DeCenter Seminar: Trust at Scale: The Economic Limits of Cryptocurrencies and Blockchains

March 27, 2024 4:30 pm

Friend Center, Convocation Room

Speaker: Eric Budish, Chicago Booth

Abstract: Satoshi Nakamoto (2008) invented a new kind of economic system that does not need the support of government or rule of law. Trust and security instead arise from a combination of cryptography and economic incentives, all in a completely anonymous and decentralized system. This paper uses a simple three-equation argument to show that this new form of trust, while ingenious, is deeply economically limited. A zero-profits condition on the providers of blockchain trust and an incentive-compatibility condition on the system’s security against attack together imply an equilibrium constraint that the recurring, “flow” cost of blockchain trust must be large relative to the one-off, “stock”-like benefit of attacking the system. Moreover, this equilibrium cost of blockchain trust scales linearly with the value secured — which means that if cryptocurrencies and blockchains were to become more economically useful than they have been to date, then their costs would have to grow to absurd levels. There is a way out of the flow-stock argument but it is premised on the risk of economic collapse, which is itself a serious problem – pick your poison. The key contrast between Nakamoto trust and traditional trust grounded in rule of law, and complementary sources such as reputations, relationships and collateral, is the economies of scale that arise from credible deterrence as in Hayek (1960) and Becker (1968): Society or a firm pays a fixed cost to enjoy trust over a large quantity of economic activity at low or zero marginal cost.

Bio: Eric Budish is the Paul G. McDermott Professor of Economics and Entrepreneurship at the University of Chicago, Booth School of Business. He is also a Research Associate at the National Bureau of Economic Research, Co-Director of the Clark Center for Global Markets at Chicago Booth, and the Co-Director of the Chicago Booth Economics PhD Program. Budish is a leading researcher in the academic field of market design. He is best known for his market design inventions for financial exchanges and matching markets. He has also conducted influential research on market design theory, blockchains and cryptocurrencies, patents and innovation, event ticket markets, and various aspects of Covid-19 economic policy. Budish teaches an MBA class on competitive strategy and PhD classes on market design and the research and writing process. He received his PhD in Business Economics from Harvard University, his MPhil in Economics from Oxford (Nuffield College), and his BA in Economics and Philosophy from Amherst College. Budish gives frequent keynotes on his research and has received numerous academic awards including the Marshall Scholarship, the Sloan Fellowship, giving the joint AEA/AFA luncheon address, the Arrow award, and the AQR insight award.