The Blockchain and Economic Organization
Jul06
Money & Macro

The Blockchain and Economic Organization

There are two things necessary for regular human exchange: 1) a way to keep track of balances, how much one has contributed versus taken, and 2) a way to prevent people from running consistently negative balances – i.e. to prevent theft and fraud.

Over the course of human history and economic development, accounting technologies have moved progressively more of the accounting out of human heads and into records or tokens such as money. This movement has brought a lot of benefits. The intricate division of labor that characterizes a modern economy would be impossible without the decentralized accounting provided for by the use of money. The drawback, however, is that every step of this process has made the accounts more vulnerable to manipulation. This makes it more and more costly to prevent people from running negative balances, and is a likely reason why state capacity, which centralizes and regularizes the punishment of theft and fraud (among other things), has been so closely associated with economic growth.

Blockchain technology has the potential to address this drawback without moving any more of the accounting back into peoples’ heads. By doing so, it has the potential to vastly increase the intricacy of the division of labor and the scale of human economic organization without a corresponding increase in the institutional cost of punishing thieves and fraudsters, including those within the government itself.

To start at the beginning, hunter-gatherer exchange is time-separated and in-kind. Theft under such organization is necessarily theft of specific items. With accounting kept track of by personal knowledge, there is no way to “forge” the accounts and systematically receive more than one gives.

The introduction of indirect exchange, while making honest exchange much more convenient, also vastly increased the returns to theft: by stealing a cache of the medium of exchange, the thief can induce his none-the-wiser peers to render services of more value than he had rendered himself.

Political control of the medium of exchange, established very early in human history, amplified the problem. While petty theft came to be more or less effectively punished by the new administrative class, that same class’ control of the accounting medium gave it a large (though not infinite) latitude to accumulate resources to itself without resorting to exchange, production, or coercion. Devaluations, inflations, and extortion of financiers have been the norm throughout humanity’s monetized history. It is only with the relatively recent development of credibly restrained political institutions that fiat currencies – which allow the administrative class to manipulate the accounting system much more easily and extensively compared to full-bodied currencies – have become viable.

Each step along the path toward lower-marginal-cost exchange institutions, with accounting taking place more and more outside individual minds, has been accompanied by an increase in the losses due to account manipulation – whether through theft or political influence – and a concomitant increase in the resources spent to mitigate these losses. More than likely the majority of these tradeoffs have been “worth it” in the sense of resulting in a more advanced division of labor. But, on the plausible assumption of a diminishing marginal rate of substitution between convenience and trustworthiness, the most beneficial advances from our already high-convenience vantage point will likely be in the trustworthiness of the accounting system.

The emergence of blockchain technology, for the first time, holds forth the prospect of an increase in the reliability of the accounting system without a diminution in convenience, at least once handheld computers and smartphones are sufficiently ubiquitous. The blockchain, as well as associated technologies like “smart contracts” and decentralized autonomous organizations (DAOs), are all tools that direct and manage the ownership of records1 according to pre-specified rules, written in code and distributed across many different computers on the internet.

Obviously the widespread use of blockchain technology for payments and record-keeping requires a staggeringly intricate division of labor to support the necessary communications infrastructure and mass production of computers, which in turn requires an existing money economy. But because the protocols are administered by no individual or organization, no individual or organization has the capability to reverse transactions, forge accounts, or inflate the money supply unexpectedly. An increase in the reliability of the tokens used to manage the accounting of exchanges also makes possible an increase in the reliance on those tokens. The extension of the money economy, then, sustains advances in the division of labor. By ensuring the trustworthiness of the records and their immunity to manipulation, blockchain technology has the potential to sustain advances in the division of labor far into the future, and far beyond the advances that would be exhausted under an accounting system subject to political manipulation.

Footnotes

  1. Cryptocurrency is the prototypical example, but nonmonetary records can also be managed with the same technology. In this sense the best historical precedent might be the invention of double-entry bookkeeping: a revolutionary development in business organization used predominantly for, but not necessarily limited to, monetary values.

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Hi, I'm C. Harwick, an economics PhD candidate in Virginia with an interest in monetary theory, institutional evolution, and folk music.

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