Why Cryptoassets are This Legendary Economist's Dream
Updated: Jul 12, 2019
In 1937 Nobel Laureate Ronald Coase wrote a paper called “The Nature of the Firm.” Economists like the break things down to their simplest form, and Coase pondered on the existence of companies at all. That may sound crazy, but wouldn't you like like to be your own boss, and work wherever whenever you want? So why don't we do that?
The Nobel winning idea that says, in part, that transaction costs are the reason why capital is aggregated, and people form corporations. Because transaction costs are high, people work together in business to lower that transaction cost collectively. Coase cites property rights, minimizing overhead costs, search and information costs.
In his second most famous paper “The Problem of Social Cost,” in 1960 Coase argued that property rights "should be distributed in such a way so as to encourage the owner of the property to take economically efficient actions." So what does that mean? One of the major tenants of economics is that people respond to incentives. Property rights refer the right of ownership of one's work and the guarantee of assets they produce.
Take music for example. A person makes a song, records it, and tries to bring it to market. To do so, they need to set up contracts that agree to pay the creator when the product is used. To guarantee that, contracts are made with record companies who solicit the work to radio stations and sell the record to stores. Lots of transaction costs involved in that process, in which not all the value created from the song are realized by the creator.
Digital ownership is a new form of property rights. Previously property rights were something that was protected by laws and governments i.e., you can’t steal, and the government can’t possess your property. However much of the wealth we own today is not measured in property or material things, it is measured in currency that’s is inherently not physical as well as intellectual property (like a song).
Currently, copyrights protect intellectual property, but we all know don’t do a good job as artists don’t get compensated fairly; and the Federal Reserve protects the integrity of the dollar. They are both centralized. This system has continued to place more value on owning capital (being the record company, not the artist) which has hurt wealth distribution. Transaction costs made corporations and owning capital extremely valuable.
Blockchain technology can prove ownership of currency and intellectual property through its network encryption protocols in a decentralized manner. The internet has drastically reduced transaction costs which has given technology firms a huge advantage in creating super-profitable businesses. Decentralized networks can essentially recruit any worker that has access to the internet and have them perform a task.
Ripple, a cryptoasset is the greatest example of how a blockchain structured over an incentive-based network can greatly reduce transaction costs. Currently, the market for currency exchanges racks up extensive fees and is split between multiple financial intermediates. Coase would argue that because transaction costs are high, the industry would continue to consolidate to lower transaction costs. Ripple’s network which pays independent validators of transactions in a token called XRP is a singular efficient entity. The network processes, validates and rewards securely using blockchain technology. What Ripple can do is skip the financial intermediary (large corporation or aggregated capital) and essentially perfects Coase Theorem.
This may seem complex, but let's go back to the song example. If someone were to download the song from your computer, they would have it and potentially put it up for download for the rest of the world to have. One way to maintain ownership is through a distributed network, (a blockchain) in which computers all over the world come to a consensus on who a particular digital asset (like a song) belongs too. The network could then identify when the song is played/downloaded and reward you each time that occurs.
Ethereum is an example of a distributed network in which these validations occur. As a result of these computers validating ownership (proof of stake) the "miners" who power these validations are incentivized with the reward of the Ether token (ETH).
Let's take a look at how a decentralized network can solve the ownership problems and high transactions costs associated with the music industry by making up my own Token "Music Coin"
- Coase Theorem states that we have firms because transaction costs are high i.e ownership costs
-More value flows to those who own capital as a result of transaction costs
-People respond to incentives and Blockchain technology offers secure, decentralized incentive networks
-Ripple and my imaginary "music coin" can help solve the problems associated with ownership and transaction costs... solving Coase's dilemma