The Blockchain Economy: A Beginner’s Guide To Institutional Cryptoeconomics

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Sep 26 · 14 min read

The Blockchain Economy: A beginner’s
guide to institutional cryptoeconomics
Chris Berg, Sinclair Davidson and Jason Potts are from the RMIT
Blockchain Innovation Hub, the world’s Crst social science research centre
into the economics, politics, sociology, and law of blockchain technology.

. . .
The blockchain is a digital, decentralised, distributed ledger.
Most explanations for the importance of the blockchain start with Bitcoin and the history of money. But money is just the ?rst use case of the
blockchain. And it is unlikely to be the most important.
It might seem strange that a ledger — a dull and practical document associated mainly with accounting — would be described as a revolutionary
technology. But the blockchain matters because ledgers matter.

Ledgers all the way down
Ledgers are everywhere. Ledgers do more than just record accounting
transactions. A ledger consists simply of data structured by rules. Any
time we need a consensus about facts, we use a ledger. Ledgers record
the facts underpinning the modern economy.
Ledgers con0rm ownership. Property title registers map who owns
what and whether their land is subject to any caveats or encumbrances.
Hernando de Soto has documented how the poor suHer when they own
property that has not been con?rmed in a ledger. The ?rm is a ledger, as
a network of ownership, employment and production relationships with
a single purpose. A club is a ledger, structuring who bene?ts and who
does not.
Ledgers con0rm identity. Businesses have identities recorded on government ledgers to track their existence and their status under tax law.

The register of Births Deaths and Marriages records the existence of individuals at key moments, and uses that information to con?rm identities
when those individuals are interacting with the world.
Ledgers con0rm status. Citizenship is a ledger, recording who has the
rights and is subject to obligations due to national membership. The electoral roll is a ledger, allowing (and, in Australia, obliging) those who are
on that roll a vote. Employment is a ledger, giving those employed a contractual claim on payment in return for work.
Ledgers con0rm authority. Ledgers identify who can validly sit in parliament, who can access what bank account, who can work with children, who can enter restricted areas.
At their most fundamental level, ledgers map economic and social
Agreement about the facts and when they change — that is, a consensus
about what is in the ledger, and a trust that the ledger is accurate — is
one of the fundamental bases of market capitalism.

Ownership, possession, and ledgers
Let’s make a distinction here that is crucial but easy to miss: between
ownership and possession.
Take passports. Each country asserts the right to control who crosses its
borders, and each country maintains a ledger of which of its citizens
have the right to travel. A passport is a physical item — call it a token —
that refers back to this ledger.
In the pre-digital world, possession indicated ownership of that right.
The Australian passport ledger consisted of index cards held in by the
government of each state. Border agents presented with a passport could
surmise that the traveller who held it was listed on a distant ledger as allowed to travel. Of course this left border control highly exposed to

A Belgian passport held by the Australian National Archives, A435
Possession implies ownership, but possession is not ownership. Now
modern passports allow the authorities to con?rm ownership directly.
Their digital features allow airlines and immigration authorities to query
the national passport database and determine that a passenger is free to
Passports are a relatively straightforward example of this distinction. But
as Bitcoin has shown: money is a ledger, too.
Possession of a banknote token indicates ownership. In the nineteenth
century the possessor — ‘bearer’ — of a banknote had a right to draw on
the issuing bank the value of the note. These banknotes were direct liabilities for the issuing bank, and were recorded on the banks’ ledger. A
regime of possession indicating ownership meant that banknotes were
susceptible to be both stolen and forged.
In our era ?at currencies a ?ve dollar bill cannot be returned to the central bank for gold. But the relationship remains — the value of the bill is
dependent on a social consensus about the stability of the currency and
government that issued it. Banknotes are not wealth, as Zimbabweans
and Yugoslavians and Weimar Republic Germans have unfortunately

learned. A bill is a call on a relationship in a (now synthetic) ledger and if
that relationship collapses, so does the value of the bill.

