Token Economics 22: Trust & Transparency

TRUST AND TRANSPARENCY

In a Facebook survey done in 2016 asking millennials if they trust banks, 92% of them said they do not trust banks.

In contrast to this, the blockchain is creating a new form of native digital trust that is significantly absent in existing institutions today.

This loss of trust in centralized institutions is one of the hallmarks of many post-industrial societies today. In a world of trusted centralized institutions, few would take interest in a distributed system that requires a paradigm shift in thinking.

These token economies are going to gain the trust that is lost from our existing institutions by being more transparent and the fact that they are auto-enforced by code.

Blockchains are a technology of transparency. Public ledger systems let us see all the interactions in the whole system – even if those interactions are anonymous – and this is very different to the world we live in today.

TRANSPARENCY

The closed nature and misalignment of interests within centralized institutions of today reduces their capacity for transparency.

Facebook does not tell you that they are making a profit out of you, with your data and the advertisements they deliver to you because there is a subtle misalignment of interests there and they don’t want that to be transparent. Likewise, their algorithms are black boxes, they don’t want others to know about them.

Centralized systems create many boundaries that block the flow of information across the whole network and increase its overall opacity.

Gavin Wood a co-founder of Ethereum describes well the kind of economy that we have created with centralization when he says, “the world is much like a set of walled gardens, within the garden you’re free to play, you are taken in if you accept the authority of the household that actually owns the garden. But it’s very difficult to get between the gardens in reality. This boils down to banks and various financial institutions making it very difficult and timely reconciling transactions that go between them. But the more important thing is that as individuals and small business owners it’s very difficult for us to interact with each other if we don’t yet know or trust each other. Instead we have to go to these guardians of society, these intermediaries, these trusted authorities the middlemen in order to interact.”

When you remove the centralized component in these networks you also remove the wall around them that they create, which can work to greatly increase transparency across whole networks. By switching to a peer-to-peer model, you switch to a model based upon direct feedback loops between peers. To get that dynamic real-time information feedback loop you need transparency. The information has to actually flow directly instead of being mediated.

By aligning the interests of the network, you can make transparency possible as people have less of their misaligned incentives to hide from each other. When things are on the blockchain then everyone can go and audit what has happened. This is like finding bugs in open source software where “many eyes make all bugs shallow.”

Part of the problem with centralized systems is that they are vulnerable to a rich get richer lock-in effect.

The issue with the centralized model is that large organizations get capital easier, greater liquidity and they get to dictate terms because they are seen to be more efficient and stable. This makes it more difficult for new startups to compete.

When the Internet started it was built on open protocols like email or TCP/IP and everyone was able to create. It was easy to discover websites. That’s not true in the internet anymore.

Closed networks like Facebook or Twitter are gated communities that use their user data to gain an advantage.

If you are a startup they also have the potential to shut you down as soon as you compete with them or violate their terms of service.

Once a centralized organization of this kind has grown it is very easy for them to become extractive, because it is difficult for people to change providers. Any system that becomes extractive will not want you to know that it is such and this will again reduce transparency in the system.

FRACTURED SYSTEM

One of the major challenges faced by organizations today is rapidly escalating complexity within almost all domains.

As our environments become more complex bureaucratic organizations have responded to that by creating more subsystems – more specialized departments and domains – the result being that things have been broken up into these different silos.

These silos provide the organization with some of the specialized capabilities for it to respond to the increased complexity within its environment. But at the same time have the effect of locking information about what’s going on inside because they don’t want to share that information; because they’re afraid competitors or customers will take advantage.

The more complicated things get the more we basically break things up and the more fractured and siloed the system becomes.

The greater the resistance to the overall flow of information within the system and the greater the overall opacity.

Blockchain networks enable us to collaborate within large networks, connecting horizontally and replace proprietary technology with open source protocols, greatly increasing transparency on the network.

This transparency can be used to reduce risk and uncertainty and thus reduce costs. With the blockchain – because everything is digitally native – we can have the actual information about transactions within the network. And we can, for example, lend against that with minimal risk.

If there is a smart contract that an organization pays you every month then you can use that to get a loan against it with minimal risk and thus minimal cost.

Also because these may be smart contracts you could just adjust those contract so that the capital is automatically routed to the lender as payback. Also no one can run away with the money because it is controlled by the network which reduces risk again.

Likewise the network could control for bad actors routing the finance around them.

OUTCOMES ECONOMY

Just as the underlying technology is based upon a proof-of-work or proof-of-stake system, so to a true services economy that the blockchain enables should be based on outcomes delivered. Unlike selling products which are all about the promise of a functional system, services can be measured according to the actual functionality delivered; the work delivered instead of simply being given a product that may or may not function well. The proliferation of sensing and big data analytics will enable us to measure and quantify our economies in unimaginable ways and in so doing begin to track the actual functionality delivered, which is at the end of the day what people really want, or are increasingly wanting as the so-called “burden of ownership” of the industrial age product-based system starts to take hold within consumer societies.

An “outcomes” system of this kind is again just one more way that a blockchain based economy could work to better match the information layer of token exchange with the underlying flows of real value.

Token Economics 21: Automated Networks

AUTOMATED NETWORKS AND SMART CONTRACTS

The term used to describe the new forms of organization created by blockchain networks is “decentralized autonomous organizations.” But one could just as well term them “decentralized automated organizations” as the automation of basic organizational procedures will be a central aspect of this new form of economic organization.

Blockchain protocols build upon the capacities of telecommunication networks to interconnect, and of the capacities of the microprocessor to run complex software systems for coordination. But whereas the previous set of information technologies gave us digital platforms for organizing economic production, the blockchain promises to extend this model to fully automated distributed networks.

The promise of the blockchain since its beginnings has been to challenge centralized, top-down decision-making through, distributed consensus, radical transparency, and auto enforceable code.

Smart contracts on the blockchain disintermediate existing institutions and radically reduce transaction costs thus allowing for new forms of decentralized organizational structures that were not feasible before. More specifically, this business model “automates” the governance to a certain degree. It frees up more time to actually spend on getting work done, although it also requires a much larger leap of faith by all parties involved to trust in an automated “trustless system.”

As one commentator noted, we can call private blockchains training wheels for public blockchains and now public blockchains are in many ways just training wheels for these new autonomous decentralized networks, which just work and everyone can trust them. These are gonna be some of the most powerful networks that we have seen because the code is immutable and many functions are automated. In many ways, they will be unstoppable in the way that Bitcoin is automated and likewise in many ways unstoppable.

DECENTRALIZED ENTERPRISES

An enterprise can be defined by its business model as a system that operates within some environment, intercepting resources and processing those into some output of value, while capturing some of that value and redistributing it within the organization.

People work together to create value and then redistribute that value amongst members, what changes with the blockchain model is that we take out the centralized coordination component and replace it with code in the form of smart contracts.

Smart contracts on the blockchain radically reduce transaction costs and automate basic management operations creating the basis for a peer-to-peer economy; allowing for new forms of organizational structures that were not feasible before.

The enterprise can be converted into an automated plug-n-play model where anyone who can deliver a service can plug into the system and provide that service directly through a smart contract receiving tokens in exchange.

Brendan Blumer CEO of Block.one, the makers of the EOS network, describes this evolution in the enterprise when he says “what we’re really moving into is the era of open source companies and the types of innovations that you’re seeing with open source technology, the explosion in development and projects like GitHub… the core of open source allows us to all build on each other’s work. In the future when I wake up I may not even have an employee or employer. I may be able to just work for absolutely any company in the world that I can add value to. Imagine that you wake up and say I have a great idea for Airbnb, you examine the code you start writing something and you put it out there, the public accepts that, forks you into the network, pays you a bounty, now you’ve got a decentralized network a piece of code that has essentially just hired you, that has taken your ideas, that has incorporated them into the organization and you have been paid and they don’t even know who you are.”

