What A Sympathetic Free-Market Economist Glimpses in the Crypto Space
This post is a collection of insights (in no particular order) about the interesting connections the cryptocurrency space has with broader ideas and issues.
The connection between basic science and technology
The conventional wisdom about the relationship between science and technology is that it is fairly linear. Scientists discover the fundamentals about how the world works and then engineers put these ideas to work. Historians of science and technology like Terrence Kealey have long realized that this view is simplistic and misguided. For instance, only with the advent of the steam engine could thermodynamics even start to develop. The same can be said about telescopes and modern astronomy, printing and accurate clocks and modern science in general, and so on.
Blockchain technology provides another good illustration of this point. For decades, computer scientists thought that the problems with creating distributed consensus systems (e.g. the famous Byzantine generals problem are insurmountable). But then Satoshi Nakamoto (whoever stood behind that pseudonym) showed that in a specific case where the consensus involves an intrinsic cryptocurrency, these problems can be overcome. Which, in its turn, created a whole new field of research for computer scientists.
The Regression Theorem and the world’s most expensive pizza
The first blockchain-based cryptocurrency, Bitcoin, has provided a beautiful illustration of one of the most important ideas in economics from an Austrian economist’s perspective — Mises’s regression theorem. According to it, the value of any currency which serves as a means of exchange must ultimately be grounded in nonmonetary utility. Bitcoins certainly had such a value before they became currency units. They had value to a small cadre of libertarian techno-utopians.
The fascinating first-recorded exchange of bitcoins for other goods came place when a Hungarian programmer Laszlo Hanyecz purchased two pizzas for 10,000 BTC, which means that each pizza cost more than US$3 million at the current BTC/USD exchange rate. Remarkably, Hanyecz does not have a lot of regrets for not predicting that bitcoins would soon soar but, in any casem without people like him Bitcoins would never have become a widely accepted means of exchange.
The (Imperfect) Rationality of Markets
When the Ethereum blockchain and community recently split over the issue of whether the ledger should be modified to not allow a hacker to steal tens of millions of dollars worth of ether from the DAO, this created two competing cryptocurrencies with an identical underlying technology. This gave economists a great opportunity to study essentially a stock market with a relatively limited number of stocks and factors determining their prices.
For some time, the contest between the two Ethereums was very volatile but ultimately the forked chain with better fundamentals won out. It carried the day after someone on the official Ethereum sub-reddit decided to ask the developers of distributed applications on top of Ethereum to publicly state which chain they supported. Those developers overwhelmingly stood by the forked chain which is exactly what is to be expected from the fundamentals’ point of view.
This seems to support a middle-road position in the debate about efficiency of (asset) markets. Markets are not perfectly efficient but nor are they just casinos where rich people play with other people’s money.
Competition involves a lot of collaboration
People like to view competition among businesses as a dog-eat-dog process. This gets reflected even in the cryptocurrency space where some adherents of Bitcoin, in particular, frequently blast other blockchains for hampering the development of Bitcoin and even being disrespectful of Satoshi Nakamoto.
However, the relationship between Bitcoin and other cryptocurrencies is more symbiotic than cutthroat. For starters, most cryptocurrencies cannot be bought using traditional fiat currencies, the only places you can acquire them are purely crypto exchanges the chief of which is Poloniex. And most cryptocurrencies can only reliably be bought for bitcoins. At the same time, the existence of crypto exchanges is a positive for Bitcoin because it boosts its transaction volume. Secondly, competition spurs innovation, and competitors (especially in the open source environments) can easily copy the good ideas of others and avoid their mistakes.
Intellectual property is not necessary
Ethereum’s hard fork that was mentioned above and the subsequent decline of the minority Ethereum Classic chain contains another important lesson in it. Even when copying a technology is uniquely easy at a point in time because of a very special coincidence of factors, it is not easy to turn mere copying into a winning strategy.
The key thing is being able to further innovate on top of what you have copied, and that requires a healthy combination of people with a strong grasp of the underlying technology, as well as visionary business leaders.
There is a limit to decentralization of production processes
The modern world provides more and more opportunities for things to be produced outside of centralized companies, often by people working in completely different locations. The blockchain space has this in abundance but the woes of Bitcoin blocksize debate show that even cryptocurrency communities need clear leadership and final decision-making mechanisms. The dysfunction of the Bitcoin community with respect to the blocksize debate is so obvious it has commentators worrying that Bictoin would be unable to respond to a dangerous challenge like the potential arrival of quantum computers in a timely manner.
Cryptocurrencies create strong communities (and bitter conflicts, sometimes)
An interesting aspect of the crypto space is that far from having only technical aspects, it contains a whole ecosystem of communities some of which are at least partly bitterly opposed to some other communities. When the Ethereum community split over the hard fork, the arguments about it quickly become highly charged with mutual accusations being hurled, conspiracy theories advanced and even calls for 51% attacks.
Crucially, though, what mitigates this problem in the crypto space is the fact that it is generally possible for the groups that are locked in an irreconcilable conflict to split and implement their own view of how things should be done. There is no higher authority favoring artificial centralization or enforcing homogeneity. And communities create arround real-world products to which people can meaningfully contribute are, in my view, far better than ones created around meaningless random attibutes like a language or ancestry.
Cryptocurrency space as a glimpse of what the truly free society could be
Which brings us to the final point. Perhaps, like no other sphere of human activity, the fairly young cryptocurrency space already provides fascinating glimpses of what a truly free society could be, and so far these glimpses are not disappointing for someone who does not seek an unattainable perfection.
In addition to breathtakingly fast innovation with regard to cryptocurrencies and their diverse applications, the cryptocurrency ecosystem has already beautifully demonstrated the high capacity of distributed systems to handle issues that even most social scientists believe they could not possibly handle. These are the issues of dispute resolution and security.
The DAO debacle involved complicated, essentially legal questions of whether using a bug in the code of a smart contract constituted a theft and whether people who lost money had to be made whole. The Ethereum community has reached a relative consensus on this issue, despite the vocal minority that disagreed. And even in that vocal minority most people only objected to chainging the underlying ledger as a means of dealing with the attacker.
The community also dealt with multiple calls to launch 51% attacks against the minority chain which could easily succeed at the moment of its emergence. The vast majority of community members and the community leaders realized and maintained that such an attack would be unjust, and it never materialized.
In dealing with these two issues, the Ethereum community demonstrated that a decentralized nascent quasi-legal decision-making process could reproduce the basic legal principles underlying a free economy in a high-stakes case, even in the absence of institutionalization of private courts and a precedent system.
Blockchain communities have also been impressively successful at providing network security. None of the major blockchains has been severely compromised by external attacks. The biggest points of temporary failure being projects on top of blockchains, like the DAO and exchanges like Mt. Gox and Bitfinex. Even the recent massive Ddos attacks on Ethereum have at worst resulted in a temporary crash of part of the nodes but the chain never stopped propagating.
Contrast this to massive cybersecurity breaches that have been affecting even the US government-protected institutions lately, like the hacks of the US Democratic National Committee and Democratic Congressional Group, and to the findings of the US GAO on the weak security system for government agencies on which US$6 billion was spent.