Crypto-economics and the Future of Blockchain Economy
Today’s society is on its way to embrace decentralised solutions for human interaction. As we can observe there is a need to develop complex models and frameworks to evaluate the issues facing contemporary societies. The study and application of crypto-economic principles will help in building and preparing the new world to adopt decentralised solutions and evolve the cryptocurrency ecosystem.
The birth of Bitcoin over a decade ago sparked a revolution in the digital world and as of 2019 the jump in the number of cryptocurrencies has been about 2x (jumping from 1,600 to 3,000 worldwide). As of late 2020, countries such as Ukraine, Venezuela and Columbia are among the few that are starting to accept crypto as legal digital currency for daily trade by introducing regulations and enabling businesses and people – it’s happening.
What is Crypto Economics?
In simple terms – crypto economics is the use of incentives and cryptography that will shape the way we design new patterns for systems, their applications and the underlying networks. Technology protocols are being re-written to overcome fundamental challenges that will pave the way for innovation. Crypto economy in particular concerns the analysis of human behaviour in a zero-trust world. As traditional economics examines how individuals and groups respond to incentives, crypto-economics is associated with mechanism design, a field related to game theory and a sub-discipline of economic theory and mathematics.
In game theory one observes the given strategic interaction and evaluates the best strategies for each player and the probable outcome if players follow those strategies eg: relation between countries or negotiation between two firms. While mechanism design is often referred to as reversed game theory, we start at a desired outcome and work backwards to design a game such that if the players pursue their own self interest it will produce the outcome we desire. In cryptoeconomics, the mechanisms used to create economic incentives are built using cryptography and software and the systems we are designing are almost always distributed or decentralised.
Future of Digital Finance
Cryptocurrencies or “cryptos” will play an important role in the future of digital finance. As cryptos are borderless, accessible and secure and aim to lower transaction costs whilst also ensuring censorship-free control of our finances, there is no doubt the adoption of cryptos will forever alter how we live and work and how people will participate in global financial markets. Cryptos go beyond just replacing cash, they provide an entire ecosystem of unique solutions in finance, security, identification and ownership.
The categorisation of cryptocurrencies by their primary application within the ecosystem are as below:
- Payments: Cryptocurrencies will substitute digital cash and assist in online purchases and other retail businesses. Eg: Stellar, Ripple’s XRP
- Store of Value: Usage of currencies as a new form of scarce native currency and a means of settlement. Eg: Bitcoin, Litecoin
- Stablecoins: Crypto version of flat currencies tied to the value of an external resource like the U.S dollar or gold for stability. Eg: TrueUSD, Dai, Paxos
- Privacy: Cryptocurrencies offering anonymity via private digital transactions. Eg: Monero, Verge or Zcash.
- Alternative Finance: Assets such as collectibles or NFTs, commodities such as silver dimes and tokenization of securities such as corporate shares and real estate. Eg: Cryptokitties (collectibles), Reitium (securities), Tiberius (commodities).
- Decentralised utilities: Crypto-enabled networks, products and services capable of exchanging between assets issued on the networks. Eg: Ethereum (decentralised internet), NEO (smart contracts)
Source: Visual Capitalist https://www.visualcapitalist.com/cryptocurrency-redefining-future-of-finance/
As cryptocurrencies are programmable and customizable computer code, these can be programmed to solve several use cases in a digital economy. Smart contracts for example are a good use case where one can program a set of actions based on a user input. For example imagine paying your building contractor a price contractually agreed and based on your payment, micro payments will be sent to sub-contractors almost instantaneously – no delayed payments whatsoever.
Growth of Crypto Economy
Overall the number of cryptocurrency users has increased by 8.5x. In October 2016 the estimated number of cryptocurrency users was 9.2 million. This number has risen to 78.5 million by the October 2021 and is still rising at a tremendous rate.
Decentralised Apps or better known as DApps have also increased at a rapid rate with about 75 apps produced in October 2015 and rising to about 3,723 by September 2021.
