The Blockchain and Increasing Cooperative Efficacy.

• Author: Nair, Malavika
• Position: Essay

Bitcoin is a cryptocurrency based on open-source software created by the pseudonymous Satoshi Nakamoto in 2009. The Bitcoin currency has attracted considerable attention, first among computer scientists and later among businesspeople and the general public. It is being accepted by an increasing number of merchants worldwide; the current market price of Bitcoins is now widely available; and thousands of people worldwide used more than 1.46 terawatt hours of electricity in Bitcoin mining in 2015. Economists have noted the potential for Bitcoin or perhaps a rival cryptocurrency to supplement or even displace fiat currencies. Regulators and policy makers have taken note as well, sometimes responding with regulations not well informed by the realities of Bitcoin (Brito and Castillo 2016).

The Bitcoin payment system is based on the blockchain, a permanent record of all transactions maintained on users' computers. The blockchain is a distributed ledger that not only allows the Bitcoin payment system to operate but also opens possibilities for new forms of contracting and cooperation. Tech writers, bloggers, private corporations, government organizations, and economists have begun to notice the economic implications of the blockchain, recognizing that it may far exceed that of Bitcoin itself. As Melanie Swan points out,

More important, blockchain technology could become the seamless embedded economic layer the Web has never had, serving as the technological underlay for payments, decentralized exchange, token earning and spending, digital asset invocation and transfer, and smart contract issuance and execution. Bitcoin and blockchain technology, as a mode of decentralization, could be the next major disruptive technology and worldwide computing paradigm (following the mainframe, PC, Internet, and social networking/ mobile phones), with the potential for reconfiguring all human activity as pervasively as did the Web. (2015, vii) In this paper, we offer a framework for evaluating and integrating the various different consequences and impacts of the blockchain for the economy. We apply the public-goods argument for government and a comparative institutional approach to assess the government's and the voluntary sector's ability to produce different individual public goods. The public-goods argument holds that government provision (via taxes and regulation) will be frequently chosen given the limitations of voluntary provision--namely, the free-rider problem. In a comparative institutional framework, however, the imperfections of government must be compared against the effectiveness of voluntary mechanisms. People's willingness to contribute voluntarily to public goods and various mechanisms' ability to convert willingness into effective provision have been labeled "cooperative efficacy" (Cowen and Sutter 1999).

We interpret the blockchain as a technological innovation that has the potential to increase cooperative efficacy significantly and consequently to reduce the size and scope of government. Toward this end, we provide examples of already existing and potential applications of the blockchain that illustrate cases of increasing voluntary cooperation outside of government-provided public goods. Specifically, we identify three mechanisms stemming from technological properties of the blockchain that help create trust between potential trading partners by replacing the need for a third-party watcher or enforcer of rules: a publicly verifiable ledger, open entry, and decentralization of power through a widely distributed mining network as well as the open-source nature of the underlying code. The blockchain thus allows the creation of trust without the need for a concrete third-party watcher who has vested authority and impartiality that the potential traders must trust.

We do not discuss the factors affecting whether the scope of governments will actually expand or contract. Blockchain innovations will reduce the need for government to provide certain public goods or types of regulation on behalf of citizens, but this does not mean that the scope of government will immediately shrink. Entrenched interests benefiting from government provision or the regulatory status quo could conceivably block privatization or deregulation regardless of the blockchain's potential. The blockchain does, however, offer significant potential for de facto or unauthorized privatization of current government activities, as perhaps best illustrated by the potential for Bitcoin or another cryptocurrency to serve as a medium of exchange without government permission. Thus, the blockchain and its applications could also bring about significant disruption of the status quo despite entrenched interests' efforts. We focus, however, primarily on their tremendous potential for voluntary society.

The first section provides a summary of the existing public-goods argument. It is followed by a brief explanation of the blockchain. In the third section, we describe current as well as potential examples of the blockchain in uses that illustrate increasing cooperative efficacy. We close by considering potential problems in the fourth section and then drawing broader conclusions.

Cooperative Efficacy and the Public-Goods Argument

The public-goods argument for government recognizes that many of the core functions of maintaining civilized society, such as enforcing property rights, adjudicating disputes, and protecting against criminals and foreign invaders, have the characteristics of a public good--namely, nonrivalry and nonexcludability. Apprehension and punishment of criminals benefit all citizens in the community, regardless of whether they contribute to law enforcement. Sufficient institutional protection of property to enable people to trade with one another, invest in capital goods, or conserve durable assets and natural resources can lead to spillover prosperity. Voluntary efforts at providing public goods typically fail to provide the efficient level due to free riding, suggesting the use of coercion to increase the supply. The fact that people generally benefit from these goods suggests that the value of coercion can be justified on a consequentialist basis (Taylor 1987; Schmidtz 1991).

Beyond the fundamental functions of government, citizens may choose to have the government supply other goods and services with public-good characteristics, following the distinction between the productive state and the protective state (Buchanan 1975). A citizen evaluating the provision of public goods from a consequentialist perspective may consent to government coercion to collect taxes in order to increase the supply of public goods. The public-goods argument does not require that voluntary cooperation be unable to supply public goods or that government provision be perfectly effective. Citizens make a comparative analysis and direct government to supply the public goods that it more effectively provides.

The term cooperative efficacy refers to the joint effectiveness of voluntary mechanisms (Cowen and Sutter 1999). Cooperative efficacy involves a community's or group's ability to engage in collective action. The extent of voluntary cooperation depends on individuals' willingness to contribute to a common cause and to effectively do so by overcoming the free-rider problem as well as by achieving lowered transactions costs. Solving these two problems separately or in some combination of the two may conceivably come about in various ways (as elaborated in Cowen 1988).

Mechanisms for achieving exclusion include creating a club or tying a public good to a private good, defining property rights over previously unowned resources, making technological and entrepreneurial innovations, and making effective emotional appeals (Cowen 1988). The blockchain, we argue, represents an unprecedented technological and entrepreneurial innovation that lowers transactions costs and overcomes free-riding problems by creating trust, for reasons explained later in this paper. This innovation brings about an increase in cooperative efficacy that manifests itself through different dimensions, depending on the specific application. Regardless, everything else being equal, an increase in cooperative efficacy makes citizens more likely to choose private provision over government provision, and thus cooperative efficacy is related to the optimal size and scope of government.

We illustrate the choice for the specific case of the provision of a public good, but the examples considered later also involve instances of regulation. Figure 1 offers a graphical presentation of a choice by citizens between imperfect alternatives for public-good provision, meaning that neither voluntary provision nor government provision satisfies the Samuelson efficiency condition. Demand or the marginal social value of the good is captured by D, and MC represents die minimum marginal cost of providing the good. We provide concrete versions of inefficiency for both voluntary and government provision; other varieties of inefficiency can be substituted without affecting the general point. The effective demand falls short of D under voluntary provision due to free riding, but provision is efficient given this demand. Let the effective demand be D', the exact location of which depends on the extent of free riding or, alternatively, the amount of cooperative efficacy. The voluntary provision quantity is denoted [G.sub.v]. Under public provision, we assume that costs are excessively high, MC', due to public-sector inefficiency in production or procurement and that the quantity supplied, Gp, exceeds the efficient level, G* due to special-interest rent seeking on the part of the suppliers. Citizens evaluating the institutional choice in instrumental terms compare the net benefits under each form of provision. With voluntary provision, the net benefits would be area abed, and under public provision the net benefits...