When everything is open source and everything is able to be viewed anyone can add value to that business, anyone can connect and say what if we do this, or what if we add that feature. The past decades have shown how open-sourcing software and open-sourcing development can skyrocket the acceleration of technology innovation and service delivery.

Because we’re not reinventing the wheel anymore and anyone can come in and add a good idea and it can be adopted by the greater public. What happens when you do that to a company? When you’re competing with Uber with everybody as your employee? Every bit of your code is auditable, anyone can make suggestions, if those suggestions are good they can be forked right in that’s really what these decentralized autonomous corporations enable.

EMPLOYMENT

Blockchain networks will extend the recent development of the on-demand economy and online freelancing platforms that have enabled people to work as freelancers contributing to many different projects without one fix form of employment.

By digitizing everything, automating networks and enabling micro exchanges of value token networks will enable a new mode of production where tasks are modularized and made available for anyone with skills to pick up, perform and receive tokens in exchange. And of course, because token economies are multi-value economies this production process could be of any kind.

The influential blockchain thinker William Mougayar describes this when he says “We are moving from user-generated content that you are familiar with, which is really the cornerstone of social media when you post a picture on Instagram, when you write a few lines on Facebook or Twitter, that is called user-generated content. In the future, we are going to have user-generated work, but this is work that we are going to get paid for by the blockchain by all of these cryptocurrencies that will come into existence.”

A good illustration of this is initial bounty offerings (IBO) which are a more recent development to ICOs. IBOs are “a way to crowdsource human resources, business development, marketing and user acquisition for blockchain technology ecosystems, by offering network tokens in exchange for contributions to the ecosystem.” They represent a limited-time process by which a new cryptocurrency is made public and distributed to people who invest their skills and time to earn rewards in the new cryptocurrency. Unlike an Initial Coin Offering where the coins are sold, an IBO requires an exchange of skills and greater commitment by community members in the development of the technology.

UCash is one project using this method, you can earn UCASH tokens for doing tasks like, writing an article, blog post or producing a video about UCASH or translating the UCASH white paper into different languages.

The technologist Vince Meens talks about the potential at the intersection of virtual reality (VR) and blockchain for enabling these new on-demand token networks. Where anyone could put a bounty on something that they want to see done, whether that is having the lawn mowed in the park or feeding homeless people. With the use of VR goggles, one could walk around and see the digital currency bounties left all around us available for earning by performing valued tasks.

Indeed bounty hunting is a surprisingly general and powerful model which could be used to incentivise people to find and remove any unwanted phenomena. We could have bounty hunters that are going after rewards for finding bad transactions on the blockchain, for finding bad data on the internet, for removing spam messages or for finding violations of some law etc. We just simply post rewards for finding anything that we don’t want and it is a decentralized system anyone can go after the reward. Once again this is the power of being able to now design incentive systems.

SERVICE DELIVERY

Likewise, these smart contract networks will automate the provisioning of services. Entrepreneurs will be able to create an application and release it into the “wild” ready to be employed by anyone and everyone who needs that functionality. The entrepreneur in turn simply observes micro-payments accumulating in their wallet. A designer could release their design into the “wild” and end users could download that design to their 3D printer and have the product almost immediately, paying automatically with their download.

Likewise, music services will follow suit. Currently, music licensing relies heavily on paperwork and trust in a music industry dominated by centralized organizations that take the majority of profits at the expense of producers. These intermediaries between the producer and listener of the music can easily take 80% of the price of the good. Musicians hope and trust that sales of their music and merchandise are properly calculated and reported to them but have no way of really verifying. As streaming and digital downloads eliminate physical sales of media containing songs, the music would appear to be a great candidate for tokenization. If music ownership was represented on a blockchain, the many participants in creating the music could have their shares set electronically. The vision would be to have every listener of their music require “unlocking” the file and paying, with payment then being distributed to the appropriate holders.

This model could though, be generalized to the whole of the economy. Once a product has been turned into a service the terms of that service can be encoded in a smart contract, the contract is put on the blockchain and made publicly accessible through APIs. Tokens are then automatically streamed to a wallet in exchange for the usage of the service. That is a generic model that would apply to any economic good once it has been servitized.

SUPPLY NETWORKS

These automated blockchain token networks hold out the possibility to radically improve the efficiency across the supply networks that run our globalized economy. The founder of the Sweetbridge project describes well the role of supply chains in the global economy when he notes, “most people don’t know what supply chains are, but everything you eat everything you wear almost everything you own and everything we use on a day to day basis was processed by, moved, stored or created in a supply chain. Supply chains manage 2/3 of global trade, so that’s about 54 trillion dollars worth of global GDP. Supply chain is the science of managing the creation of something and the construction of it through value chains that have many, many parties involved in them, so the blockchain has an ability to affect the supply chain far more than I think most people recognize.”

Token networks will enable automated coordination and the flow of goods along whole supply chains. Supply chains that currently involve massive amounts of friction, in terms of verification, regulation, financing and various forms of information exchanges. These supply chains may work to a certain extent in developed economies, but 40% of exchanges are now between emerging markets. Take for example a rice farmer who wants to sell rice from Vietnam to Nigeria, this involves an exchange between Vietnamese dong and Nigerian pounds. Just to go from one of those currencies into the dollar – the international exchange currency – and then back into the other currency it may costs up to 20% of the transaction value.

Binkabi, is one blockchain startup that tries to replace this model with a direct peer-to-peer network for agricultural products, which automatically identifies the trades coming from the different countries in different directions and tries to match those of similar size so that the companies can exchange currencies directly between them. This can work to take out the centralized component and remove massive amounts of redundancy in the network.

But going forward we will start to tokenize whole supply chains. As we begin to understand supply chains not in terms of products and companies but instead as service networks or value networks that deliver a service and build token economies around that process of value delivery. Here again whole supply chains, just like enterprises and whole economies, will evolve into service-oriented networks where tokens reflect the service delivered and individuals and organization can plug in to deliver modular capabilities to the network receiving tokens in return.

IoT

The important thing to always remember in this respect is that much of the greatest potential of blockchain systems is only possible given the effective interaction between the token network and the physical world. Having highly efficient automated token networks that then bump into very slow, manual, physical procedures would be like driving a super fast Ferrari in rush hour traffic.

Blockchains are protocols for networks, they can only deal with what is inside the network. But for those networks to become the dominant mode for organizing society and economy, they have to interact with the real world of people, organizations, things, and physical environments.

At present virtually all of our newly formed networked systems are dependent upon traditional centralized systems of organization to support their existence in the physical world. The only way that these networks are going to gain their full autonomy is by interacting directly with physical technology and real-world environments. This is now made possible by the Internet of Things and advanced data analytics.

The blockchain and token economies exist within the context of this next generation of web technologies and they have to all be working synergistically.

If the linkage between IoT, big data, and the blockchain is not made then these new systems will remain – like the networks of web 2.0 – dependent upon industrial age institutions and the potential will be lost.

We will end up in the same situation as previously where networks like Twitter and Facebook gave people the tools to connect and start the protests of the Arab spring, but not the physical means to realize that change.

Both the Internet of Things and complex analytics are massive technological changes. If you simply focus on token economies and the blockchain without thinking about those other elements, you are missing the bigger picture. The platforms that manage to use all three effectively and synergistically will likely, for better or worse, dominate the world of tomorrow.

Token Economics 20: Token Service Networks

TOKEN SERVICE NETWORKS

In just the past few decades our world has been radically changed by the development of almost invisible layers of information networks that now wrap around the planet connecting ever more people into common exchanges.