The evolution of the ledger
For all its importance, ledger technology has been mostly unchanged …
until now.
Ledgers appear at the dawn of written communication. Ledgers and
writing developed simultaneously in the Ancient Near East to record
production, trade, and debt. Clay tablets baked with cuneiform script detailed units of rations, taxes, workers and so forth. The ?rst international
‘community’ was arranged through a structured network of alliances that
functioned a lot like a distributed ledger.

A fragment of a late Babylonian cuneiform ledger, held by the British Museum, 58278
The ?rst major change to ledgers appeared in the fourteenth century
with the invention of double entry bookkeeping. By recording both
debits and credits, double entry bookkeeping conserved data across multiple (distributed) ledgers, and allowed for the reconciliation of information between ledgers.

The nineteenth century saw the next advance in ledger technology with
the rise of large corporate ?rms and large bureaucracies. These centralised ledgers enabled dramatic increases in organisational size and
scope, but relied entirely on trust in the centralised institutions.
In the late twentieth century ledgers moved from analog to digital
ledgers. For example, in the 1970s the Australian passport ledger was
digitised and centralised. A database allows for more complex distribution, calculation, analysis and tracking. A database is computable and
But a database still relies on trust; a digitised ledger is only as reliable as
the organisation that maintains it (and the individuals they employ). It is
this problem that the blockchain solves. The blockchain is a distributed
ledgers that does not rely on a trusted central authority to maintain and
validate the ledger.

Blockchain and the economic institutions
of capitalism
The economic structure of modern capitalism has evolved in order service these ledgers.
Oliver Williamson, the 2009 Nobel laureate in economics, argued that
people produce and exchange in markets, ?rms, or governments depending on the relative transactions costs of each institution. Williamson’s
transactions cost approach provides a key to understanding what institutions manage ledgers and why.
Governments maintain ledgers of authority, privilege, responsibility and
access. Governments are the trusted entity that keeps databases of citizenship and the right to travel, taxation obligations, social security entitlements, and property ownership. Where a ledger requires coercion in
order to be enforced, the government is required.
Firms also maintain ledgers: proprietary ledgers of employment and responsibility, of the ownership and deployment of physical and human
capital, of suppliers and customers, of intellectual property and corporate privilege. A ?rm is often described as a ‘nexus of contracts’. But the
value of the ?rm comes from the way that nexus is ordered and structured — the ?rm is in fact a ledger of contracts and capital.

Firms and governments can use blockchains to make their work
more e?cient and reliable. Multinational ?rms and networks of ?rms
need to reconcile transactions on a global basis and blockchains can allow them to do so near-instantaneously. Governments can use the immutability of the blockchain to guarantee that property titles and
identity records are accurate and untampered. Well-designed permissioning rules on blockchain applications can give citizens and consumers
more control over their data.
But blockchains also compete against 0rms and governments. The
blockchain is an institutional technology. It is a new way to maintain a
ledger — that is, coordinate economic activity — distinct from ?rms and

The new economic institutions of capitalism
Blockchains can be used by ?rms, but they can also replace ?rms. A
ledger of contracts and capital can now be decentralised and distributed
in a way they could not before. Ledgers of identity, permission, privilege
and entitlement can be maintained and enforced without the need for
government backing.

Institutional cryptoeconomics
This is what institutional cryptoeconomics studies: the institutional consequences of cryptographically secure and trustless ledgers.
Classical and neoclassical economists understand the purpose of economics as studying the production and distribution of scarce resources,
and the factors which underpinned that production and distribution.
Institutional economics understands the economy as made of rules.
Rules (like laws, languages, property rights, regulations, social norms,
and ideologies) allow dispersed and opportunistic people to coordinate

their activity together. Rules facilitate exchange — economic exchange
but also social and political exchange as well.
What has come to be called cryptoeconomics focuses on the economic
principles and theory underpinning the blockchain and alternative
blockchain implementations. It looks at game theory and incentive design as they relate to blockchain mechanism design.
By contrast, institutional cryptoeconomics looks at the institutional
economics of the blockchain and cryptoeconomy. Like its close cousin
institutional economics, the economy is a system to coordinate exchange. But rather than looking at rules, institutional cryptoeconomics
focuses on ledgers: data structured by rules.
Institutional cryptoeconomics is interested in the rules that govern
ledgers, the social, political, and economic institutions that have developed to service those ledgers, and how the invention of the blockchain
changes the patterns of ledgers throughout society.

