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Blockchains: Designing the Digital Markets of the Future

The Carlsberg Foundation's 'Semper Ardens' Research Project

Photo by Philipp Katzenberger on Unsplash

A new Internet infrastructure is being designed with potentially deep impact on our society, challenging our economic institutions, data sharing and digital interaction. Key to ensure a smooth transition is to understand the interaction of the basic building blocks of the technology. As issues of infrastructure design and market design are delicately intertwined, this calls for collaboration between computer scientists and economists.

By Jens Leth Hougaard, Professor at Department for Food and Resource Economics, University of Copenhagen, and head of Center for Blockchains and Electronic Markets (BCM).

A New Type of Internet

There is an ongoing development of a new type of Internet in which “value” can be distributed as easily as we currently distribute information. This new type of Internet is creating miniature economies where not only humans, but also devices such as your fridge or car, can bid on on-line auctions, trade, and set up contracts in a decentralised environment.

"Whereas most technologies tend to automate workers on the periphery doing menial tasks, blockchains automate away the center. Instead of putting the taxi driver out of a job, blockchain puts Uber out of a job and lets the taxi drivers work with the customer directly." 
Vitalik Buterin

The infrastructure uses advanced cryptography to verify information, interactions, and transactions. Thereby, it reduces the need for a traditional trusted third party. It is a more secure infrastructure as well as an economic infrastructure that challenges the way we make decisions and organise the economy in terms of money, banking, ownership, data sharing, and digital interaction. The impact on society is therefore potentially deeper than that of the Web and its http protocol.

Blockchain technology

The blockchain technology (Nakamoto, 2008) allows digital information to be distributed but prevents it from being tampered with. Through a distributed ledger, transactions are kept secure in a joint effort by a large network, alleviating the need for a single point of trust and control

In short, these new Internet layers comprise three fundamental building blocks:
  1. A distributed ledger and the protocols that make it operational (a blockchain);
  2. Self-executing digital (smart) contracts and decentralised applications;
  3. Privacy measures to allow access to and computation on private data.

To illustrate, consider running a closed-bid auction for a digital commodity. A smart contract embedded on a blockchain (Nakamoto, 2008) ensures that the auction runs as intended, transferring ownership to the winning bidder. 

Secure multiparty computation (Cramer et al., 2015) then guarantees privacy so buyers and sellers can safely reveal bids and reservations prices.

Figure 1: Multiparty computation enables secure computation on private data, for instance to find salary averages without revealing individual salaries. In practice, more complex methods are employed to safeguard the information against collusion among the participants and other forms of misbehaviour.

Collaboration between Economists and Computer Scientists

The blockchain technology is still in its infancy and many dilemmas between functionality and security remain. A recurrent theme in solving such challenges relates to system design and the implied user incentives. 

Tokens

Tokens (e.g. cryptocurrencies) are the means of exchange in a blockchain. Unlike fiat money, tokens are virtual and thus programmable.

For instance, is there an optimal way to motivate the network to verify new blocks of transactions? Can we, by clever design, prevent users from manipulating, delaying or subverting this process? Observed behaviour in blockchains and mining pools show that users do indeed try to “game the system”. 

While design of the technical infrastructure naturally is in the hands of computer scientists, the study of strategic behaviour under various protocols is central to economics and game theory. Therefore, study of the complex interactions between the technology’s building blocks can benefit greatly from the combined knowledge of researchers from both fields. 

Thanks to the Carlsberg Foundation we got a unique chance to establish the Center for Blockchains and Electronic Markets (BCM). The core staff consists of cryptographers from Aarhus University and economists from University of Copenhagen. 

This mix creates opportunities for interdisciplinary research that combines knowledge and methodologies from both fields in new and creative ways with a focus mainly on adaptation of the blockchain technology to efficient markets with privately informed participants.

Market Design

Blockchains provide a way to implement allocation mechanisms with proven desirable properties. Thus, construction of smart contracts is closely related to designing the rules of market interaction, whether these constitute market-like mechanisms (such as auctions) or “negotiated” agreements between business partners (Roth, 2002, Hougaard, 2018). 

Through the interdisciplinary framework of BCM, we analyse the full-fleshed market functionality resulting from integrating blockchains, smart contracts, and multiparty computation. 

Smart contracts

A smart contract is a self-executing program that contains the rules of economic interaction. Smart contracts can be integrated with the blockchain. Combined with the Internet-of-Things, smart contracts will allow us to redesign almost any type of economic interaction as we know it.

The contract design must induce the right user incentives so it cannot be manipulated, the private information upon which the contract is built must stay private, and computations must be processed within a time span short enough to make the mechanism operational; these challenges call for close collaboration between economists and computer scientists.

Privacy

Privacy measures, such as secure multiparty computation, ensures that private information stays private even in a distributed system.

Thus, understanding the complex interaction between the technological development itself and its related new market forms is essential to manage the many new opportunities that arise and to ensure a smooth transition of the economy.

References:

Cramer, R., I.B. Damgård, and J.B. Nielsen (2015), Secure Multiparty Computation and Secret Sharing, Cambridge University Press.

Hougaard, J.L. (2018), Allocation in Networks, MIT Press

Nakamoto, S. (2008), Bitcoin: A Peer-to-Peer Electronic Cash System, Available online at http://bitcoin.org/bitcoin.pdf

Roth, A. (2002) The economist as engineer: game theory, experimentation, and computation as tools for design economics, Econometrica, 70, 1341-1378.