by Muskaan Garg
The classic assumption of the theory of homo-economicus persists at the very root of Neo-classical economics. Homo-economicus is a figurative human being, derived from the term Homo sapiens. It was first defined by John Stuart Mill as “a being who desires to possess wealth, and who is capable of judging the comparative efficacy of means for obtaining that end” (Mills, 1836). Emphatically, it is a human being who has the infinite ability to make rational decisions. The notion of the homo-economicus model trails back to Adam Smith’s views on how economic benefits can be accrued when individuals act in self-interest in the Wealth of Nations. This theory of homo-economicus has been heavily criticised time and again. Daniel Kahneman and Amos Tversky founded the field of behavioural economics with their 1979 paper, “Prospect Theory: An Analysis of Decision under Risk” which criticised the self-interest behaviour of individuals. Indian economist and Nobel Laureate, Amartya Sen, posits that humans have the ability to rise above their self-interest and be compassionate. In the approaching era of data-based blockchain, incentivized cooperation among individuals will hold leverage over the assumption of a self-interested homo-economicus in order to fulfill collective interests. The aim here is to analyze the importance of incentivized cooperation among individuals and propose a design mechanism to achieve it in the upcoming dynamics of Crypto-economics.
Blockchain is a distributed, decentralized public ledger managed by a peer-to-peer network. 1991 marked the onset of a digital era which fundamentally altered the way technology was to be perceived in the coming years. In the same year, Stuart Haber and W. Scott Stornetta in their academic paper, ‘How to Time-Stamp a Digital Document’, sought to create an immutable ledger to tamper-proof document time-stamps (Haber and Stornetta, 1991, p.100). It is described as one of the first works on a cryptographically secured blockchain. Later in 1993, the efficiency of the prior model was improved by Haber, Stornetta, and Dave Bayer via employment of Merkle trees which allowed several documents to be compiled into one block, thereby resolving the earlier constraints of storage and verification (Bayer et. al., 1993). Finally, in 2008, the first application of blockchain in the form of bitcoin was introduced in a white paper published by an individual or group of individuals going by the pseudonym, Satoshi Nakamoto. While most of us understand ‘blockchain’ as a late 20th century innovation, the concept actually predates modern civilisation. The primitive form of blockchain is a reflection of the underlying principle of recordkeeping which is “keeping tabs on one another”. Before the Neolithic Revolution, the hunters and gatherers followed the primitive form of blockchain wherein every member of the community kept a block of information with themselves to be able to recall instances where a person evaded on their responsibilities. The slacker would earn a bad reputation and his future actions would not receive the community’s verification. It ensured a system of checks and balances without reliance on a central authority like kings or chiefs. However, within such close proximity, self-interest of the members was bound to conflict, contrast and be compromised. Thus, by utilising the blockchain method of keeping in memory a block of information they sought an alignment between members’ self-interest and the interests of the community. This led to group cooperation and in cases of non-compliance, members were termed as outcasts. After millennia of this mental tracking among small groups of people, the data-based digital blockchain was ready to be scaled globally and these groups transcended into the modern civilisation.
Is blockchain the way forward?
The most fundamental questions to ask are; is the blockchain technology even helpful for the economy?: and does it improve the efficiency? Oliver Williamson argued that people produce and exchange in markets, firms, government depending on the transaction costs of each institution. The significance of transaction cost in the institutional structure and functioning of the economy was first illustrated by Ronald Coase in his Nobel Prize winning work, The Problem of Social Cost. His theory on law and economics suggested that contracts are at the heart of economics. It is contended that the transaction costs in terms of the contracts can be reduced via smart contracts. A smart contract is a self-enforcing agreement embedded in computer code managed by a blockchain (Voshmgir, 2019). They allow contractual agreements to be automatically, autonomously, and securely executed. Smart contracts can eliminate an entire class of work of accountants, auditors, lawyers, and indeed much of the legal system: and blockchain technology is the catalyst behind the implementation of these smart contracts.
The primary reason cooperation becomes crucial is to afford investors the opportunity to transact with each other. If individuals act in self-interest then how can we create trust between investors to afford them the opportunity to transact with each other? The well-established critique of the assumption of non-cooperation in neo-classical economics is that it can still result in sub-optimal outcomes. Thus, it can be argued that adoption of a cooperative strategy among investors particularly in a blockchain environment might increase the likelihood of reaching a socially desirable outcome.