Telecommunications has connected us. Online platforms have provided the coordination mechanisms for organizing more and more spheres of our lives.

But now a new dimension is being added to this as blockchains enable us to securely record and exchange value automatically and with low friction.

It is when we put all these components together that we get the infrastructure for truly rethinking and redesigning economic and enterprise structures based upon open dynamic networks.

Information technology, telecommunication networks, online platforms and blockchains are enabling us to create ever larger systems of organization for economic production and exchange. Enabling the switch from closed organizations competing to open networks with these networks being organized via market mechanisms.

The blockchain, through smart contracts, lowers the information costs and transaction costs associated with many interorganizational contractual arrangements. And so expands the scale and scope of economic activity that can be undertaken.

It allows markets to operate where before only large firms could operate. And it allows businesses and markets to operate where before only government could operate.

Previously institutional structures and technologies worked to strengthened coordination and cooperation within organizations leading to the formation of ever larger centralized operations.

Large-scale differentiation of labor was a key innovation in the enterprise that greatly expanded during the industrial revolution. With mechanized automation individuals could focus on repeatedly performing the same operation rapidly with those diverse activities being coordinated through production processes. Meaning that it was now not any one individual that produced things, but instead the whole organization.

We saw the development of the very large enterprises of the industrial age, such as the corporations that were hired to build the American railroads, with ranks of salary middle managers expanding as fast as the tracks were being laid down.

This industrial model for the generation of value is largely a product of two factors. Firstly, the centralization of production and economies of scale that is inherent to an industrial economy.

And secondly, it is also a product of the relatively high cost of collaboration and communication.

In order to achieve the mass scale that the industrial environment selectively favored, standardization and predictability were a key component. Within this model, there is a strong divide between producers of value and consumers.

On the one side, we have formal well-bounded professional organizations. By aiming to maximize their efficiency, they include only the people who are most productive.

On the other side, we have the consumers who consume the products and services made by the professional organizations. There is a strong divide between producers and consumers, professionals and amateurs, work and play.

Today information technology is changing the very foundation of this dynamic. Blockchains radically reduce the cost of interaction and collaboration between organizations, compared to within them. Thus, the natural size of an organization can be far smaller.

So, once large enterprises have tokenized, then it will also be natural for them to split into smaller and smaller entities, and to reform as needed.

The distinction between the inside of organizations and their external market economy will become increasingly eroded as networked forms of coordination span across traditional boundaries linking inside and outside in a greatly more fluid fashion.

This will have a very profound effect on the overall structure of our economies, as they go from many closed organizations competing within markets to the emergence of large ecosystems of collaboration along whole supply chains and within the provisioning of complex service systems.

Indeed the last few decades with the emergence of the internet has already seen the formation of large business ecosystems.

Eamonn Kelly of Deloitte consulting describes this transformation well when he notes “ecosystems today are doing nothing less than redefining the shape and structure of the economy. They’re increasingly determining business success and business failure. They’re enabling massive and rapid innovation around the world and essentially they’re playing a very, very critical role in shaping the future of our society… Essentially boundaries are blurring everywhere, the boundaries between what large firms and small firms can do. The boundaries between industries and sectors. The boundaries between organizations. The boundaries between technology domains. The boundaries between producers and consumers. Where consumers used to be passive recipients now they’re active participants in the economy… We’re now living in a world where there are more nodes across more networks with more specialized capabilities and above all this extraordinary ability to connect them, to collaborate, to co-create across these systems. That’s the fundamental shift that’s restructuring economies and I think is actually going to fundamentally change our society.”

SERVICE ECOSYSTEMS

Recently an important idea has been gaining acceptance within the business community, the idea that businesses of many shapes and sizes can thrive and serve customers better as participants in ecosystems. More diverse and collaborative, more adaptive and agile than traditional industry structures and supply chains.

The term “ecosystem” is a useful metaphor that points to a deep interdependence across players as they Co-evolve and together create and share resources.

Many of these ecosystems are built on top of powerful platforms that facilitate connectivity and invite the active participation of a large number of other players.

Businesses that understand ecosystems and how they work are discovering exhilarating new opportunities to co-create new value streams with multiple players often including customers. They achieve this by harnessing the new coordinating power of advanced technologies to create scale and serve untapped markets, faster than ever before, work with others to meet important human needs and by delivering complex services in ways that would be beyond the capacities of any single organization. They attract and activate passionate communities of talented individuals and organizations and accelerate learning and innovation. To understand the potential of this idea we need just think of one relatively trivial example.

Imagine all of the drug companies having the means and incentives to collaborate on producing a single best drug instead of 90% of their resources being wasted competing while only one gets to patent a new drug.

ARCHITECTURE

With the shift towards token economics, our economies will evolve from the traditional model of the industrial age, based around centralized closed organizations competing, to more user-generated systems that both collaborate and compete within large open networks.

The critical change that will come about will be the move towards a service-oriented architecture to whole macro economies and indeed the global economy as a whole.

As the strength of these open trusted networks grows and connectivity proliferates the centralized organization will become unbundled along many dimensions and the product based, push model of competition of the past will evolve into a dynamic, plug and play networked model that works to aggregate modular on-demand services around the needs of end users. Over time those service-oriented blockchain based networks will become increasingly automated through the development of smart contracts.

In a recent article from the RMIT Blockchain Innovation Hub, the authors write “for many industries, the blockchain will radically redefine the boundaries of the firm, allowing individuals to trade their talents and skills in an environment devoid of big business. The eclipse of the large public firm has been predicted before, of course, but this time we believe those predictions will eventuate for many, if not most, industries.”

The organizational paradigm of the token economy will be large service networks. Digital networking technologies enable networks to overcome their historical limits. They can, at the same time, be flexible and adaptive thanks to their capacity to decentralize performance along a network of autonomous components, while still being able to coordinate all this decentralized activity towards a shared purpose.

A huge structural change that is coming about as we move into the information services economy – base on these information networks – is the shift from static structures to dynamic flows of value as the organizational model.

Unlike the industrial economy that was based on fixed structure such as the formal hierarchy or products produced, a service and token economy is one that is fundamentally based on value delivered.

The organization is not based on fixed structures, roles or boundaries, but instead is based more upon value produced and exchange, this value can be defined in terms of services. From this perspective, the organization is a network of value exchange and the members of the organization are those that provide value, the service providers.

MICRO TRANSACTIONS

Existing centralized companies when they design their products they have to design around the constraints of the existing fiat currency system.

Although not often noticed this, in fact, has a lot of limitations as transfer costs are high. They are slow that’s why we pay employees at the end of the month. It is for this reason that we don’t pay every person, every second. That’s a constraint of the existing financial system and we build our products around those constraints. But this is going to change with the micro-transaction capacities of the blockchain.

When economic activity is moved to a blockchain, tokenized and servitized we can then begin to actually track the real flow of value exchanges and match those with token exchanges. Instead of buying a song you stream it and pay in tokens for what you stream. Instead of paying a flat rate road tax you pay as you drive, or instead of paying a fixed insurance rate you pay your insurance as you drive, etc.

GLOBAL SYSTEM

Digital communication networks are the backbone of the network society, as the electrical power networks were the infrastructure on which the industrial society was built.

Furthermore, because the network society is based on networks, and communication networks transcend boundaries, the network economy is global, it is based on global networks.

By reducing the border around centralized organizations blockchain networks morph into ever-larger systems as they provide the underlying infrastructure for the evolution of a new level of economic organization on a global level.