The economic consequences of the
Institutional cryptoeconomics gives us the tools to understand what is
happening in the blockchain revolution — and what we can’t predict.
Blockchains are an experimental technology. Where the blockchain can
be used is an entrepreneurial question. Some ledgers will move onto the
blockchain. Some entrepreneurs will try to move ledgers onto the
blockchain and fail. Not everything is a blockchain use case. We probably
haven’t yet seen the blockchain killer app yet. Nor can we predict what
the combination of ledgers, cryptography, peer to peer networking will
throw up in the future.
This process is going to be extremely disruptive. The global economy
faces (what we expect will be) a lengthy period of uncertainty about how
the facts that underpin it will be restructured, dismantled, and
The best uses of the blockchain have to be ‘discovered’. Then they have to
be implemented in a real world political and economic system that has

deep, established institutions that already service ledgers. That second
part will not be cost free.
Ledgers are so pervasive — and the possible applications of the
blockchain so all-encompassing — that some of the most fundamental
principles governing our society are up for grabs.

Institutional creative destruction
We’ve been through revolutions like this before.
It is common to compare the invention of Bitcoin and the blockchain
with the internet. The blockchain is Internet 2.0 — or Internet 4.0. The
internet is a powerful tool that has revolutionised the way we interact
and do business. But if anything the comparison undersells the
blockchain. The internet has allowed us to communicate and exchange
better — more quickly, more ecciently.
But the blockchain allows us to exchange diSerently. A better metaphor
for the blockchain is the invention of mechanical time.
Before mechanical time, human activity was temporally regulated by nature: the crow of the rooster in the morning, the slow descent into darkness at night. As the economic historian Douglas W. Allen argues, the
problem was variability: “there was simply too much variance in the
measurement of time … to have a useful meaning in many daily

The 12th century Jayrun Water Clock
“The eHect of the reduction in the variance of time measurement was felt
everywhere”, Allen writes. Mechanical time opened up entirely new
categories of economic organisation that had until then been not
just impossible, but unimaginable. 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. Both employers and employees could look at a standard, independent instrument to verify that a contract had been performed.

Complete and incomplete smart contracts
Oliver Williamson and Ronald Coase (who was also an economics Nobel
prize winner, in 1991) put contracts at the heart of economic and business organisation. Contracts are at the centre of institutional cryptoeconomics. It is here that blockchains have the most revolutionary
Smart contracts on the blockchain allows for contractual agreements to
be automatically, autonomously, and securely executed. Smart contracts
can eliminate an entire class of work that currently maintains, enforces
and con?rms that contracts are executed — accountants, auditors,
lawyers, and indeed much of the legal system.
But the smart contracts are limited by what can be speci?ed in the algorithm. Economists have focused on the distinction between complete and
incomplete contracts.
A complete contract speci?es what is to occur under every possible contingency. An incomplete contract allows the terms of the contract to be
renegotiated in the case of unexpected events. Incomplete contracts provide one explanation for why some exchanges take place in ?rms, and
why others take place in markets, and provides a further guide to questions surrounding vertical integration and the size of the ?rm.
Complete contracts are impossible to execute, while incomplete contracts
are expensive. The blockchain, though smart contracts, lowers the information costs and transactions costs associated with many incomplete

contracts and so expands the scale and scope of economic activity that
can be undertaken. It allows markets to operate where before only large
?rms could operate, and it allows business and markets to operate where
before only government could operate.
The precise details of how and when this will occur is a challenge and a
problem for entrepreneurs to resolve. Currently, oracles provide a link
between the algorithmic world of the blockchain and the real world,
trusted entities that convert information into data that can be processed
by a smart contract.
The real gains to be made in the blockchain revolution, we suggest, are
in developing better and more powerful oracles — converting incomplete
contracts to contracts that are succiently complete to be written algorithmically and executed on the blockchain.
The merchant revolution of the middle ages was made possible by the
development of merchant courts — eHectively trusted oracles — that allowed traders to enforce agreements privately. For blockchain, that revolution seems yet to come.

