token system then unmeasurable variables incentives, like contributions to community and operational, will become weaker and weaker.

Reference:

http://mp.weixin.qq.com/s/2eZInRESemoA2gsWZaQqdA

http://mp.weixin.qq.com/s/_pBqLn1tBMcR_vo7eoYBHw

https://www.jianshu.com/p/eaafcf00f98c

http://www.sohu.com/a/126212013_611499

Blockchain industry top think tank, affiliated to Huobi Group.

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Blockchain industry top think tank, affiliated to Huobi Group.

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