1.

 Introduction
This book introduces a new field of economic inquiry. What we call
‘institutional cryptoeconomics’ is the application of the transaction cost
economics of Ronald Coase, James Buchanan, Oliver Williamson, and
Elinor Ostrom to blockchains; the distributed ledger technology first
invented by the pseudonymous Satoshi Nakamoto for the development
of the Bitcoin cryptocurrency. Where cryptoeconomics is the study of the
economics of blockchain consensus mechanisms – a field of game theory
and mechanism design – institutional cryptoeconomics is the study of how
blockchains interact with our existing and future social institutions, from
the nature of contracts, to the shape of the firm, to the structures of global
trade, all the way to the dynamics of capitalism and geopolitics.1
An economic analysis can be called institutional if it studies the social
institutions that coordinate and govern exchange. Adam Smith discov-
ered the function of markets in arranging production and distribution
through incentives.2 Friedrich Hayek uncovered the function of dispersed
information and its relationship to prices.3 Ronald Coase revealed the role
of the firm, pioneering the transaction cost tradition which informs this
book.4 Duncan Black and Anthony Downs conceptualised the role of
democratic government.5 James Buchanan discovered the role of clubs.6
Elinor Ostrom revealed the commons as a mechanism for economic coor-
dination.7 Institutional cryptoeconomics adds another institutional form
to this schema: blockchains. Blockchains are an economic infrastructure,
alongside markets, the firm, governments, clubs, and the commons, for

1  On cryptoeconomics, see Vitalik Buterin, ‘Introduction to cryptoeconomics’, Ethereum

Foundation (2017).
2  Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (University

of Chicago Press, 1976 [1776]).

3  Friedrich A. Hayek, ‘The use of knowledge in society’, American Economic Review 35,

no. 4 (1945).
4  Ronald H. Coase, ‘The problem of social cost’, Journal of Law and Economics 56, no. 4

(1960); Ronald H. Coase, ‘The nature of the firm’, Economica 4, no. 16 (1937).
5  Duncan Black, Theory Committees and Elections (Cambridge University Press, 2011);

Anthony Downs, An Economic Theory of Democracy (Harper, 1957).

6  James M. Buchanan, ‘An economic theory of clubs’, Economica 32, no. 125 (1965).
7  Elinor Ostrom, Governing the Commons: The Evolution of Institutions for Collective

Action (Cambridge University Press, 1990).

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 2 Understanding the blockchain economy

coordination and exchange. They have distinct economic characteristics

that give them the potential to complement, and in some circumstances
directly compete with, this existing suite of institutional choices.
Institutional innovation at this scale is rare. If our analysis is right, dis-
tributed ledgers are an institutional innovation with comparable signifi-
cance to the invention of the joint stock company in the sixteenth century
or the spread of representative democracy in the nineteenth: they are a
new mechanism with which we govern and coordinate economic activity.
The rarity of institutional innovation is one reason that institutional
cryptoeconomics is such an exciting field. Markets, firms, governments,
clubs, and the commons existed long before they were formally identified
and understood by economists. The Smithian division of labour was
mature – his pin factory example has no less than 18 steps – when the
Wealth of Nations was published. Duncan Black and Anthony Downs
were able to understand the economics of government by looking at the
sophisticated party democracies of the developed world. The blockchain
industry is young, just a decade old at the time of writing. Many of the
technologies that make it so interesting are even younger. The consumer-
facing and business back-end applications of distributed ledgers are still
in their experimental phase. The consequences of the joint stock company
took hundreds of years to become evident. Yet through a straightforward
application of new institutional economics to this new class of technolo-
gies, we can make predictions about the long-run future of the economy.8
This book is a contribution to that project – understanding the long-
run implications of a new institution – and a contribution to economic
theory in its own right. Blockchains are a technology of trust; what
The Economist called the ‘trust machine’.9 This book offers an analytic
framework by which we can understand the role of trust and ledgers in
economic coordination. What do we mean by trust? Trust is the belief or
assurance that another party will not exploit our vulnerabilities.10 Oliver
Williamson pointed out that many of our economic, social and political
institutions have evolved in order to safeguard against opportunism – ‘self-
seeking with guile’, as Williamson put it – by providing ex ante or ex post
compensation for the uncertainty that rules will be followed.11
We recast this as the following: economic institutions provide a trust

 8 
Davidson, Filippi, and Potts.
 9 
The Economist, ‘The trust machine’, 31 October 2015.
10 
J.L. Morrow Jr, Mark H. Hansen, and Allison W. Pearson, ‘The cognitive and affective
antecedents of general trust within cooperative organizations’, Journal of Managerial Issues
16, no. 1 (2004). See the discussion in Sinclair Davidson, Mikayla Novak, and Jason Potts,
‘The cost of trust: a pilot study’, Journal of the British Blockchain Association 7 (2018).
11  Oliver E. Williamson, The Economic Institutions of Capitalism (Free Press, 1985).