These token economies can be at once local, in that they enable anyone to set up their own micro exchanges of value, but also inherently global. These networks – because they’re living in this global computer network rather than inside of a specific cluster of servers somewhere – have a certain magical property, which is that they’re global by default, they’re everywhere from the day that you release them and the services are universally available. This is quite interesting because it changes delivery at the edges of the network. Currently, we are not very good at delivering services beyond the two billion richest people on earth.

The fact that these networks are inherently global, the fact that all the logic is kind of buried in the payments architecture, the fact that there’s no real recognition or international borders in these systems, because they all operate embedded in the internet, they don’t see the world as a set of countries they just see as an enormous global network, all of those things point to the possibility, currently quite far off, that we are beginning to see global service architectures that run on these systems. Not just the payments which we already have and are being used very successfully in a lot of poorer countries but also the possibility that the services which are built on top of those payments will turn out also to be global by default, which could have a huge democratizing effect on the global economy.

Token Economics 19: Token Markets

TOKEN MARKET SYSTEM

Openness is one of the key design features of blockchain networks, they are inherently designed to enable intra-organizational collaboration. As soon as you start to use a blockchain to support a closed organization, you start to find that there is no real reason to use a distributed ledger at all and that it is better just to use a centralized authority to maintain the database.

With closed centralized institutions the drive is to concentrate the most efficient resources in the center. Indeed the most valuable and effective centralized organizations are the ones that can concentrate the most efficient nodes in the center and exclude those that are less efficient.

Distributed networks, however, have a very different dynamic. Quite the opposite, they create the most amount of value by going outwards towards the edges to harness the resources of the mass of people within user-generated systems of exchange.

These open user-generated systems are what we would call markets.

One of the most effective ways to understand this shift into a token market economy is through looking at transaction costs, as it is the reduction in transaction cost and the increase in automated coordination that is now enabling us to convert centralized organizations into open networks. By automating transactions, automating compliance and trust and connecting people peer-to-peer, blockchain systems will radically reduce the friction within economic networks of exchange and make markets a primary mode of organization.

Markets can enable the decentralized coordination of large and complex organizations. One of the basic features of complex systems that we see in the world around us is that complex organization can, in fact, be the product of simple rules.

Markets engender this principle. Actors in markets can operate based only on very simple local information, if someone will pay me more for this car than it is worth to me, then I will sell it. If I get paid more at one job than another and I like the job then I will do it. The rules under which actors operate within an economy are often very simple, but through all the interactions we can get complex emergent behavior on the macro level without that organization being pre-specified.

Blockchain networks enable the shift in organization from formal structures to much more fluid structures based on value exchange via markets and those markets are organized through price signaling that alter people’s local incentives.

PRICE SIGNALING

Prices are the signals that coordinate economic activity via markets. A price is a signal wrapped up in an incentive. An increase in the price of oil signals users that oil has become more valuable in alternative use. But we don’t just want to signal to people we also want them to move in the right direction, to take the signal seriously, to adjust in the right way. The higher price does exactly this. It gives users of oil an incentive to respond to the signal. They respond by using less, by substituting a lower cost alternative. Suppliers are also incentivized by the signal to invest more in exploration, to look for alternative sources, to build more etc.

The price system economizes on information. It’s able to allocate resources in a decentralized fashion using all of the information available, but without collecting all of that information, without having to transmit all of the information, because it makes use of the information in a decentralized fashion. It uses the information which is in people’s heads via the local choices they make in the market.

Markets are linked. They are linked geographically across the world. They are linked across different goods. They’re also linked, through time. The market acts like a giant computer that arranges our limited resources over space, time, and across different goods so that we can allocate resources via a decentralized mechanism.

For example, after a hurricane, it’s quite common for the price of generators and chainsaws to become very expensive. It’s signaling that we need more of those resources. The higher prices in a hurricane-devastated region, that says, “Bring the resources here!” The high price is a signal saying that the value of generators, the value of chainsaws — it’s really high in this location, at this time. And that higher price is acting as an incentive. It’s telling entrepreneurs, “You can profit by bringing resources from where they have low value to where they have high value.” The price system is doing exactly its right job. It’s signaling and incentivizing people to respond to these shortages.

Jason Potts an economies at RMIT University describes well how tokens work similar to the pricing system. “The purpose of the token system is to publicly coordinate private actions and that’s the interesting part of this. It’s not a monetary system it’s not a price system per se but it’s still a system where you’ve got coordination going on where individuals are able to look at the tokens what they’re doing, the tokens are doing the coordinating, and adjust their behavior with respect to that and what you get then is emergent order. That emergent order is an economy, the proper word for it is catallaxy, not an economy. But the tokens are doing the coordinating and they’re not doing it because of their exchange value or they use value or the store value, value they’re doing it because of their coordination value… anything that can do that, use rules that can create private coordination using a public signal is an economy.

In this respect the best way to understand money and currencies is as “current” “sees” that is to say tokens allow us to see currents within the network. Jason goes on to note that “what [tokens are] about to open up is a whole new world of coordinating signals that didn’t exist before, that’s the big thing, that’s the game changer that we’ve never seen before” we are going to get a much more refined pricing system with all these tokens and automated exchanges “that means we can coordinate an economy so much better with all this new coordinating information which requires a token.”

LONG TAIL

This reduction in transaction costs that will be enabled by distributed blockchain networks will have a systemic nonlinear effect. It is not like simply altering one component or one section of the system, it will alter many exchanges within the economy, that kind of nonlinear systemic change can give exponential improvements.

Transaction costs are fundamental to wealth creation and economic well-being. Interestingly reducing transaction costs across an economy by just a small percentage can massively increase the wealth creation in that country.

The result of that lowering of transaction cost means that it will be easier to access resources out on the edges of the network.

What decentralization and the reduction in friction does is to enable access to resources out on the very edges of the network.

By shifting from closed organizations to open decentralized markets we have the opportunity to really build global networks that begin to include those right out on the edges.

Today, about two billion worldwide remain unbanked. In Asia 60 percent of the people are cut off from the world economy, they do not have bank accounts, they don’t have access to the financial system. In South America, it is 65 percent and in Africa, it’s 80 percent. The majority of the world’s population is cut off from the world economy. In most cases, they can only use cash which means they can only deal with the people that they see face to face, it’s a very small community of economic trade.

The average sub-Saharan African makes about 550 dollars a year. It is simply not financially feasible to expand a traditional banking system into remote countries that are sparsely populated with individuals that make only a little income.

The marginal cost of adding an account at that level with a protocol and open source community is marginally close to zero, so if we are able to build this decentralized economic infrastructure that is where the value will be, out on the edges of the network.

There are 4 billion under and unbanked individuals in the world and that is huge global growth potential.

With blockchain base token economies we are not just expanding what value types get incorporated into the economy but also by reducing transaction cost we are extending markets further out.

By converting centralized organizations with boundaries and borders into open networks we are making the networks of the global economy accessible to many more people.

These token networks are going to be incredibly global like we have never experienced before.

The infrastructure does not reside on a centralized server in silicon valley, but on computers around the world.

We can create protocols as peer networks that reside on a distributed computer network and simply provide the coordination mechanisms through which people interact without anyone necessarily owning or really controlling that system, thus reducing borders to entry and expanding markets to almost everywhere.

Token Economy, Curation Markets and Technical Solutions

This panel discussion was held at the Blockchain Connect Conference: Academic 2019, on Jan. 11 in San Francisco.

The panelists discuss some of the challenges of tokenization, costs and reaching critical mass, via incentivizing actors — such as content creators, or users.

They also talk about establishing an advertising equilibrium between content creators and consumers via tokenization. The central idea is that with token ownership, participants can be somewhat like shareholders in a company, except on a network. Tokenization also offers the potential for higher quality content, since clickbait is fostered by the current advertising model of driving eyeballs over value.