Whither government?
The blockchain economy puts pressure on government processes in a
whole host of ways, from taxation, to regulation, to service delivery.
Investigating these changes is an ongoing project of ours. But consider,
for instance, how we regulate banks.
Prudential controls have evolved to ensure the safety and soundness of
?nancial institutions that interact with the public. Typically these controls (for example, liquidity and capital requirements) have been justi?ed by the fact that depositors and shareholders are unable to observe
the bank’s ledger. The depositors and shareholders are unable to discipline the ?rm and its management.
Bank runs occur when depositors discover (or simply imagine) that their
bank might not be able to cover their deposits, and they rush to withdraw their money.

The bank run in Mary Poppins (1964)
One possible application of the blockchain would allow depositors and
shareholders to continuously monitor the bank’s reserves and lendings,
substantially eliminating the information asymmetries between them
and the bank management.
In this world, market discipline would be possible. Public trust in the immutability of the blockchain would ensure no false bank runs occurred.
The role of the regulator might be limited to certifying the blockchain
was correctly and securely structured.
A more far reaching application would be a cryptobank — an autonomous blockchain application that borrows short and lends long, perhaps matching borrowers with lenders directly. A cryptobank structured
algorithmically by smart contracts would have the same transparency
properties as the bank with a public blockchain ledger but with other
features that might completely neglect the need for regulators. For example, a cryptobank could be self-liquidating. At the moment the cryptobank began trading while insolvent, the underlying assets would be
automatically disbursed to shareholders and depositors.
It is unclear what regulatory role government should have in this world.
Tyler Cowen and Alex Tabarrok have argued that much government regulation appears to be designed to resolve asymmetric information problems — problems that, in a world of information ubiquity, often do not
exist any more. Blockchain applications signi?cantly increase this infor-

mation ubiquity, and make that information more transparent, permanent, and accessible.
Blockchains have their uses in what is being called ‘regtech’ — the application of technology to the traditional regulatory functions of auditing,
compliance, and market surveillance. And we ought not to dismiss the
possibility that there will be new economic problems that demand new
consumer protections or market controls in the blockchain world.
Nevertheless, the restructuring and recreation of basic economic forms
like banks will put pressure not just on how regulation is enforced, but
what the regulation should do.

Whither Big Business?
The implications for big business are likely to be just as profound. Business size is often driven by the need to cover the costs of business hierarchy — in turn due to incomplete contracts and technological necessity of
large scale ?nancial investment. That business model has meant that
shareholder capitalism is the dominant form of business organisation.
The ability to write more complete contracts on the blockchain means
that entrepreneurs and innovators will be able to maintain ownership
and control of their human capital and pro?t at the same time. The
nexus between operating a successful business and access to ?nancial
capital has been weakening over time, but now might even be broken.
The age of human capitalism is dawning.
Entrepreneurs will be able to write a valuable app and release it into the
“wild” ready to be employed by anyone and everyone who needs that
functionality. The entrepreneur in turn simply observe micro-payments
accumulating in their wallet. A designer could release their design into
the “wild” and ?nal consumers could download that design to their 3D
printer and have the product almost immediately. This business model
could see more (localised) manufacturing occur in Australia than at
The ability of consumers to interact directly with producers or designers
will limit the role that middlemen play in the economy. Logistics ?rms,
however, will continue to prosper, but the advent of driverless transportation will see disruption to industry too.

Bear in mind, any disruption of business will also disrupt the company
tax base. It may become di?cult for government to tax business at
all — so we might see greater pressure on sales (consumption) taxes and
even poll taxes.

The blockchain and associated technological changes will massively disrupt current economic conditions. The industrial revolution ushered in a
world where business models were predicated on hierarchy and ?nancial
capitalism. The blockchain revolution will see an economy dominated by
human capitalism and greater individual autonomy.
How that unfolds is unclear at present. Entrepreneurs and innovators
will resolve uncertainty, as always, through a process of trial and error.
No doubt great fortunes will be made and lost before we know exactly
how this disruption will unfold.
Our contribution is that we have a clear understanding of a model that
can be deployed to provide clarity to the disruption as and when it


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