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 Introduction ­3

layer to govern complex exchange. Blockchains industrialise this trust

layer.12 Proof of work blockchains such as Bitcoin convert energy into
economically valuable trust. Alternative consensus mechanisms convert
economic coordination tools like voting or costly signalling (such as stak-
ing capital) into trust. That trust is provided as an immutable consensus
over shared facts (the blockchain’s distributed ledger) that maps property
and contractual relationships to identities. By building into this shared
ledger self-executing ‘smart contracts’ – better understood as algorithms
that automatically execute transfers of value when preprogrammed condi-
tions have been met – exchange contracts on a blockchain potentially
eliminate ex post opportunistic behaviour by contractual counterparties.
Williamson’s framework allows us to see how human rules and organisa-
tions mitigate against the human constraints of opportunism, bounded
rationality, and asset specificity. Blockchains are mechanical institutions
to mitigate those same constraints.

BLOCKCHAINS AND CRYPTOCURRENCIES

A blockchain is a type of distributed digital database, or ledger, with two

critical properties: decentralisation and immutability. Formally, a distrib-
uted ledger technology is a:

system of electronic records that (1) enables a network of independent

participants to establish a consensus around (2) the authoritative ordering of
cryptographically validated (‘signed’) transactions. These records are made (3)
persistent by replicating the data across multiple nodes, and (4) tamper-evident
by linking them by cryptographic hashes. (5) The shared result of the reconcili-
ation/consensus process – the ‘ledger’ – serves as the authoritative version for
these records.13

Blockchains were invented by pseudonymous Satoshi Nakamoto in

order to power the decentralised digital currency Bitcoin.14 The Bitcoin
White Paper, published in 2008, described the problem this currency

12  Kevin Werbach, The Blockchain and the New Architecture of Trust (MIT Press, 2018);

Melanie Swan et al. (eds), Blockchain Economics: Implications of Distributed Ledgers:

Markets, Communications Networks, and Algorithmic Reality (World Scientific, 2019).
13  Michel Rauchs et al., ‘Distributed ledger technology systems: a conceptual framework’,

SSRN (2018).
14  Rainer Böhme et al., ‘Bitcoin: economics, technology, and governance’, Journal of

Economic Perspectives 29, no. 2 (2015); Joseph Abadi and Markus Brunnermeier, ‘Blockchain
economics’, 2018, https://scholar.princeton.edu/sites/default/files/markus/files/blockchain_pa​
per_v3g.pdf.

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 4 Understanding the blockchain economy

was trying to solve.15 As Satoshi described it, internet commerce relies

on payments systems managed by trusted third parties (that is, financial
intermediaries) to process payments. Digital payments are reversable,
reducing the reliability of the system and raising the possibility of fraud.
Satoshi related the reversibility of electronic payments to the existence of
the trusted third parties: terrestrial financial intermediaries ‘cannot avoid
mediated disputes’, governed as they are by terrestrial law and national
and international legal systems. Bitcoin would be a non-reversible digital
currency ‘based on cryptographic proof instead of trust’.
The idea of a native digital currency was a recurring dream of internet
entrepreneurs and activists in the 1980s and 1990s. There were two distinct,
although not mutually exclusive, goals that inspired the development of
these currencies. First was the idea that the internet needed a native digital
currency to facilitate payments. A digital communications system should
have a digital cash to accompany it, not simply the terrestrial payments
and monetary system bolted onto the internet. The second goal was more
ambitious. A group of ‘crypto-anarchists’ or ‘cypherpunks’ saw the twin
developments of the public internet and the advances in cryptography in
the last two decades in strikingly political terms: a radical shift in politi-
cal and economic power away from big governments and big businesses
towards free citizens. Timothy C. May’s ‘Crypto Anarchist Manifesto’,
first presented in 1988, declared that cryptography ‘will alter completely
the nature of government regulation, the ability to tax and control eco-
nomic interactions, the ability to keep information secret, and will even
alter the nature of trust and reputation’.16 In a subsequent essay, May
explicitly linked cryptography to the goals of the libertarian movement,
writing that ‘it will be easier to form certain types of libertarian societies
in cyberspace than in the real world of nations and physical locations’.17
While their ambitions were broader than digital cash, the centrality of the
monetary system to an exchange economy – alongside libertarian concerns