The discussion further included empowering developers via tokenization and blockchain.

Panelists:

Colin Harper – Staff Writer at Bitcoin Magazine
Henry He – Co-founder & CEO of SesameOpen
Sichao Yang – Co-Founder of Canonchain
Yi Lu – CEO of U Network, Co-Founder of SV Insight
Yilun Zhang – Co-Founder & CTO of NKN

Token Economics 18: User Generated Ecosystems

USER GENERATED ECOSYSTEMS

As we have previously talked about the central aim in the development of an enterprise or economy is linking the individual’s interests with the whole organization in order to achieve optimal overall outcomes.

In very small communities it may not be very difficult to maintain that connection. In small communities, people can see that their efforts contribute directly to the overall value created and the overall value created is in turn linked back to the benefits that they will gain.

Likewise, there is limited need for centralized coordination. Thus no great concentration of wealth in the system and people may feel that it is fair.

The problem with this model is that it doesn’t scale and allow for more complex economic systems with specialization of work. As a consequence, over time larger more complex organizations come to subsume these smaller more basic forms.

If you want really good scientists, builders or teachers they are going to have to specialize in those activities, which will, in turn, require large systems of exchange.

We invented formal centralized institutions, monetary systems, large market exchanges so as to achieve specialization, mass production, and complex economic organizations.

However, as we did scale, there came to form a disconnect between the individual’s contribution and the value to the whole. Which creates the potential for both negative externalities, large concentrations of wealth, extraction and inequality.

As the scale of the economic systems that we are engaged in has increased, the interconnectivity and interdependence between any two random members has decreased – because they are farther apart in the network. This has worked to disintegrate traditional cooperative institutions that are based on local interactions and interdependencies. In the absence of tools for interconnecting everyone within a large national society, we have had to create the large bureaucratic centralized institutions of today.

But these centralized institutions have created notorious divides within the modern capitalist system, between owners and workers, between producers and consumers.

With the rise of information technology and globalization, we are creating organizations that span the entire planet, creating massive divides between producers, owners, and consumers, with the interests and incentives becoming increasingly misaligned.

Clothes are produced in Bangladesh by people who get paid half nothing. Revenue is sucked up into a global financial system to pay shareholders. While end users have no loyalty or care for the organization from which they buy their products.

There is a massive misalignment of incentives that creates a hugely inefficient overall system.

MISALIGNMENT OF INTERESTS

We can analyze the incentives structures of this organization by looking at the centralized technology platforms of today. Here we see on one side we have value creators and the other side we have value consumers, they’re all coming together through some type of central server platform.

For example, with Uber you would have the value creators on one side, being the drivers, sending their information to a central server and on the other side you’d have the riders that are using the transport service from the platform. In the middle you have the platform and of course the reason that these companies are doing it is for-profit. So a portion of the profit or all the profit goes up to shareholders.

The users of the system do not care if the value of Uber goes up or down, all they care about is getting from point A to point B. That is their involvement with the organization and that’s the limited vested interest that this centralized structure is able to take advantage of.

The drivers likewise don’t care about the value of the overall organization, they just want to get paid and the shareholders and management are only interested in the quality of the service and the conditions of the workers to the extent that it affects the profits of the organization.

Likewise, we can look at Facebook and see that it is at odds with its users. Facebook’s founders and shareholders have made massive amounts of money.

Yet its users didn’t, despite contributing the key personal information and content that is the central value proposition of Facebook.

Profits are drawn inwards and upwards to the top management and shareholders. With its billions of users and high engagement, Facebook has become enormously powerful in our world. Yet it’s controlled by a small handful of people. This is dangerous for society. Especially given the fact that it is not really structured to handle such
responsibilities.

The only reason that these companies or shareholders are putting forth the products is for the money that they can make and that is the entire business plan. It is to maximize profits and that drives our whole economy.

What you have here is a split between the users and the beneficiaries rights and that creates a huge degree of misaligned interest. Not only this, but there is no user vested interest, the users don’t really care about the success of the company in which they’re using that product. That really leaves a lot of value on the table, because the user’s engagement can be hugely beneficial.

TOKEN SYSTEM

Token economics offers the potential to reintegrate this whole system. Break down divides between users and producers, between workers and owners; working to align their incentives within a whole ecosystem.

By connecting people peer-to-peer and automating the operations of the network, blockchain technology enables us to take out the centralized component and reintegrate producers and consumers into a much more functional ecosystem of exchange.

As illustration, we can think of the production of a movie. Currently, this is achieved through a centralized organization for-profit that then hires producers, directors, and actors to make the film which people then pay to see with profit going to the investors.

But this could be turn into a token network. We use a blockchain network to create a token, call it a “movie coin.” Actors, directors, and others get paid in that coin that viewers have to buy in order to see the film. People can purchase the token before production to raise the initial capital to fund the project, thus cutting out the intermediaries.

As another illustration, we can think about the fact that the average tenure of an employee in Silicon Valley is less than two years. One of the causes is the lack of alignment between employees and the owners. This is called the Principal-Agent Problem. Every group of people has principles, which are the owners, and agents, which are the employees, and it is easy for them to become misaligned. What may be good for the employee may not be good for the company.

In startups, principals and agents are the same. That’s why they are all really motivated to work together and can create a great amount of progress rapidly. But as the organization grows there becomes a growing gap between owners and employees and growing potential for the misalignment of their interests.

By creating micro-economies we can work to reintegrate the two. Distributed organizations have no centralized management structures for controlling and coordinating the organization. The architecture of the code is the rules of the organization and people may have an input on how that code is altered. The aim is to have autonomous actors who feel integrated with the organization to create true user engagement. By functioning as both equity and currency the token can work to link the value of the ecosystem with the value that people exchange within that market.

Moving to decentralized ecosystems you really have the same parties involved but, you removed the centralized entity completely, thus closing the economic loop of that company with a peer-to-peer token exchange. Instead of sending money to a centralized body with fixed fees on both sides taking off a profit margin, these companies can introduce a token.

Because of the linkage between the value of the exchange token and the value of the network, in the token system, the value generated gravitates not upwards within the hierarchy but naturally propagates to the token layer that reflects the value of the whole ecosystem and goes into the pockets of anyone holding the token.

Because it is also a utility token it means that the value goes to those using the network, the producers and end-users.

In the example of Uber, imagine every single user paid in a native currency or a native token of the actual organization itself and then every driver receives that token and then they sell it back to people that need to have rides. This closes the economic loop and aligns the interests of everybody in the organization. You now have unprecedented vested interest, every single person involved in that corporate ecosystem is now invested in the success of the organization.

Just as everyone holding a Bitcoin will promote the digital currency to their friends, anyone holding the token of any network will be incentivized to promote the use of that network, so you are turning the users into evangelists.

Another example would be Brave. Brave is a new token network for the digital advertising industry. It pays publishers for their content and users for their attention. This service creates a transparent and efficient Blockchain-based digital advertising market relative to the traditional model.

An Ethereum based network that radically improves the efficiency of digital advertising by creating a new token that can be exchanged between publishers, advertisers, and users. By connecting all parties involved directly via a token market, publishers receive more revenue because middlemen and fraud are reduced. Users, who opt-in, receive fewer but better-targeted ads that are less prone to malware. At the same time, advertisers get better data on their spending and more engaged users.

What we start to get are economic networks that are really like a cross between private enterprise and public utility. We are getting a hybrid of the community system with its vested interests, where the work you produce is connected to the value of the ecosystem, but also getting the option to exchange within broader systems involving high levels of specialization and complex coordination.

Token Economics 17: Mechanism Design

MECHANISM DESIGN

Token economics represents the merging of economics and information technology. It shifts economics into a more technical realm.

