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Consensus Mechanisms and Economy

Apart from the environmental awareness shift that is happening across political regimes led by grass roots people engagement and hence forcing democratic governments to re-thing value and assets, there is a technological paradigm shift happening, that is in fact, helpful to those decentralized grass roots efforts. The internet was the first step in this direction and now the Blockchain technology has emerged as a way to enter into smart and secure contracts that redefine value transmission.

Much has been written on the Blockchain and its first crypto currency the bitcoin and financial institutions specifically are starting to invest not millions but Billions into this new technology that has proved already its efficiency and cost reduction capabilities.

Top tier banks are acknowledging that it will take not more than 10 years before the Blockchain technology could well make retail banks totally obsolete. Investment banks on their part, who have been profiting from the trust gap between investor and creditor have also been investing heavily in the new technology since it is clear that smart and secure contract could potentially put them out of business once collateral obligations are not signed off by lawyers but rather Blockchains.

The change in the transmission of value will undoubtedly have significant consequences that cannot all be foreseen at the moment but which are being taken very serious by industry and intellectuals. One comment by Coinbase CEO recently was that, “the Blockchain has currently the state of the internet in 1994” and “we will see the full adaption and effects of the Blockchain in about 10 years’ time.

Melanie Swan, a distinguished technology writer even referred to the emergence of a “crypto enlightenment” period, similar to the enlightenment period in the 17th century that led to democratic government and the law as the fundamental principle of consensus mechanism.

So how does the BlockChain come in?

So how can the emergence of the Blockchain technology be linked to the emergence of a grass roots political activism towards environmental awareness and considerations?

The link is most obvious through already functioning nodes such as e.g The underlying workings are closely tied to democratic governance and control which is the core function government institutions themselves, however now they become linked to a consensus mechanism. That mechanism allows citizens to “vote” for themselves which investments or ideas they would like to support. Of course this was possibly before, but not at the micro managed level and cheap access that the Blockchain technology allows.


Hence, whereby voting was left to anyone who had access to political knowledge, future voting mechanisms will simply send a link with the various political options on a “monthly” or “yearly” basis and the voter is just left to validate the link i.e. the Blockchain transaction.

Payments and Investments

Thinking of Investments theoretically, it comes to mind that Investments are an important “input variable” in capital markets models, micro and macro. So if investments are affected in a fundamental way in those basic economic functions, the “knock on” affect would also need to be significant.
This can be seen e.g. easily by looking at how recently crowd funding mechanism have aggregated micropayments to sufficiently significant levels to allow serious funding for even the most outsider of ideas.
This is an important shift of practice, that are creating new consensus voicing mechanism to calculate the rating grids — across industrial sectors and governments. The way this will be possible is e.g. by aggregating huge amounts of data from servers such as Amazon, Alibaba or any other financial institutions that gather transaction data. Comparing the annual reports of those entities to their transactions and the risk inherent in those transactions (something that Alibaba does for each of their traders automatically today) will reveal a good estimate for credit risk — sourced from trillions of data points.
Clearly, in an environment where ranking algorithms (e.g. credit rating agencies) would need to defend their rating levels much stronger against the competition, there is room for market failures such as revenue driven rating assignments.

Such failures could only be avoided, if the focus of the rating bodies was put on the consensus mechanisms governing the perception of risk.
It has been argued that given the concentration of power of the most prominent industrial institutions a perception of risk maybe industry specific risk and hence biased towards such centers of power. See e.g. a recent study by ETH Z├╝rich which identified only 147 corporations governing most of industrial activity, or recent study by OXFAM identifying that only 62 people own half of human wealth. This criticism has long been echoed by scholars such as Nassim Talib and Daniel Kahnemann in their work around biased decisions and biased perceptions.

To this extent, the technological shift — that M.Swan from the BlockChain University, has termed Blockchain Enlightenment, may bring about a new consensus mechanisms that will allow for broad participation and hence more discrete risk assessment. Such risk assessment would ultimately need to be as detailed as each participant in the Blockchain. The Blockchain would reveal political i.e. consensus preferences and such preference could be considered an estimate for risk perception. After all, when voting for a “new coal plant” becomes a broad decision by affected citizens, instead of faraway political institutions or powers (e.g. People of China vs. People of Beijing), the perceived risk to the project is obviously in line with the benefits. If the risks outweigh the benefits, the factory will not be built.

The Cost of Capital in the era of BitPay

So an interesting question in investment theory arises about the cost of capital. Would it decrease given that transaction mechanisms such as the Blockchain make capital more easily accessible to networks of trust and the “right ideas”? How would it manage “money” as a “exchange of value”? And how could it affect consensus mechanisms from “feeding the poor” i.e. charitable giving to “barter” or exchange of value?

BitPay is an online tool which allow businesses or private persons to engage in instantaneous transactions by way of the crypto currency BitCoin.
In this day and age, with interest rates at an all-time low, to fuel an economy that was brought to collapse with the overambitious lending habits and false investment decisions by Lehman and PE funds such as Long term capital management, the question needs to be asked, how crypto currencies would change assumptions about the cost of capital.

As is well known, the Central Banks are in charge to manage the nominal rate of interest and it is their key tool for influencing whatever part of the “real” economy they can actually influence. In recent years, there were strong signs like in Japan but also in Europe that the effectiveness of the interest rate policy by the major central banks was benign. Yet, any rise in the rate of interest would have cause further troubles for already struggling corporates who were looking to refinance their existing debt with cheap new money.
Clearly, the central banks were confident that no overheating of the economy would occur. The often cited argument was that strong competition within the real economy was almost leading to “deflationary” tendencies. Prices were stable and in some instances were even lowered due to advances in technology and innovation.

Indeed the efficiency gains of the emergence of the internet may well have been a quantitative factor in the data when the decision to lower interest rates were taken over the last decade. However with the interest rate at an all-time low and equity asset prices at an all-time high the crux is now in how to reverse the equity bubble. This is because the low interest rate environment and huge credit lending volumes have now caused equity prices to inflate to pre-crisis levels. Whether those equity prices are justified against the credit liabilities on corporate balance sheets is a difficult guess.

Whereas academic books have allowed for various reasons for interest rate adjustment by central banks, those reasons usually are around managing the investment decisions of corporate capital investments. So most of interest theory is around the supply of capital by the central banks.

But clearly there is also a demand side to capital. Namely the demand of a “trusted medium of exchange” to invest. That “trust” is not by chance, but managed carefully through political, democratic and regulatory policies. The Cost of Capital is also the costs of managing “trust” in a currency.

At the core of such “trust” mechanisms are information systems monitoring the supply and demand of money by financial institutions and large corporations. Without such monitoring there would be little trust in a currency. To ensure monitoring is adhered to by all involved institutions, financial or corporate, extensive regulatory and compliance policies have been built around money contracts between the central banks, financial institutions and corporates.
Enter the Crypto Currencies, which are to this date hardly regulated. With a constant maximum transaction cost of 1% the current transaction value of bitcoin is the lowest in any medium of exchange available. This means that anyone with an internet access and a product to sell, can instantaneously receive BitCoins without any further transaction costs but 1% on the actual transaction value.

The tremendous efficiency gain from this is obvious. Private individuals in niche markets are hence able to create businesses in the real economy which may previously been closed to barriers of entry and such micropayment levels. Effectively, nodes such as “Bitpay” enable anyone to become a bank buy accepting money instantaneously from all parts of the world.
So the key question emerges about whether such low transaction prices can be sustained over the long term to include regulatory and compliance costs which are integral parts of creating trust in currencies.

Economy 5.0 | Publishers