15  We refer to this as Satoshi’s Bitcoin rather than Nakamoto’s Bitcoin following the

naming convention of the fundamental unit of a bitcoin as a Satoshi, not as a Nakamoto. The
Satoshi identity went silent after 2010. Satoshi’s last post is on the Bitcoin forum is https://
bitcointalk.org/index.php?topic=2228.msg29479#msg29479. Despite much effort by journal-
ists and amateur internet detectives, his, her, or their true identity is still unknown.
16  Timothy C. May, ‘The crypto anarchist manifesto’, 22 November, https://www.activism.

net/cypherpunk/crypto-anarchy.html.
17  Timothy C. May, ‘Libertaria in cyberspace, or cyberspace more hospitable to ideas

of liberty and crypto anarchy’, 1 September, https://www.activism.net/cypherpunk/libertaria.

html. See also Timothy C. May, ‘Thirty years of crypto anarchy’ (paper presented at the
Hackers Congress Paralelní Polis, Prague, 1 October 2017); Timothy C. May. ‘Crypto anarchy
and virtual communities’, Satoshi Nakamoto Institute, https://nakamotoinstitute.org/virtual​
-communities/.

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 Introduction ­5

about central banking – made the development of a digital payments

system a priority.
Accordingly, the 1990s and 2000s saw numerous developments in digital
cash. Prominent early attempts include eCash (launched in 1990 by the
computer scientist David Chaum), PayPal, and e-gold, which exchanged
physical gold for digital assets. These early attempts tended to founder
on their reliance on services provided by existing organisations (such as
banks) or central trusted authorities to provide security and mitigate
against what has come to be known as the ‘double spending problem’. The
double spending problem comes from one of the most attractive features
of the digital world: the ability for users to make infinite copies of a single
digital item (such as a string of text or a file) that is an exact replica of
the original. This characteristic of digital goods has led to the advances in
communication and given us email, file sharing, social media, and digital
archiving, but is a terrible characteristic for money. Infinite copying of a
digital financial asset is, in the fiat currency world, described as counterfeit-
ing. For a digital cash system to function, there needs to be a mechanism
to prevent a single unit of digital money from being copied and spent
twice. Relying on a single source of authority – call it a ‘central bank’ – to
validate that transactions had not been double spent left the entire digital
cash system vulnerable if that authority was to be compromised, or suffer
technical problems, or try to extract monopoly rents.18
Bitcoin solved the double spending problem through an ingenious
distributed consensus mechanism.19 Security against double spending
in Bitcoin is provided by distributed agreement about the validity of
transactions. Bitcoin records all transactions on a shared ledger (held on
thousands of voluntary nodes around the world) which can in principle
be audited by any user of the network. A special class of self-selecting
users, called ‘miners’, listen for new transactions on the network, group
those transactions into blocks and add those blocks to the chain of prior
transactions – hence ‘blockchain’ – each with a digital pointer referring to
the previous block.
While relying heavily on cryptography, the active prevention of double
spending is provided by economic incentives. Miners compete against each
other to be first to produce the next block by solving a computationally

18  A good overview of the state of electronic payments at the turn of the century is

N. Asokan, Phillipe A. Janson, Michael Steiner, and Michael Waidner, ‘The state of the art
in electronic payment systems’, Computer 30, no. 9 (1997). See also Jaap-Henk Hoepman,
‘Distributed double spending prevention’ (paper presented at the International Workshop on
Security Protocols, 2007).
19  John P. Conley, ‘Encryption, Hashing, PPK, and Blockchain: A Simple Introduction’

(working paper, Vanderbilt University, 2017).