In the past, we could really just tweak around the edges. But now we can really design economies like we never could before.

Once we shift business and economic organization into this more formal and technical realm, we can begin to bring very powerful mathematics and analytical tools to bear on what we are doing.

One aspect of this is using the models from game theory to design these incentive systems.

Game theory is the study of the strategic interaction between adaptive agents and the dynamics of cooperation and competition that emerge out of this.

A much more recent extension of this is mechanism design. Mechanism design is a field in economics and game theory that takes an engineering approach to designing economic incentives toward desired objectives, in strategic settings. Because it starts at the end of the game, then goes backward, it is also called reverse game theory. It has broad applications in the management of markets, auctions, voting procedures and is of particular relevance to token economics.

As an economic theory that seeks to determine the situations in which a particular strategy or mechanism will work efficiently – compared to situations in which the same strategy will not work as effectively – mechanism design theory allows economists to analyze and compare the way in which markets or institutions lead to certain outcomes, because of their inherent incentive structures.

With mechanism design, we are trying to design the system towards a certain desired equilibrium state. With this approach we first think about what outcome we would like to see from the system. We can then build a set of rules that will hopefully lead to those optimal outcomes.

Legal systems are a kind of mechanism, as they are a method for shaping human behavior. A particular set of laws is usually trying to shape a particular type of outcome through the imposition of a set of penalties, fines, rewards or incentives such as tax breaks, etc.

Of course, these existing systems are centralized in their design, but with token networks, we are looking for a mechanism design that does not depend upon
a centralized authority specifying and enforcing the rules, but instead some kind of peer-to-peer value exchange mechanism that is self-regulating through direct information feedback loops.

FEEDBACK SYSTEMS

As previously mentioned coordination within distributed systems, like token economies, is not achieved via centralized coordination, but instead by the interaction between members and the incentive structures created by the exchange of tokens. The primary dynamic for us to consider then is that of the feedback loops that are created out of people interacting peer-to-peer. We are trying to enable cooperative structures without imposing them and that is achieved through peer-to-peer interaction.

Creating optimal outcomes for the whole system means effectively linking the payoffs of the individual to those of the whole system and thus reducing negative externalities.

Every action that an agent takes has an effect and we can ask what are the repercussions of those actions and who bears the costs and benefits. When an actor gains from an action but the costs are born by others this is a negative externality.

Pollution is the classic example of a negative externality. So too, excessive inequality may be seen as a negative externality of people’s greed.

Negative externalities incentivize actors to overperform a given action as they are not bearing the cost and leads to unsustainable results overtime, as that cost is being born by someone else, the whole system or environment.

Building systems of cooperation in such a context means enabling ongoing interaction, with identifiable others. With some knowledge of previous behavior, lists of reputations that are durable and searchable and accessible, feedback mechanisms, transparency etc.

The development of current web platforms is good illustration of where we are going as they often incorporate many of these design components.

Sites like TripAdvisor and Yelp exist as standalone feedback platforms, while Amazon and eBay legitimize their products by allowing users to place feedback on their purchases.

Feedback systems are used to rate and rank content on social media like Reddit and Facebook.

All of the above have become an essential part of how we identify quality products and services that meet our needs.

But while the internet gives a voice to all, misinformation has become an accepted reality. Competitors may falsify reviews to discredit a product, while the review platforms themselves may modify or delete feedback that doesn’t fit their agenda.

The combination of blockchain tech and advanced analytics could take the possibility of bias and corruption out of current feedback systems, with an end-to-end process designed to pick out quality feedback and then safeguard it.

Revain is one blockchain platform that works to secure feedback systems. All incoming reviews will have to pass an initial screening test, with IBM’s Watson AI platform analyzing emotional and unconstructive language. Users are rewarded with RVN tokens for submitting a review, while companies can use the token to purchase quality feedback, direct from its customer base. And at the end of the whole journey, consumers have access to transparent, high-quality feedback to aid their decision-making.

Uber is an example of mechanism design. From this perspective, Uber just adds to the financial contract of paying someone to take you somewhere a reputation feedback system.

Uber adds reputation for both drivers and for riders and adding reputation into the system actually significantly influences the way that people behave within that system.

The goal is to shape the behavior of the participants and adding that additional reputation can have a significant impact.

But of course with blockchain systems, this can all be tokenized, and because tokens can represent any form of value exchange – natural capital, social capital, cultural capital, industrial capital etc. – we can build in many different forms of feedback loops and different forms of mechanism design.

Token Economics 16: Incentive Systems

TOKEN INCENTIVE SYSTEMS

Incentives are a central part of economics and blockchain networks give us new ways to design and build incentive systems.

As Mike Goldin, a lead engineer at ConsenSys noted “Blockchain gives us programmable money. When you can program money, you can program incentives, and when you can program incentives you can program people.”

Programming people may sound a bit funny but in fact, it captures something of what is now possible. Like never before we have the capacity to rapidly build and implement large-scale structures for incentivizing human behavior towards certain ends.

We are increasingly moving into a world where we can analyze, design and adjust real-world economic and social outcomes by deploying new protocols on the internet. This is a new capacity that we now have, one that offers both huge potential and is at the same time frighteningly powerful.

How to create incentive systems that align the interest of the individual with the overall beneficial outcomes for the organization or economy, is a central issue of interest in business management and economics in general.

A central premise of economics is that people respond to incentives.

One of the key insights of Adam Smith was that overall beneficial outcomes for society and economy should not depend upon the virtues of the individuals within the system but instead, optimal outcome should be achieved by designing incentive structures that link the individual’s self-interest with beneficial overall outcomes.

This is captured in his famous passage “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our necessities, but of their advantages.”

This is a very important insight and history will teach us time and time again that we should not depend upon the virtues of the agents within the system, if we wish for long-term stable functional outcomes. Over time the most virtuous of leaders can turn into the most brutal of dictators.

The only way we can assure long-term stable outcomes is by a clear analysis and design of the incentive structures in the system. The only way we are ever going to get really functional economic systems is by really understanding the incentive structures in the network and designing those so that they are aligned with the overall desired outcomes.

Every misalignment of incentives will over time turn into a dysfunctionality within the network.

The structure of the incentives within the system is critical to whether the economic system will thrive or fail. Capitalism has succeeded to a certain extent where communism failed precisely because of its incentive structure.

A good illustration of this is The Jamestown Colony, the first English-speaking colony in North America founded in 1607 in Virginia. The colonists spent the first 10 years of their existence hungry, they never had enough food, with over 80-percent of the colonists perishing in what became known as the “Starving Time”.

But then after those first ten years, the colony thrived, the colonists had plenty of food and their numbers increased and it took off. It was the same people using exactly the same techniques so what changed. Before 1615 they all went out to the field they all worked and then they took the output from that field and divided it up equally. In such a system people have no incentive to work harder than the minimum required; there was no linkage between individual incentives and overall beneficial outcomes. In 1615 they made a very simple change to the rules, they divided up the farmland so that each person had their own individual plot of land. You could now do whatever you wanted with the food that you grew, they grew their own food, they ate it, they sold it to each other, they gave it to their families and the colonies thrived.

It was a change in incentives that ended the starvation and brought about abundant food supplies.

Human beings have always been bad with incentives getting ourselves into all sorts of situations we don’t intend to because of how we try to direct the ways that groups behave.

We can look a what the incentive structure that a deregulated financial system has caused, or anonymous political donations of money. The reality of how incentive systems play out in the world is complex and typically beyond the designer of the system’s capacity to foresee. As a consequence we often just lurch from one model to the next as we react to the unintended consequences of the previous system.

