In this guest post, blockchain theorist Melanie Swan discusses three recent developments in the blockchain economy, using classical economic principles to distinguish between hype and long-term structural change.
The Hard Fork of August 1
The first important recent event in the blockchain economy is the long-anticipated Bitcoin hard fork that happened on August 1, 2017. A hard fork is a change to the software protocol that creates a permanent divergence from the previous version of the blockchain, such that nodes running the old software are no longer accepted by the newer version. The change was for the purpose of improving scalability, the Bitcoin blockchain’s ability to handle larger-size blocks of transactions.
The number of transactions per block swelled from 400 in 2014 to 2,000 at the beginning of 2017, so developers had plenty of advance warning to work out a solution for greater scalability. The hard fork is an example of decentralized democracy in action in that participants registered their preference regarding one of two methods for addressing the scalability challenge. The majority of the constituencies (developers, miners, exchanges, wallet companies and merchants) elected the hard fork to one of the new protocols (SegWit2x), while the other group split to a new Bitcoin blockchain, Bitcoin Cash, which supports another protocol.
It was almost possible to see Adam Smith’s invisible hand operating in real-time as transactions amassed and the first block was recorded on the new Bitcoin Cash blockchain six hours after the split. It comprised of 6,985 transactions in a block size of 1.9 MB, indeed almost two times the previous block size, thus demonstrating greater scalability.
The economic theory upshot of the Bitcoin hard fork is that it is a demonstration of competitive markets proceeding in an orderly and efficient fashion, offering choices to participants, who coordinated themselves between the two options.
Developments in Regulation: The SEC
A second recent event in the blockchain economy is in regard to regulation. On July 25, 2017, in the U.S., the SEC (Securities and Exchange Commission) ruled that ICOs (initial coin offerings, also known as token sales), unlike crowdfundings, in certain cases, may count as securities and therefore would be subject to securities registration laws (both the offerings and any exchange coordinating their purchase and sale).
An initial coin offering is similar to an IPO but is an investment directly in a company project, in exchange for cryptocurrency coins or tokens, which provide greater liquidity to both investors and companies. It is complicated because the SEC may use the Howey test, a long-standing mechanism, to determine whether a particular instrument is a security or not, in their analysis of ICOs.
It could be that ICOs are split into two categories: those that are regulated (i.e., subject to securities laws) and those that are unregulated (i.e., exempt from registration).
Unregulated offerings may pertain to “utility coins” as in the case of storage cryptocurrencies (such as Siacoin [SC] and Storj [STORJ]). These projects may be categorized as internet network public goods creation, where tokens are related to network operation but not profit-garnering.
Regulated offerings concern investments that are more like the traditional idea of stock, where shareholders have an expectation of profit and a say in corporate governance. ICOs in the latter form would need to comply with securities registration laws.
The economic theory implication is that involved parties are sorting out the definitions and treatment of new kinds of entities in the blockchain economy using established precedents. Above all, knowing the regulatory stance of governments can help to stabilize the market. The SEC acted in the wake of what some call an “ICO dotcom bubble,” in which some firms raised millions of dollars within minutes for their crypto-projects.
The result is that the investment market for cryptocurrencies is becoming distinctly more institutional. One indication is the SEC’s move to regulate ICOs. Another is the decision of the U.S. CFTC (Commodity Futures Trading Commission) in July 2017 to grant approval for cryptocurrency derivatives to be launched by LedgerX on the CBOE (the largest U.S. options exchange). This is important because derivatives markets are already connected to the vast global institutional trading ecosystem, and thus cryptocurrency derivatives might be a more accessible and liquid means of trading and investing in cryptocurrencies than the underlying cryptocurrencies themselves. A third indication is “Project Omni’s” announcement in August 2017 that it will be building a platform for trading large-size positions (i.e., $20 million and up) for the institutional market.
Many Sectors of the Economy Go Crypto
A third important recent development is the awareness that the blockchain economy is a system in which businesses create private currencies that compete for customer acceptance in the marketplace.
Economists from Friedrich Hayek to Paul Krugman have envisioned and heralded this development. The word “private” has different meanings in the blockchain economy. Here, “private” is meant in the sense of being offered by companies in the private sector as opposed to governments in the public sector. Traditionally, governments have had a monopoly on offering currencies, but blockchain technology is changing that.
The other meaning of “private” in the blockchain economy is that there are public chains where anyone may participate, like Bitcoin and Ethereum, and private or “closed” chains where users must be approved, such as the closed banking chains envisioned for securities clearing.
The closed banking chains (like those of the consortia R3 in U.S./Europe and NEM in Japan) would be a shared ledger for an industry group that wants to clear transactions among themselves.
While Hayek only saw private currencies for financial institutions (i.e., there would be a ChaseCoin, a CitiCoin, etc.), cryptocurrencies are emerging for many kinds of businesses across all sectors of the economy. A notable example is decentralized storage (private online cloud storage), where consumers may choose between Sia (SC), Storj (STORJ) and MaidSafe (MAID).
The CoinMarketCap listing starts to read not only as a directory of money-like cryptocurrencies, but closer to what might be Hayek’s wildest dream: a listing of a new-world economic order.
There are businesses in storage, news (Steem [STEEM] and Yours), healthcare (Factom [FCT]), financial services (NEM [XEM]), the Internet of Things (IOTA [IOTA]), blockchain as a service (BaaS) technology platforms (Stratis [STRAT]), fundraising platforms (Waves [WAVES]) and interbank transfer (Ripple [XRP]). Business cryptocurrencies are mixed in with cryptocurrency cash systems (e.g., Bitcoin, Ethereum, Litecoin, Dash and Zcash). CoinMarketCap is a listing of the rich panoply of the economy itself.
Recent blockchain economy events — the Bitcoin hard fork, the SEC ruling about ICOs and a growing awareness that blockchains are popping up in many sectors of the economy — suggest that economic principles might be a helpful tool for distinguishing hype from structural change in that these three developments appear to be significant and enduring.