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 6 Understanding the blockchain economy

­ ifficult puzzle known as ‘hashcash’, where miners perform a crypto-

d
graphic hash function operation on a combination of data drawn from the
network and random data until a hash with a certain number of leading
zeroes is returned. There is no intrinsic benefit from a hash with many
leading zeroes; the constraint only exists to make producing new blocks
hard. The Bitcoin network increases the difficulty periodically, to keep up
with advances in hashing technology. Miners are rewarded by being able to
place into the next block a new quantity of Bitcoin (currently 12.5 Bitcoin,
although the reward is halved automatically every four years) that they can
send to themselves.
It is that combination of a difficult task and a strong reward that makes
the network secure against double spending; miners are incentivised to
protect and validate network transactions. But that security comes with a
cost: the computational difficulty of the proof of work scheme, combined
with the highly competitive mining industry, means that proof of work
is extremely energy intensive. Estimates vary about the energy costs of
maintaining the Bitcoin ledger, but a 2018 study suggested that the net-
work consumes 2.55 gigawatts of electricity, comparable to the electricity
consumption of Ireland.20
As far as we know Satoshi did not develop any of the constituent
technologies that go into Bitcoin. Public key cryptography dates back to
the 1970s, Bitcoin’s ledger structure (‘the Merkle tree’) was first proposed
in 1980, Hashcash was first proposed in 1997 to prevent email spam, and
arguably the first peer-to-peer network was ARPANET itself, in which
each university research node had equal peer status with each other.21 The
Satoshi innovation – the genius – was combining these technologies in a
way that aligned economic incentives to maximise security even assuming
the network would operate in a low-trust environment. The problem of
achieving consensus in an environment where not all parties can be trusted
is described in the context of blockchains as the Byzantine Generals’
Problem, a problem named in 1982, but which describes the problem
of coming to consensus over information in the presence of faults.22 In
Bitcoin, consensus has to be achieved in in a world of criminals and faulty

20 
Alex de Vries, ‘Bitcoin’s growing energy problem’, Joule 2, no. 5 (2018).
21 
For the academic progenitors of Bitcoin see Arvind Narayanan and Jeremy Clark,
‘Bitcoin’s academic pedigree’, Communications of the ACM 60, no. 12 (2017). For peer-to-
peer networking see A. Oram, Peer-to-Peer: Harnessing the Power of Disruptive Technologies
(O’Reilly Media, 2001).
22  The problem was named in Leslie Lamport, Robert Shostak, and Marshall Pease, ‘The

Byzantine generals problem’, ACM Transactions on Programming Languages and Systems 4,

no. 3 (1982); but more clearly stated in Marshall Pease, Robert Shostak, and Leslie Lamport,
‘Reaching agreement in the presence of faults’, Journal of the ACM 27, no. 2 (1980). Leslie
Lamport traces the original problem to NASA’s work on Software Implemented Fault

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 Introduction ­7

communications infrastructure. But the key to understanding the Bitcoin

network provides an economic, rather than technical solution to the prob-
lem of trust. We have described blockchains as machines that industrialise
trust, but the fuel for those machines is high-powered economic incentives.
This approach allows us to clarify the relationship between blockchains
and cryptocurrencies. The Bitcoin cryptocurrency (what we will refer to as
BTC, to distinguish it from the network) is an essential part of ensuring
that incentives are aligned. Good behaviour by miners is rewarded in
BTC, and all users have high-powered incentives to defend the network to
protect BTC they already hold. But in this sense the cryptocurrency has
an instrumental purpose: to maintain and ensure consensus over a distrib-
uted, decentralised ledger. Cryptocurrencies are artefacts – ‘tokens’ – that
can be traded and valued as money-like assets, and have become an asset
class with some significance for the future of the monetary and payments
system.23 But their function is to ensure consensus over the shared ledger.
In Bitcoin the ledger primarily tracks transactions of the cryptocurrency.
But users can place unrelated data into the blockchain. Nakamoto’s first
transaction on the Bitcoin blockchain included the text ‘The Times 03/
Jan/2009 Chancellor on brink of second bailout for banks’.24 (January
2009 was a fascinating time to create a payments system that did not rely
on existing financial institutions.)
Nakamoto released Bitcoin as open source, and a decade’s worth
of innovation on blockchains and other distributed ledgers has led to
significant innovation. Blockchains have been released with innovation
along almost every margin, such as different cryptocurrencies with dif-
ferent monetary characteristics, how private or anonymous the ledger is,
and the difficulty and speed at which the consensus mechanism operates.
One of the most significant areas of innovation – and one of the most
critical for the future of the blockchain ecosystem – is in the consensus
mechanism itself. The Bitcoin proof of work system is energy intensive and
hard to scale. Alternatives such as proof of stake (where users stake tokens
for the right to validate new blocks), proof of burn (where tokens are
ritualistically destroyed), distributed proof of stake (where token holders
vote on a limited pool of miners) are among the many innovations in this
space. Private or permissioned blockchains, such as the Linux-IBM project

