Blockchain's Simple Economics

A new paper out of MIT and the University of Toronto offers a bird's-eye view of blockchain economics, defined by greater network efficiency and a decentralized market design.

"Some Simple Economics of Blockchain," by Christian Catalini and Joshua Gans, is a valuable read for blockchain business leaders. Its insights and economic phrasing can help explain the value of blockchain-based products to investors, business media and customers.

The upshot of the paper is that blockchain technology drastically increases the efficiency of distributed networks. Network participants are able to share infrastructure without allowing platform operators to wield outsize market power.

In public blockchains, platform operators essentially are automated. For network users, this translates into lower fees, greater privacy and less exposure to the risk of censorship. It also eliminates the problem of platform operators monopolizing the market.

General Purpose Technology

"Blockchain technology allows a network of economic agents to agree, at regular intervals, on the true state of shared data," write Catalini and Gans. That shared data can represent everything from currency and intellectual property to financial assets and contracts.

Because blockchain technology is able to represent data with great flexibility across many settings, Catalini and Gans give it the distinction of a "general purpose technology" (GPT), along with the steam engine, electricity and the internet.

Blockchain is a general purpose technology (GPT) like the steam engine, electricity and the internet, say Caltalini and Gans, who are part of the new MIT Crytpoeconomics Lab.

Networks By and For Users

From my reading of Catalini and Gans, platform operators such as Amazon, Facebook, Google and Twitter have amassed outsize market power as the networks they own have expanded. This has spawned natural monopolies that lock in users and blockade the market for would-be innovative competitors.

Monopolistic platform operators tend to compile and sell user data and raise fees, reducing the efficiency, privacy and security of the networks for users.

I would add to Catalini's and Gans's observations that we've seen many cases of networks such as Facebook continuously refining the network design, terms and conditions, and algorithms to further increase market power--a goal that is often at odds with serving user needs or is detrimental to users (e.g., fostering extremism, fake news, voter manipulation, internet addiction and loss of privacy).

In this dominant model, economic and social costs of networks continue to climb as innovation declines.

In contrast, open, permissionless blockchains--among the platforms I'm familiar with, for example, are #Steemit (a #Facebook alternative where users earn tokens by contributing content), and #bitcoin (where miners earn bitcoin by contributing computing power)--do not produce outsize market power the way centralized networks do.

As open blockchain networks grow, market power is distributed among users. The networks are more efficient, with automated verification and auditing of transactions.

"On these platforms, trust in a platform operator is replaced by trust in the underlying incentives, code and consensus rules. As a result, market power of the intermediary, privacy risk and censorship risk are drastically reduced. This is possible because blockchain technology decreases the cost of networking." -- Catalini and Gans

Catalini and Gans appear to suggest that gaining market power for a relatively small group of owners (consider, for example Mark Zuckerberg and Facebook shareholders) is not a goal for open blockchains. This makes sense, as open blockchains have no "owners" other than the users of the networks themselves. It naturally follows, therefore, that changes in fees, data scraping, and, I would add, network design and terms and conditions for network usage, would tend to better favor users.

Checks and Balances

If bad actors attempt a power grab on a blockchain network, participants can replicate the network's underlying open-source code and split off like an amoeba (to "fork," in blockchain terms) and re-establish the original purpose of the network to serve network participants.

In this decentralized market model, the market remains open to "permissionless innovation," note Catalini and Gans. The barriers to entry are low and start-ups can compete directly with popular platforms.

Open blockchains also help to solve the growing problem of privacy and security. The Equifax and Target data hacks and Cambridge Analytica's Facebook data scraping are examples of this threat.

In cases where personal data needs to be shared for online transactions, the distributed nature of blockchains can guard against information leakage simply by the fact that the information is not stored on central servers. Blockchain technology also can facilitate more selective methods of sharing information on a need-to-know basis.

Resources

• "Some Simple Economics of Blockchain", by Christian Catalini (MIT) and Joshua Gans (University of Toronto): free download with sign-up

• Cathy Barrera, PhD's write-up on the paper: "The Blockchain Effect: Network Effects without Market Power Costs"

• The new MIT Cryptoeconomics Lab