The U.S. dollar was initially on Gold standard and it was backed by physical gold, as a result of which people had faith and confidence in it. When it went off the gold standard, it was backed by a social contract. A contract where it was widely agreed that dollar has value. Similarly, the same social contracts hold with tokens (or crypto-currencies) as long as enough investors agree that they have value. This agreement demands cooperation between the investors. Thus, trust and confidence-building plays a key role in incentivising cooperation and usage of blockchain. Don Tapscott (CEO, Tapscott Group) floated the idea of the Trust Protocol which enables one to do transactions, commerce, exchange money without a powerful third-party administrator. Blockchain is a decentralised platform with no government or third party intervention. The Trust Protocol in the blockchain environment is established through mass collaboration and coding rather than through powerful third-party institutions. Empirically, it is not about figuring out the non-cooperative tendency of human behaviour, but rather how to make people cooperate when no one is looking. People cannot be trusted to be selfless. Thus, cooperation among agents needs to be incentivised, since theoretically they will always act in self-interest. This is important in order to induce a willingness to invest in the blockchain system. In the token economy, a designing mechanism or intervention is imperative in order to incentivise the agents to trust and invest in blockchain technology. In the realm of crypto-economics, the crypto-currencies with their peer-to-peer exchanges are yet to receive worthy acceptance due to its decentralised nature. A model to incentivise cooperation and induce willingness to invest is proposed below.
En route towards a greater incentivised investors’ base
Commons dilemmas are social dilemmas in which non-cooperation between individual people leads to the deterioration and possible collapse of a resource (Hardin, 1968). The dilemma faced by the investors is whether they should invest and use crypto-currencies or not. Cooperation in terms of mutual acceptance of the technology is desired. Or else it might lead to the collapse of the crypto-currency start-ups due to lack of mutual trust shown by the investors. Thus, to successfully resolve this dilemma, social psychologist Mark Van Vugt’s 3Is model for creating designing interventions to motivate individuals is proposed. According to him recent developments in social psychological theory and research suggest that in such commons dilemmas people are not just motivated by narrow (economic) self-interest but that they also consider the broader implications of their decisions for others and for the environment around (Vugt, 2009). Hence, a positive deviation from the self-interest behaviour towards cooperation may have broader implications in the realm of crypto-economics. The 3I components are (a) Information, (b) Identity, and (c) Institutions.
Humans as a species yearn for information. In order to incentivise them to invest in the technology, the crypto-currency start-ups need to make them perceive that their cooperative decision to invest is competent enough to make a significant difference to the collective interest. They need to educate the users about the cause and effects of the technology and how non-compliance will affect the overall ecosystem. The aim is to drive the marginal cost of information to near-zero such that everybody is well-informed about the decentralised nature of blockchain and its privacy equation.
It is often observed in human behaviour that if you can connect actions with a person’s true face and name, behaviours become increasingly pro-social (Bering and Piazza, 2008). Blockchain is a decentralised public ledger interface on which users advance transactions. Due to this lack of identification of the system with a central institution like a bank, investors are sceptical about investing. This issue arising out of the behavioural aspect of people’s decision making process is being addressed. For example, in order to induce greater cooperation, Martti Sirius Malmi, the first developer of Bitcoin after Satoshi, is currently working to create a decentralised identity system, called Identifi.
A more liberal outlook of Van Vugt’s view on the need of institutions to build trust between individuals during an exchange is taken. It is contended that in the cipher world the algorithms substitute the need for institutions. Crypto-currencies like Bitcoin have made the concept of trustworthiness of the purchaser irrelevant. They have created a trust-less system where algorithms ensure that transactions are added automatically to the former block and being public everyone is a witness to this interaction.
The current paradigm of Blockchain technology stands at the crossroads of technical transformation and trust-building amongst investors. Trust and value among economic actors can be sought by collectively incentivising them into forming a mutual agreement or social contract around a technology or mechanism. The possibility of individuals to deviate from their self-interest behaviour opens doors for blockchain start-ups to tap into the prospects of a cooperative and incentivised investors’ base. It is imperative to develop design mechanisms to stimulate cooperation and investment by aligning investors’ self-interest with the collective interests. According to the proposed 3I model, to enable investors to make a rational and informed decision, the algorithms need to be presented as identity institutions via communication of relevant information. Thus, to reap the benefits of blockchain in terms of reduction of transaction costs by employment of smart contracts, cooperation among investors is crucial and must be incentivised through suitable design mechanisms.
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About the Author
Muskaan Garg is a second year BBA LL.B., (Hons.) student at Jindal Global Law School. Her interests primarily lie in the captivating interaction of business, law and technology. With AI and blockchain expansion as the impending future, she believes knowledge of the technological machinery will be crucial for a career as a corporate lawyer. The debates around liability assessment and automatic dispute resolution mechanisms in the upcoming AI and blockchain concerned lawsuits also appeals to her interests. A curiosity towards Economics as a dynamic discipline motivated her to integrate it with the domain of technology and produce this piece of work. Being an enthusiastic writer by day and an avid reader by night, she seeks to actively engage with content and opportunities in the area of law, business and technology.