Tolerance for computer-flown aircraft, see Leslie Lamport, ‘My writings’, 20 September,
https://lamport.azurewebsites.net/pubs/pubs.html.
23  Our contribution to this is Chris Berg, Sinclair Davidson, and Jason Potts, ‘Beyond

money: cryptocurrencies, machine-mediated transactions and high frequency bartering’,

SSRN (2018).
24  For an overview of techniques to place data into the Bitcoin blockchain see Andrew Sward,

Ivy Vecna, and Forrest Stonedahl, ‘Data insertion in Bitcoin’s blockchain’, Ledger 3 (2018).

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 8 Understanding the blockchain economy

Hyperledger, control who can validate new blocks and who can access the
ledger. While guaranteeing much faster transaction times, these private
blockchains trade off decentralisation for efficiency, resulting in a hybrid
between traditional shared databases and fully distributed ledgers.
One of the most significant innovations in the blockchain space is the
addition of fully operational scripting languages into the blockchain.
Bitcoin is built around a highly constrained programming language
called Script, which allows developers to impose restrictions (such as
multi-­signature keys) on how individual tokens are spent. But if any
arbitrary data can be placed into the Bitcoin blockchain, why not entire
computer programs? Ethereum, which was released in July 2015, claims
to be fully ‘Turing complete’ programming language, a criteria for general
purpose computing derived from the work of the computer scientist Alan
Turing.25 Ethereum programs execute as written everywhere that the
Ethereum blockchain is stored; the result being distributed, censorship-
proof algorithms that underpin Ethereum’s goal to be a ‘world computer’.
Where Bitcoin was designed with the intention of an un-censorable global
payments system, Ethereum generalises that to all digital algorithms. There
are now a number of blockchains that offer comparably complex program-
ming languages, whether those languages are hosted ‘on-chain’ (such as
NEO and EOS) or ‘off-chain’ (such as NEM).
These features allow for the implementation of what the computer
scientist and legal scholar Nick Szabo first conceptualised in 1994 as
‘smart contracts’. A smart contract, wrote Szabo, is a ‘computerized trans-
action protocol that executes the terms of a contract’.26 Smart contracts
are algorithms with contractual conditions built in, such as automatic
transfers of value when conditions are triggered. Smart contracts are
arguably an ironic misnomer. They execute precisely as written under any
circumstances, even when unanticipated events might mean that all parties
to the contract would rather they did not do so. Once a contract is pub-
lished onto a blockchain, it will execute, even if it has been written poorly
featuring coding bugs. Researchers have found numerous contracts on the
Ethereum blockchain that might lock funds indefinitely or leak funds to
unauthorised users.27 With no central authority to appeal to, contractual
terms are irrevocable even in circumstances of error. But this is a feature,

25  There is some dispute as to whether Ethereum is genuinely Turing complete, given it

is restricted by the amount of Ethereum tokens Ether (ETH) in the network. See Andrew
Miller, ‘Ethereum isn’t Turing complete, and it doesn’t matter anyway’ (Consensys, 2016).
26  Nick Szabo, ‘Smart contracts’, http://www.fon.hum.uva.nl/rob/Courses/Infor​ mationIn​
Speech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart.contracts.html.
27  Ivica Nikolic et al., ‘Finding the greedy, prodigal, and suicidal contracts at scale’, arXiv

preprint arXiv:1802.06038 (2018).