The central aim of economies is to enable people to work together within a combined enterprise. To do this we have to align the behavior of the individual with the whole.

Blockchain networks are all about protocols that enable coordination between actors. The great innovation of blockchain networks is as a new system for incentivizing a network of autonomous nodes towards maintaining a shared infrastructure.

Token economics builds upon this underlying technological innovation. With tokenization, we are going to start to incorporate explicit incentive systems into more and more spheres of life. We are attempting to build these micro-economies around every source of value so as to align people’s individual incentives with delivering an overall functional ecosystem.

TRUST EQUILIBRIUM

In every socio-economic organization, there is the opportunity for collaboration and cooperation which leads to optimal outcomes for all and there is the opportunity for competition and conflict that will lead to suboptimal overall outcomes and unequal pay-offs for actors. The point of a social or economic institution is to achieve coordination and optimal overall outcomes.

Every game has two equilibria. There’s a good equilibrium where everybody cooperates resulting in everybody gaining and there’s a bad equilibrium when nobody cooperates, nobody gives in and nobody gets anything. The optimal overall equilibrium is typically very fragile. It’s enough for one person to deviate from the good strategy and the whole system can deteriorate. The bad equilibrium though is very stable. Trust is about our ability to stay in the good equilibria, what do we do to live in a society where we all benefit because everybody has a short-term incentive to betray the public good. But the moment people start betraying the public good things deteriorate quickly?

The traditional way that we have solved this equation is through a centralized authority that mandated that all act according to the economically or socially beneficial outcome. Token economics attempts to achieve this alignment through peer-to-peer exchanges of value that incentivizes the actors to operate according to overall effective outcomes.

To illustrate this dynamic we can think of the torrent file sharing system. In a torrent network, anyone can share their files with a decentralized group of peers. The idea was that people would download them and keep sharing the file with the network for others to download. If you were downloading a file, then you were expected to seed as well. This is what we would call an honor system, which is a system operating based on honor or honesty without having strictly enforced rules governing its principles.

The problem is that humans are not always the most honorable of creatures and without any economic incentives it made no sense for people to keep seeding a file which took up unnecessary storage space and bandwidth.

What token economics adds is the capacity to incentivize these peer networks. Unlike open source software, peer-to-peer file sharing or creative commons where the infrastructure is dependent upon the goodwill of the actors, tokens incentivize the peers to participate. So instead of a file storage system being dependent upon a centralized for-profit organization or people’s charitable willingness to provide the resource, it gives those members tokens to incentivize their provisioning of the resource.

The fact that tokens can be used to define and exchange any form of value means that these distributed organizations can be used to deliver all forms of services; both what has been previously delivered by private organizations but also services that have previously been the purview of the public sector.

Public services like cleaning up litter, maintaining parks, public security, care for the elderly, reduction in noise pollution, civic engagement etc. Indeed anywhere value could be generated by the coordination of members, we can define a token for that value and use it to incentivize the agents towards the coordinated behavior, thus enabling the delivery of the service through peer-to-peer token markets.

The Ethereum developer, Karl Floersch, summarizes the current situation well when he notes: “Incentives drive behavior and open access to programmable incentives sets the stage for radical change. This is a really unique moment in history, this change can be good or this change can be bad, we can program incentives which promote cooperation and equitability and general happiness, everyone’s goal, or we can create incentives which prop up a few people and give them way more power than they already have. This is like kind of terrifying, so we need to design mechanisms, test them in the real world and share our findings and do that over and over on a large scale.”

Token Economics 15: Decentralized Token Organizations

DECENTRALIZED TOKEN ORGANIZATION

Token economies can be understood as a new way of coordinating human activity in a decentralized fashion, this being done through peer-exchanges within market networks.

As Primavera De Filippi of Harvard puts it, “Today the blockchain is marking the beginning of a new digital revolution, whose focus is not just human communication but rather human interaction and cooperation. What the internet has done to achieve global interpersonal communication the blockchain could do today to achieve global and systematic collaboration.”

It is common to compare the invention of Bitcoin and the blockchain with the internet. In this respect, it is often said that the blockchain is Internet 2.0 The internet has been a powerful tool that has revolutionized the way we interact. But if anything this comparison undersells the significance of the blockchain. As the authors of a recent article on “The Blockchain Economy” suggested, a better metaphor for the blockchain is the invention of mechanical time. Before the modern mechanized measuring of time, human activity was temporally organized by natural cycles: the crow of the rooster in the morning, the gradual descent into darkness at night. The problem with this though was variability, there was simply too much variance in the measurement of time for it to function as a widespread system for synchronizing economic activities.

Mechanical time opened up entirely new categories of economic organisation that had until then been almost unimagined.

During the industrial revolution, the effect of the reduction in the variability of time measurement was felt in almost all areas. Mechanical time allowed trade and exchange to be synchronised across great distances. It allowed for production and transport to be coordinated. It allowed for the day to be structured, for work to be compensated according to the amount of time worked — and for workers to know that they were being compensated fairly. Working life became routinized around this new objective standard of time measurement.

The blockchain and token economics may well be such a systemic transformation in human coordination.

DECENTRALIZED COORDINATION

The blockchain is a new coordination technology that relies on a decentralized network of computers in order to coordinate individual actions in a decentralized manner.

We can think of token economies as a way for people to mimic the social dynamics found in certain highly social creatures like bees, ants, and termites as a way to promote and ideally achieve effective collective organization.

By recording individual actions on a distributed database the blockchain makes it possible for people to coordinate themselves indirectly and collaborate on a global scale, without any centralized authority or hierarchical structure. This is something quite new in human civilization. Until very recently the basic premise has been that order and organization are achieved by centralized authority.

CENTRALIZED INSTITUTIONS

Throughout history, we have achieved widespread coordination and economic organization via centralized systems that imposed common standards. The evolution of civilization can be understood as the rise and fall of ever larger more complex systems of human organization.

Economies are built around networks of trust and common protocols. Traditionally these have come from either a government institution or from some form of Church which are structured in a pyramid form.

In those power structures, you’re able to do business, you’re able to trust people who are not your immediate family because the centralized authority provides the common standards, the protocols, the regulatory and legal structures for you to trust each other and exchange; fiat currencies being one good example of that.

Although centralized systems have their advantages they also have their disadvantages and are inherently limited when it comes to the formation of very complex organizations.

ALIGNMENT OF INTERESTS

One of the primary issues with current centralized organizations is that they are not general purpose as each organization acting as an authority also has its own vested interests. This creates a misalignment of incentives between the centralized authority and users of the system. If we are lucky and we get virtuous members in the center of the organization the interests of the centralized authority may be aligned with those of the network, but equally, they may not.

As we will discuss in the coming module, there is really a misalignment of interests at the heart of centralized organizations.

We have this problem today where most of our most important economic and financial functions are provided by centralized for-profit organizations. The incentive of the organization is to create profit for its owners. The result of this can be that profit gets sucked into the center and upwards, reducing the quality of the network delivering the function and accentuation inequality.

BOTTLE NECKS

Likewise, centralized coordination creates bottlenecks. Resources are brought into the center, processed and then pushed back out to the edges. The system always works much better close to the center and then coordination drops off the further out you go.

This is why, for example, Zimbabwe is a much better use case for cryptocurrencies than say Singapore, because Singapore is close to the center of the global financial systems while Zimbabwe is out on the edges.

Centralized systems have problems delivering structure and functionality all the way out to the edge of the network. The result is that we end up with a trickle-down economy with the edges always being dependent upon the center, but the center not being properly incentivized to deliver services all the way to the edges. Those at the center get a good service but those at the edges don’t. The billions of people who are left out of the global financial system because they are not economically worth serving is illustration of this.