Source: State of DApps https://www.stateofthedapps.com/stats
With more technology-driven solutions being created to solve challenges presented either due to centralisation by big institutions or lack of platforms and solutions to help with trade across borders, cryptocurrencies and the platforms supporting it are leading the growth of the crypto economy by creating an innovative and accessible financial system around the world.
With blockchain being assessed as a viable approach for several industries where decentralisation is a key objective alongwith secure, tamper-proof and transparent systems to process daily ledger transactions in finance and banking, law, realestate, healthcare or government; it is quite intriguing to observe how the world economies begin to adopt blockchain and governments regulate the disruption.
Here are a few industries and how they prepare to adopt blockchain.
- Supply Chain Management: Currently with the Covid-19 crisis, it is evident that supply chain has been under a critical spotlight. With several sectors taking a hit on materials being unavailable and costing businesses millions of dollars, it is key to address the transparency and digitisation aspects of blockchain that would require trust as a core component to tie any technical solution. Solutions in this space can greatly reduce time delays and human errors and help in monitoring costs, labour and even waste and emissions.
- Banking and Payments: Blockchain is disrupting the banking industry by providing access to billions of people around the world especially people in third-world countries who never had access to traditional banking. More importantly cryptocurrencies help in cross-border payments almost instantaneously with relatively low fees as compared to traditional banks. Several banks such as Barclays and ANZ are exploring blockchain technology to speed up and reduce unnecessary operational costs thereby attracting customers. Payment platforms are innovating micropayments using blockchain to assist in smart contracts requiring small payments to multiple parties at low cost.
- Insurance: Currently the global insurance market is based on trust management and blockchain is helping to disrupt and build trust by verifying many types of real-time data in insurance contracts and feeding it into smart contracts.
- Charity: The challenges in the charity space are of opaque dealings and corruption thereby preventing money from reaching those that are meant for it. With blockchain technology, donation tracking can help in ensuring your money is going to end up in the right hands and providing the traceability and transparency required.
- Online Music: This is one area that has always suffered at the hands of intermediaries. With blockchain disrupting this industry, several startups are coming up with ways to pay the artists directly from their fans without having the need to pay up large percentages to platforms and music record companies. Music licensing issues can also be using smart contracts.
- Healthcare: The challenges in the healthcare industry are the ideal candidate for blockchain disruption especially in the area of storage and sharing of patient medical records. Blockchain can help hospitals store and share medical records with authorised professionals or patients.
Source: Future Thinkers https://futurethinkers.org/industries-blockchain-disrupt
With every new wave of promises each emerging technology brings there are challenges that come along with it. Blockchain has its own challenges and hence it is key to assess its viability. It may not be a solution for problems with similar patterns.
Here is a glimpse into the popular challenges for blockchain adoption:
- Inefficient technological design: Blockchain has a lot of advantages however a “bug” in the code can add a significant risk or an inefficient design can end up costing more in infrastructure costs.
- Scalability: Blockchains are not highly scalable. Currently some consensus protocols are inefficient where every participating node must process every transaction. With every additional node the inter-node latency will exponentially increase.
- Energy Consumption: Popular consensus protocols require a significant amount of energy to run in acceptable time-frames. Bitcoin miners consume about 198.21 TWh annually.
- Other challenges such as lack of skill sets, privacy, security and government regulations can slow down the adoption of blockchain technology.
Each of these areas need further innovation to improve and benchmark for solutions to be built. Most of the above challenges are currently limitations of the technology and several individuals, groups or organisations are racing to solve them. Some of them are looking at rewriting technology in order to overcome these challenges.
Although it has been a decade since the birth of the blockchain economy, it is still at its infancy and is starting to shape the future. Blockchain cannot solve every problem and requires us to unlearn a lot of traditional approaches to problems to create new and innovative solutions. Some solutions may not be viable from a financial perspective although they may promise to solve our problems. Blockchain will disrupt several sectors and will face a lot of resistance from people, governments and the large institutions for a long time before adoption.