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 Introduction ­9

not a bug. As we shall see, a smart contract self-executes – that is, triggers,
transfers payments, and enforces terms – without the need for any external
agent, such as a court. Smart contracts are one of the central underlying
technologies of the blockchain economy.
Blockchain innovation has been intense since Satoshi published the
Bitcoin White Paper in 2008, and cryptocurrencies are merely the first
use-case for this new technology. While a complete survey of the applica-
tions of blockchain is neither possible or necessary here, blockchains are
being used to manage supply chains in fields as diverse as agriculture
and advanced manufacturing, to coordinate trade finance, for identity,
certification and licence management, banking, registries for land, water
energy, and intellectual property, for medical records, to organise data for
smart cities, and to register legal documents such as wills.28
More ambitious applications exploit the possibilities of smart contracts
to coordinate activity without the need for hierarchy, even human agency.29
Distributed autonomous organisations (DAOs) are organisations built
around smart contracts and a blockchain, controlled in a decentralised
manner by its owners. The Ethereum game CryptoKitties, which allows
users to breed and exchange unique digital cats, represents an entirely new
category of intellectual property.30 Cellarius, also built on the Ethereum
network, is an ambitious attempt to build a collective storytelling plat-
form, where users coordinate around a sci-fi world building and narrative
creation structure. Throughout this book we shall explore some blockchain
applications in depth. But for now, the remarkable breadth of applications
that have already been developed, and the extraordinary diversity of fields
in which blockchains are being trialled and applied, suggests, at a first
instance, that this technology has particular economic properties that
make it institutionally significant.

28  Jason Potts, Ellie Rennie, and Jake Goldenfein, ‘Blockchains and the crypto city’,

it-Information Technology 59, no. 6 (2017); E. Ganne, ‘Can blockchain revolutionise inter-
national trade?’, 2018, https://www.wto.org/english/res_e/booksp_e/blockchainrev18_e.pdf;
Evangelos Benos, Rod Garratt, and Pedro Gurrola-Perez, ‘The economics of distributed
ledger technology for securities settlement’, SSRN (2017); Michael Casey et al., ‘The impact
of blockchain technology on finance: a catalyst for change’, Geneva Report on the World
Economy, no. 21 (2018); Amy Whitaker and Roman Kräussl, ‘Blockchain, fractional owner-
ship, and the future of creative work’, CFS Working Paper Series 594, Center for Financial
Studies (CFS), 2018.
29  Anthony J. Casey and Anthony Niblett, ‘Self-driving contracts’, Journal of Corporation

Law 43 (2017); Richard Holden and Anup Malani, ‘Can blockchain solve the holdup prob-
lem in contracts?’, University of Chicago Coase-Sandor Institute for Law and Economics
Research Paper, 2017; Joshua S. Gans, ‘The fine print in smart contracts’, NBER Working
Paper No. w25443, 2019.
30  Chris Berg, Sinclair Davidson, and Jason Potts, ‘KodakOne could be the start of a new

kind of intellectual property’, Conversation, 12 January 2018.

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 10 Understanding the blockchain economy

SOME METHODOLOGICAL CONSIDERATIONS

Blockchains are an early stage technology. While Bitcoin now has a dec-
ade-long history, many of the blockchain innovations which have led to the
field of institutional cryptoeconomics are only a few years old. Ethereum
was only released in July 2015. The zero knowledge proof privacy coin
Zcash was only released in October 2016. There are many uncertainties
about the future of blockchain development as we write this book. Public
blockchains tend to have low transaction throughput, at least compared
to centralised systems. The proof of work algorithm used by Bitcoin and
many other second and third generation blockchains is highly energy
intensive, and has created many environmental concerns. Alternative
mechanisms that might solve scaling problems and environmental costs –
such as proof of stake, distributed proof of stake, and practical Byzantine
fault tolerance – are in an earlier experimental stage of development.
Even if the technical challenges are worked out, the user experience for
blockchains leaves something to be desired: it is time consuming and tedi-
ous to convert fiat currency into cryptocurrency; key management can be
complex and brings security risks; and there is still a non-trivial amount of
technical knowledge necessary to interact with blockchains.
These limitations are what might be expected from a technology just a
decade old, but it is also possible that there is some as yet undiscovered
limiting condition around a critical blockchain characteristic. For example,
Zooko’s triangle, suggested by the developer of Zcash, Zooko Wilcox-
O’Hearn, suggests that there is a trade-off between three desirable proper-
ties of identities on a network protocol: that they are human-­readable, that
they are secure, and that they are distributed (that is, no central authority
has control over identities). Wilcox-O’Hearn suggested that identity man-
agement systems can only have two of these three properties.31 There is
a chance that researchers or developers will discover constraints around
decentralisation, consensus, availability, and persistency that prevent limit-
ing the potential of blockchain as an economic institution.
Alternatively, it is possible that blockchains might be superseded by new
distributed ledger technologies. Nakamoto’s data structuring technique –
grouping transactions into blocks that include hash pointers to previous
blocks – is unlikely to be the end state of distributed ledger development.
For example, there are a number of distributed ledger protocols built
around directed acyclic graphs (DAGs) which store transactions in nodes
rather than blocks. Richard Goldschmidt described the first consequential