FRACTURED SYSTEM

Centralized systems end up forming either monopolies or a fractured overall system.

Centralized systems have a specific locus as their center and then push out until they meet another organization. The end result, is either a monopoly where one comes to dominate overall others or a fractured system, with lots of different patterns forming. The nation-state is a good example of this. Within a given jurisdiction we have a monopoly of public services but on the global level, we remain with a fractured system.

PEER-PRODUCTION

The alternative to these centralized systems is decentralized peer-to-peer networks. Without centralized authority being used to achieve coordination, this coordination is achieved via direct exchanges of information and value peer-to-peer, such as in a pure market, where the price is decided by the interaction between members.

Token economics turns these centralized institutions of the industrial age into distributed token markets. The critical change that is coming about is that we are now able to design token systems that work to incentivize people’s behavior towards coordinated outcomes, without that coordination being imposed by some centralized authority.

What is different now is that we have the technological means that we can design economies instead of just organizations. Economies that create the right incentive systems and feedback loops to coordinate the activities of the organization in a decentralized fashion.

Token economies build upon the development of peer-production, an alternative model to economic activity that has arisen with the development of the internet.

Peer-production is a process taking advantage of new collaborative possibilities afforded by the internet and has become a significant mode for the division of labor within post-industrial economies.

Free and open source software and open source hardware are two examples of peer-production.

With the development of web 2.0 technology, it became possible to coordinate a large number of people using software systems as the coordination mechanism instead of any centralized authority. This was exemplified by projects like Wikipedia.

But these networks were lacking the critical element of economic incentive. Token economics provides a new way to fund and incentivize these newly formed distributed networks.

Juan Benet, founder of Protocol Labs, describes well what is happening today, “One of the interesting properties here is the ability to create markets where there wasn’t a market before… what [blockchain] application platforms can do is suddenly cut out this huge middleman with a protocol and that is a massive cost-saving for the entire network… you can turn this into a protocol that will optimize the entire process much faster than any centralized company can do, because it turns it into a market. The moment you can take a very complicated process and translate it into a market where a whole bunch of different actors can vie for opportunities and just beat each other, you have this amazing optimization power, where it will just fit the function much better than a centralized entity could have.”

The blockchain provides the infrastructure of trust, secure record keeping and peer interaction required to create general purpose networks for the provisioning of economic and financial services via distributed markets.

The challenge of doing this though is one of designing incentive systems and this is what we will talk about in the coming module.

Token Economics 14: Physical Assets

BLOCKCHAIN PHYSICAL ASSETS

The blockchain originates out of the purely digital realm of Bitcoin. Thus blockchain networks themselves can only ever manage what is on the network. This is fine if the asset is simply a digital token. But going forwards we find ourselves increasingly wanting to use these networks to manage real-world assets. Thus these value networks will have to interface with the real economy and this interface between the physical and information realms creates major issues.

Economies are, at the end of the day, still very much physical systems of technology, land, natural resources, buildings etc. if we are serious about migrating our economic systems to the blockchain, major consideration has to be given to that interface to ensure that the tokens are securely and accurately connected to their underlying physical assets.

In a digital system like Bitcoin, there is always consistency. Transactions obey the rules of the software and there are no exceptions.

In the real world, there are often exceptions. Cars are stolen, houses destroyed, videos turn out not to be properly licensed, commodities fail to be delivered. Humans sometimes don’t obey the rules. Therefore the key challenge for any system that involves tokenizing real-world assets, is to ensure that the digital token stays linked to the real-world asset.

Very few people in the blockchain world have an appreciation for the complexities of the physical systems that run our economies and their regulation; such as containers passing through customs at a port.

There is a huge gap between this very light dematerialized culture of the blockchain and the very heavy culture of traditional physical assets and the national legal structures that they are embedded within.

Today this interface is secured by laws and ultimately the physical force of a government that backs those laws. If you have a legal document that says a piece of land is yours and someone comes and resides on it you can go to the government and they will physically remove that person from your property if need be.

Imagine a token that represents a fractional interest in a set of gold bars in a vault. If a gold bar is taken from the vault, how will that be reflected in the digital token? Who will make sure that the token value stays linked to the gold bars that should be in the safe? Who will bear the risk and how? If the buyer of a token can’t be sure that the token is properly linked to the real-world asset, then the value of the token will fall or even become zero if no one has faith in the correspondence between the two.

ARBITRATION

At present blockchain systems are still dependent upon traditional legal frameworks for this linkage between the digital representation of an asset and the asset itself.

Currently, arbitration is seen as one of the most effective ways of mapping between what is happening on the blockchain and what is happening with the physical asset and the legal systems it might be embedded within. Arbitration is a long since used method for creating legal agreements in international commerce where both parties agree to bind themselves into a legal contract of their making.

An arbitration award is legally binding on both sides and enforceable in the court of choice.

One way of linking legal systems to what is happening on a token network is through what is called a Ricardian Contract. A Ricardian contract places the essential elements of a legal agreement in a format that can be expressed and executed in software. The aim is to make the document both machine-readable and readable as an ordinary text document, such that lawyers and consenting parties may read the essentials of the contract conveniently.

From a legal perspective, the use of markup language embedded within a largely legal prose document leads to reduced transaction costs, faster dispute resolution, enhanced transparency and improved enforceability. From a computing perspective, the Ricardian contract is a software design pattern to digitize documents and have them executed within financial transactions, such as payments, without losing any of the richness of the contracting tradition.

It is robust through use of identification by cryptographic hash function, transparent through use of readable text for legal prose and efficient through markup language to extract essential information.

Mattereum is one such project that tries to use Ricardian contracts to create an effective linkage between records on the blockchain and the established off-chain legally binding dispute resolution of arbitration thus giving what happens on the blockchain full legal weight under natural language contract.

Mattereum is the first, what it calls “Internet of Agreements” infrastructure project for legally-enforceable smart contracts, enabling the sale and lease of physical property and other transfers of rights in assets. Mattereum is billed as a court that understands the nature of cryptocurrencies, making physical property and intellectual property transactable on a blockchain.

In a case where you might buy a physical asset using a fraction of a Bitcoin and the seller does not follow through, it is difficult to explain this to a judge in a small claims court. This is where Mattereum comes in, enabling technically competent arbitrators to make rulings in these cases instead of a judge. As the founder of the project, Vinay Gupta describes it “Mattereum.com is my bid to get the necessary legal frameworks in place to make direct control of physical property using the blockchain recognized in 150+ countries. I want to break the door open to the material world so you can change the status of a smart contract, and have a real-world court recognize that legal ownership of a fiat asset has changed hands. Fiddly, but it’s necessary infrastructure for all of our next steps together.”

TECHNOLOGY

The alternative to depending upon traditional centralized legal institutions is depending on technology. Code may be the law on the blockchain but outside of those networks, Big Data and IoT will be law.

Big Data is going to give us new insight into what happens when and where with high levels of statistical assurance. While at the same time IoT will put code into all of the technology around us that we are now so dependent upon and that is a new form of law enforcement. If you have the code that can stop a car or open a door lock then you control that system and can enforce whatever contract is on the blockchain.

As an illustration, we might think about a blockchain IoT securitization of gold. We create an automated warehouse, people are allocated secure sealed lots within the warehouse. We deposit a stock of gold in one area and when someone purchases a block of gold the system automatically moves it to the owner’s container and the owners gold token account is calculated by summing up the gold in their container. This is a simplified representation of a blockchain cyber-physical system where blockchain records and tokens are linked directly to the underlying asset through automated technology. By an extension of this model whole buildings, cars and other assets could be directly connected to blockchain tokens thus bridging the gap between the virtual token and the physical asset.