How Crypto Can Transform the Economy and Government

How can crypto and blockchain technology completely upend our economy and politics? If we wanted to visualize all the political ideologies up to the present moment — from Anarcho-capitalism to communism and everything in between, including democratic socialism, mixed economy, laissez faire capitalism, and so on — and how they relate to the economy, how would we do it? Perhaps the most salient representation would be a Venn diagram with one circle representing the market economy and another circle representing what people want. The area of the diagram where the market circle overlaps the circle representing what people want is the area where the market works. The non-overlapping part of the market circle represents the market’s negative externalities, while the non-overlapping part of the circle represents what people want is the area where the market cannot produce what people need.

So now we have one area where the market works and two areas where we either have negative externalities or a market failure — the market’s dual problem. This is usually where government comes in. The role of the government in the economy is to address those two parts of the economy where the market has no solution. Government needs to allocate funding and ensure people are fairly compensated by industry for negative externalities.

The Market’s Dual Problem (greater government involvement pov)

The main difference between all the different political systems therefore is how much overlap they see between the market circle and the ‘people’s wants’ circle. If we locate all the different political ideologies on a line with anarcho-capitalism at one end and communism at the other, we’d see that the closer we move toward anarcho-capitalism the more the political ideology views the ‘circles’ as overlapping, while the more we move toward the other extreme the more the political ideology views the circles as non-overlapping.

Anarcho-capitalists see the market circle and the ‘what people want’ circle as nearly or completely overlapping, and that government only distorts the market. Communists, on the other hand, see these circles as nearly or completely non-overlapping. They believe that the market itself distorts what people want and that workers need to directly govern the means of production (and later there will be no need to govern production at all). All other political ideologies in between argue about the extent of government involvement in the market, as well as how democratic or autocratic such involvement should be. Laissez-faire capitalists and neoliberals believe in very little government involvement, while socialists believe in heavy government involvement.

Of course, government has its own set of problems, both internally and in relation to the market; the bureaucratic process tends to be inherently inefficient and wasteful. Depending on how government is structured, and whether it has effective institutions to maintain a balance of power, it may lack legitimacy from the people, which would in turn affect people’s confidence in how government funding is allocated or how fairly industry is regulated.

Elected officials also have perverse incentives to distribute funding in ways that favor their allies and supporters or benefit their near-term reelection prospects (instead of considering what would be most beneficial for the people in the long term). For that reason, government may not be impartial when it needs to regulate cases of negative externalities in the market. Conversely, the more money and power businesses have in the economy the more influence they may exert on policymakers. It is also evident that the more involvement government has in the market — both in regulating negative externalities and in allocating funds — the more its perverse incentives are amplified.

Finally, governments are fragile institutions. The balance of power may be disrupted by charismatic leaders but even more so by technological advances. Consider for instance the effects of social media and how it can amplify extreme views or distort people’s sensemaking ability. Artificial intelligence, in the hands of powerful interest groups, can take that to the next level. What would happen if at some point social media becomes dominated by swarms of AI bots who are indistinguishable from real users? These AI bots could easily and completely distort people’s sense of which views are ‘normal’ or ‘mainstream’ and which are ‘fringe,’ which in turn would subvert any meaningful public debate on government policy, and likewise subvert the decisions of policymakers. Such technology could undermine the democratic process entirely. Similarly, technological change does not have to affect democratic processes directly. Massive job automation, great recessions, or other major disruptions in the economy can affect people’s belief in the ability of the government to address people’s basic needs, and consequently lead to political instability and violent conflicts.

Now imagine we could replace much of the government’s role in funding allocation with a system that is not subject to perverse incentives, that does not need multiple layers of bureaucracy, and that has strong anti-fragile properties. A system that is transparent, cannot be manipulated by powerful or wealthy interests, is directly governed, meritocratically, by the people, and whose incentive structure is built around promoting the public interest. Since the system cannot be manipulated by powerful interests, it can both allocate funding and credibly regulate negative externalities in the market. This means that, no matter where you place yourself on the political-economic spectrum we described earlier, this system will be able to offer a more effective solution to the market’s dual problem than any form of government.

The reason this system will be able to have all these — seemingly fantastical — properties is that, at its core, it will not be based on human whims, but on mathematics, robust incentive structures, and blockchain technology.

It is certainly a challenge to explain an entire decentralized economic system in a few sentences. You’re therefore welcome to read the whitepaper that describes the system at length. In a nutshell, the system works as follows: consider Bitcoin’s and Ethereum’s consensus mechanisms. Though their design is quite different — one is based on Proof-of-Work while the other on Proof-of-Stake — they are both based on pre-programmed coin issuance for providing a public good: securing the blockchain network. These protocols already issued rewards worth hundreds of billions of dollars!

The protocol we are introducing is a Proof-of-Impact consensus mechanism. Instead of issuing a predetermined amount of coins for network security, this protocol issues coins for generalized public goods, based on the economic impact of the public good. Meaning that public goods with greater realized impact on the ecosystem will receive more funding than those with less economic impact.

But how do we make sure that coins are issued equitably? Since coin issuance dilutes the value of the currency, everyone in the ecosystem has an incentive to make sure that public goods are not overcompensated. At the same time, contributors would not want to create public goods for an ecosystem that undervalues public goods. This creates a game-theoretic equilibrium value at which the amount of funds issued is exactly equal to the economic impact of the public good — any deviation from that value results in the currency losing value (due to either participants or contributors selling their coins). Since the public good adds economic value to the ecosystem, while coin issuance dilutes the value of the currency, these act as a counterbalance to maintain the value of the currency, thus creating a value-preserving coin inflation mechanism.

Since Proof-of-Impact is a consensus mechanism, the entire network has to agree that the fund issuance process for any public good truly reflects the economic impact of the public good, and that the process was not manipulated by bad actors or users colluding to get preferential treatment. For that reason there are multiple layers of security in place to ensure the process is credible; validators are selected at random to review the impact of public goods (to reduce the chance of users colluding or bribing validators). Reviews are weighted based on validators’ domain-specific expertise level (expertise is attained through contributing or reviewing public goods projects) — this makes the process meritocratic and exceedingly difficult to “buy votes.” Following the ‘expert review’ validators are randomly selected from the entire ecosystem to determine the overall impact of the public good (weighted by general expertise). The whole validation process is then subject to challenges from the entire ecosystem, with validators having to lock a portion of their funds for the duration of the challenge period — thus making fraud or sybil attacks on the validation process exceedingly costly. Only after the entire validation process and challenge period are finished can funds be issued to the public goods project.

This demonstrates the ability of blockchain technology to credibly fund any project without the need for a centralized authority (and without the need for taxation, for that matter). Similarly, since the system is based on meritocratic governance, it is capable of establishing impartial rules for negative externalities in the market — rules that cannot be manipulated by powerful or wealthy interests, since only merit — not money — can shape decisions in the system. The system solves the market’s dual problem while eliminating the need for government in the process.

For a thorough explanation of the Proof-of-Impact consensus mechanism please see the Abundance Protocol’s whitepaper here.