31  Zooko Wilcox-O’Hearn, ‘Names: distributed, secure, human-readable: choose two’,

12 October, https://web.archive.org/web/20011020191610/http://zooko.com/distnames.html.

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 Introduction ­11

evolutionary mutations in biological species as ‘hopeful monsters’, which

Joel Mokyr adapted for the study of technological innovation.32 A hopeful
monster is a macromutation; a large, ugly, surprising leap forward in evolu-
tionary adaptation. And Bitcoin is ugly.33 It is a complex, interlocking set
of cryptographic techniques and economic incentives. It is slow, expensive,
and energy inefficient by design. The need for distributed consensus has
made it hard to modify in order to alter fixed limitations. But it is merely
the first mutation. Its success – and, unsurprisingly, the high exchange rate
between Bitcoin and fiat currency experienced during 2017 – has brought
massive research resources to bear on building better blockchains, and
making Bitcoin more useful.
Nonetheless, throughout this book we use the word ‘blockchain’ near
synonymously with ‘distributed ledgers’. This is for convenience and read-
ability. Our claim is that blockchains are an incredibly successful proof of
concept for distributed ledger technology. Or, more broadly, blockchains
are an instantiation in economics and computer science of a new class of
mechanism to achieve consensus around facts – whether those facts are
who owns what cryptocurrency, or has the right to what water entitlement,
or what part of a science fiction narrative should be considered ‘canon’ –
that does not rely on central authorities, or hierarchies. As social scientists,
we are keenly aware of the economic role of those central authorities in
providing trust, and of the high costs of low-trust societies. Blockchains
reveal to us the role of trust across a new margin. They offer a new way to
provide trust, while reducing some of the costs of trust provision. A smart
contract has embedded within it not only the terms and triggers of the
contract event, but its own means of fulfilment and enforcement. While
the role of a traditional court system – that ex post provider of trust – in
a world of smart contracts is not zero, it is much reduced.34 If a firm pro-
vides a trust layer for economic activity, what does it mean to mechanise
that trust in a DAO?
As this suggests, we conceptualise the methodology of institutional
cryptoeconomics as ‘high-trust economics’. The analogy here is to high-
energy physics, which uses a particle accelerator as a tool for exploring

32  Richard Goldschmidt, ‘Some aspects of evolution’, Science 78, no. 2033 (1933);

Richard Goldschmidt, The Material Basis of Evolution (Yale University Press, 1940); Joel
Mokyr, The Lever of Riches: Technological Creativity and Economic Progress (Oxford
University Press, 1990).
33  Gwern Branwen, ‘Bitcoin is worse is better’, 2 January, https://www.gwern.net/Bit​

coin-is-Worse-is-Better.
34  See Primavera De Filippi and Aaron Wright, Blockchain and the Law: The Rule of Code

(Harvard University Press, 2018); Darcy W.E. Allen, Aaron M. Lane, and Marta Poblet, ‘The
governance of blockchain dispute resolution’, SSRN (2018).

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 12 Understanding the blockchain economy

conditions that are otherwise far removed from the observable, low-energy
world. High-energy physics seeks to understand the fundamental building
blocks of the universe – space, time, matter, and energy – by exaggerating
the conditions of normal existence. A particle accelerator recreates on
Earth conditions that otherwise pertain at the core of a star, or in the very
early universe. High-trust economics offers a similar experimental method.
It allows us to explore conditions in an economy in which trust is maxim-
ised. A high-trust economy is one in which contracts are self-enforcing. To
reveal the fundamental nature of the economy, we do high-trust economics
– we crank up the trust – which permits near perfect promise and trust.
Institutional cryptoeconomics is the study of a new technology and its
implications, but it is also a methodology, based on the exploration of the
nature of a high-trust economy using a tool as both an actual technology
in the world, and as an ideal type, a ‘perfect ledger’.
The difference of course between a particle accelerator and a block-
chain is that blockchains now exist in the real world. We do not have to
construct them as experimental domains, or theorise about their exist-
ence. Blockchains have been brought into the world and now coordinate
economic activity. Much of this book is based on our observation of the
development of this technology over the last decade. But institutional
cryptoeconomics does not actually depend upon the success of blockchain
technologies. It is sufficient for our purpose that blockchains exist as a
concept: a concept of a trustless technology of governance and coordina-
tion, a new technology of trust. The idea of a blockchain is sufficient to
establish institutional cryptoeconomics as a theoretical field. That they
exist – that they are being built, that entrepreneurs, engineers and enthusi-
asts are investing enormous resources into their success – makes the study
of institutional cryptoeconomics urgent.

