From C to D: Bitcoin and the Soviets

One hundred years after the advent of central planning in Russia, another revolution is unfolding with the potential to decentralise economic and social systems

The last century has witnessed two distinct revolutions: the Soviet Revolution and Bitcoin. The first was an experiment in centralising all economic and political decisions, so one could call it ‘revolution-C’. Central control was exerted on the money system as well – indeed, the Soviet central bank, Gosbank, was the single monetary and banking authority. What would be the polar opposite approach to money? It’s surely not that of countries with central banks: it’s something like Bitcoin. But what is Bitcoin? Well, it is the first decentralised digital currency. Before Bitcoin, every form of money was either centrally issued and controlled (e.g. the Russian ruble), or decentralised but physical (e.g. gold and silver).

The internet has been operating for over two decades now, so why did it take so long for such a type of money to develop? The simple answer is that, without a trusted supervising authority, members of a digital payments network have a tough time trusting the same unit of money will not be spent multiple times (digital files are easily duplicated). By combining specific data structures (now referred to as blockchain), cryptography and game-theoretic economic incentives, Bitcoin solved this problem for the first time. Anyone with an internet connection can join the Bitcoin network without paying for a bank account or being asked for proof of creditworthiness.

Furthermore, anyone can examine the entire history of transactions and, if he/she wishes, receive an economic reward for contributing to the integrity and security of the truth-telling network. Such reward is given in the same currency according to not political criteria but predetermined math formulae. The new ‘coins’ are thus distributed according to a digital security meritocracy. It is difficult to think of any other innovation with such disruptive power for the evolution of human trust; one could indeed refer to the set of ideas behind Bitcoin as ‘revolution-D’.

Share this insight

With Bitcoin, money becomes open-source software – the ‘killer app’ of the digital economy. Since then, new monies have been created, seeking to improve on specific aspects (e.g. Litecoin, Monero, Dash, Zcash). Entrepreneurs also realised similar ways of coordinating economic interactions could be applied more broadly to create an economy of ‘crypto assets’. By merging digital information and value in a single object, one can write code (a ‘smart contract’) that governs the transfer of value in economically meaningful ways. As a simple example, one can emulate what a derivatives contract involving two financial assets does, but without requiring central exchanges and clearinghouses (e.g. atomic swaps).

Even more broadly, the ability to program digital assets allows for the disruption of peer-to-peer software and the emergence of new internets. Although decentralised networks like BitTorrent are not new, one can now build applications that not only do not run in centralised servers but are distributed across a large number of economically incentivised nodes. Many platforms for the creation of decentralised apps already exist or are in development: Ethereumis the best known example, but also NEO, QTUM, Tezos, Lisk, Stratis, EOS, etc.

As with the internet in its beginnings, it is difficult to predict the full scope of potential uses. At the moment, we see the rapid emulation of what centrally-run platforms do: examples include social networks (Steemit), exchanges (ShapeShift’s Prism), supply chain management (Walton), identity verifications (Civic), and decentralised versions of PayPal, eBay and others. It’s too early to say whether any of these initiatives will individually succeed (as we know, Google displaced many older search engines) but the ideas behind revolution-D cannot be uninvented. In my view, several factors are likely to have an enduring impact. Let me briefly mention four that transcend capital markets.

First, the economics of open-source projects have changed fundamentally. Pioneers of a particular protocol can now economically benefit from its future growth by creating and selling tokens. In contrast, the inventors of game-changing protocols like, say, HTTP or TCP/IP, are not among the most successful entrepreneurs.

It is difficult to think of any other innovation with such disruptive power for the evolution of human trust

Second, the traditional (Coasian) view of the firm as the exclusive coordinating device of resources in private production will likely change. When transactions and contract layers are governed by software, as opposed to armies of lawyers, accountants, and regulators, individuals can more easily contribute resources to production in a self-organising fashion (e.g. decentralised autonomous organisations). As an illustration, projects like Filecoin and Substratum allow individuals to earn income by providing unused hard disk space for file storage and web hosting.

Third, the distributed nature of this new economy makes it highly resistant to censorship. New forms of decentralised webs promise to broaden the access to news in countries where the World Wide Web is censored. New funding schemes like ICOs expand the ability of individuals located anywhere in the world to participate in seed-stage equity investments. Previously, such investments were reserved to designated investors with some form of government certification.

Fourth, revolution-D challenges the centralised character of many forms of social interaction (‘institutions’) that rely on a central party keeping records of ‘who owns what’ and verifying changes/transactions. The list of candidates ranges from private property registries (e.g. land, vehicles) to personal identity systems (e.g. passports, birth and marriage certificates), reputation systems (e.g. credit scores), medical records, to group decision making (e.g. voting systems).

The history of humankind is that of disruptive ideas and tools. The primary tool of revolution-C was hardly new: the broad use of force and the threat thereof. As the lucid minds of L Von Mises and FA Hayek predicted, the Soviet project imploded, sending a clear message: centralised economic planning does not work. A century after that tragic October when the Soviets came to power, the most disruptive tool of decentralisation since the printing press is simultaneously available to everyone in the world for free. Will a genuine leap forward for humanity follow? Although one can hope so, no one knows just yet.