ABOUT THIS BOOK

This book has two distinct audiences: economists and students of econom-
ics on the one side, and those who work or are interested in the blockchain
industry on the other. We hope that the book will offer the tools that will
allow these two audiences to communicate and share ideas. We proceed,
therefore, as follows. In Chapters 2, 3, and 4 we spell out the basic founda-
tions of institutional cryptoeconomics. Chapter 2 presents a straightfor-
ward analytical framework to understand the properties of blockchains
through Oliver Williamson’s transaction cost framework. Blockchains
reduce opportunism and offer a institutional technology for governing spe-
cific assets. In Chapter 3 we fold out some of the broader consequences of

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 Introduction ­13

this analysis. We describe blockchain technology as a universal institution

that can adopt the properties of the other institutions in the institutional
schema. Chapter 4 provides a close analysis of the role that ledgers play in
coordinating exchange. Ledgers store information about property owner-
ship that allows buyers and sellers to trade. Institutional cryptoeconomics
offers a ledger-centric view of the economy.
Chapters 5 and 6 drill down into what we consider the two major use-
cases for blockchain technology: financial assets and supply chains. We
explore how, despite being apparently prosaic topics, viewing blockchains
through the financial asset and supply chain lenses helps us to conceptu-
alise the full scope of blockchain applications, even in fields seemingly
far removed from finance or logistics. Chapter 5 asks a simple question:
are cryptocurrency tokens money? Regulators and policymakers need
guidance about how to treat new technologies under current law; or some
guide about how to adjust law to suit. Applying the theoretical frameworks
earlier, we work through popular and institutional definitions of money
and conclude that cryptocurrency tokens are ‘dequity’: a theoretical hybrid
of equity and debt that Williamson conceptualised and named more than
three decades ago, but which technological limitations prevented from
being realised. Chapter 6 looks at the use of distributed ledgers for manag-
ing goods and services as they travel through a supply chain. Supply chain
information in this context can be described as the creation of identity
attributes at specific points in time. Framing supply chains in this way
allows us to see a variety of supply chain models in industries as diverse as
the finance sector, the charitable sector, and education credentials. Supply
chains offer a general framework through which we can scrutinise and
assess blockchain use-cases.
Chapters 7, 8 and 9 draw out the implications of this analysis for
the future of the firm, for public policy, and ultimately for political
economy. In Chapter 7 we explore a new mode of corporate organisa-
tion: the V-form organisation, where vertical integration is outsourced
to a distributed ledger. The V-form organisation represents a blockchain
instantiation of the so-called ‘virtual organisation’ that has been discussed
since the 1980s, but has been limited by its need to establish trust between
competing parties. Chapter 8 surveys some of the first-order public policy
consequences of the widespread use of blockchain technology, and how
a ‘crypto-friendly’ government should respond. Chapter 9 broadens
this considerably. We present a model of the demand for regulation
that stems from the political and economic consequences of corporate
hierarchy – those warnings about the implications of capitalism from Karl
Marx and Joseph Schumpeter – that a new, non-hierarchical, consensus
driven technology to manage agreed social facts potentially disrupts. As

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 14 Understanding the blockchain economy

Paul Strassman wrote in 1985, ‘The history of [information technology]

can be characterized as the overestimation of what can be accomplished
immediately and the underestimation of long-term consequences’.35 This
is what transaction cost economics offers us. A set of tools and techniques
to understand how social institutions are shaped, and how when those
transaction costs change, institutions are reshaped, with sometimes
profound consequences.

35  Paul A. Strassmann, Information Payoff: The Transformation of Work in the Electronic

Age (Free Press, 1985), p. 199.

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