Jul 1, 2019
The Supremacy of Permissionless Innovation
Cryptocurrency Forking as Voice and Exit
In the traditional financial system, central banks hold monopoly power over the supply of money, allowing them to conduct an independent monetary policy that is supposed to serve the overall interests of the citizens and the government. At least, this is the stated intent; the reality, however, is often quite different.
British economist Richard Cantillon formulated a theory back in the 18th century—known as the Cantillon Effect—describing how monetary control unequally benefits different groups. When new money is created, banks and state-owned companies are always the first to profit. If asset and real estate prices rise as a consequence, those with the greatest access to stock and bond markets are positioned to gain more from those changes than others who are not.
Economic and societal distortions created by monetary policy are difficult to quantify, but they are very real. In Human Action, his main treatise on economics written in 1949, Ludwig von Mises compared the features of a true market economy with those of a monetary democracy, in which every dollar spent is like a ballot that plays a role in deciding the production structures within the economy. The creation of new money distorts this voting process, but it usually goes unnoticed by the general public. And when new money is issued, already existing “ballots”—the money owned by real consumers and savers—is weakened. Control of the production structure of the economy shifts, albeit indirectly, from consumers to the actors behind money creation, such as central and commercial banks.
Despite these flaws, there have not been feasible alternatives and people have had to accept monetary democracy warts and all. Until now.
With what can be called “strong assurances” public blockchain networks, Bitcoin and other cryptocurrencies are trying to prevent these constant monetary distortions and offer a realistic alternative. In simple terms, “strong assurances” means that “the rules are the rules” and they are enforced in a stringent and objective way. If one does not approve of how these “strong assurances” are set up, a person can opt out of the blockchain network. Forking makes that possible by allowing the software code of a public blockchain to be copied at any time and continued elsewhere under a new name. In so doing, disagreements can be solved in a way that is not possible in the world of physical objects.
Forking Makes it Possible
The concept of forking comes from the open source software movement. In contrast to proprietary or copyrighted software, open source developers do not have to develop completely new products every time they start a new project. Instead they can copy and modify the existing program code and publish a new variant of the program. Each new version is a descendant of the previously developed code, but it is also independent and unique. The basic idea of forking is a familiar phenomenon in open source software.
Since blockchains are ultimately software, they can also go through forks. Blockchain forks are typically divided into two categories: “soft fork” and “hard fork.” A soft fork is any change to the source code that is backward compatible. If, for example, a blockchain whose blocks were previously one megabyte in size switches to block sizes of 500 kilobytes, it can be a soft fork. The new rule does not conflict with the old one, since 500 kilobytes is less than one megabyte. Old blocks can accept the new ones. In contrast, a hard fork denotes a protocol change that is not backward compatible, such as if the block size is increased from one to two megabytes. When a hard fork extends the rules in a way that cannot be fulfilled by the old blocks, a split occurs.
To illustrate this point, imagine that a blockchain is like a large, collectively-run restaurant. There is no central authority that alone can enforce decisions. At the beginning, the restaurant serves only vegetarian dishes. If the chefs decide to cook only meat dishes from now on, it is like a hard fork. Previous customers must either accept these meat dishes or look for a new restaurant. A soft fork would happen instead if the cooks decided to opt for a completely vegan kitchen. In this case, vegetarians could continue to visit the restaurant.
The cryptocurrency Bitcoin has already passed through both soft and hard forks. Early on, Bitcoin creator Satoshi Nakamoto even implemented soft forks himself through one-sided software upgrades. The 2017 SegWit update was one of Bitcoin’s most famous soft forks, creating many new opportunities for Bitcoin’s technical development. It was also around the same time when the most prominent hard fork, Bitcoin Cash, split off from the original Bitcoin Core protocol.
At first glance, blockchain forks may seem suspect because they ostensibly create monetary value out of thin air. However, those who pay a little more attention to the phenomenon realize that forks are a socio-evolutionary mechanism of public blockchain networks that make it possible to try out new ideas and solve conflicts.
Obviously, an excess of forks is not advantageous for a public blockchain network. With each splitting, there is a division of the mining capacities provided by miners, also called hashing power. The more they “dilute” and spread that power over individual forks, the more unsecure each individual version becomes. It therefore makes sense for as many miners as possible to gather on one of the versions and carry out their mining work there.
In order for a fork to be successful, it must convince members of the old community to follow along. Only if a critical mass of users, developers, and miners turn to this fork can it survive in the long run. This is where the aforementioned “strong assurances” come into play by attempting to convince users to follow the hard fork rather than remain with the old network. And since a spin-off exists as a new project independent of the old one, there is no inflation of assets within the old network. Accusing Bitcoin of being inflationary and having no value because many Bitcoin forks and other altcoins have been created is like saying that gold has no value because there are various other precious metals that are being dug up in greater quantities.
Past forks of popular cryptocurrencies have created sudden increases in value. This may be because of network effects, which happen when increasing the numbers of people or participants improves the value of a good or service. The more a service is used, the more people will start using the service, equating to a positive, upward spiral. Typically, network effects eventually lead to a winner-take-all, or at least winner-take-most, situation with one firm in a market-dominant situation.
In the crypto world this sort of network effect doesn’t seem to have kicked in yet, which is why even projects with few users currently live on. In the long run, however, it is to be expected that one version will prevail, and all others will disappear. In the case of Bitcoin, forks like Bitcoin Cash, Bitcoin Gold, or Bitcoin Diamond will likely die off.
Exit or Voice
According to German-American economist Albert O. Hirschman, participants in a network have two, basic options for reacting to a deterioration in quality on that network; they can either leave (exit) or work from the inside towards an improvement (voice). This works not unlike conventional institutions where, for example, citizens of one country either emigrate or protest against oppression, dissatisfied employees either quit their jobs or go on strike, customers either shop elsewhere or call on the managing director to insist on improvements, and so on. Which option is chosen—whether exit or voice—is a question of costs, both financial and emotional.
As digital networks become more widespread, Hirschman’s concept needs to be extended to include forks. These combine the exit option with the voice option and thus significantly reduce the costs of both.
Open source projects are becoming more and more popular. However, they often fail due to a lack of funding. While companies can market their proprietary solutions and thus generate revenue for new developments, the open source community must help itself. In the past, this has been achieved, with mixed results, through foundation support or crowd-funded donations.
With the emergence of commercial blockchains such as Bitcoin or Ethereum, the incentive structures within the open source world have changed for the better. By allowing independent exchange of values through blockchain protocols, developers can more easily be rewarded for their work by the community.
Developments like the Lightning Network, which allows micropayments of a few cents over the Internet, should be profitable for developers. Five cents from a single person is negligible, but when hundreds of thousands of enthusiasts pay five cents each the total sums involved can be considerable. This creates incentives for developers to remain innovative and receptive to feedback (voice), rather than programming regardless of users’ needs. Like the sword of Damocles, the possibility of being forked by other developers hangs over the heads of programmers and spurs them to innovate with users in mind.
Thanks to these developments, the gap between proprietary and license-free innovation is likely to shift in favor of the latter. Proprietary systems that compete with each other cannot also compete with the infinitely large resource pool of public systems in the long run.
Microsoft, the world’s largest software developer, admitted this fact in May 2019 by integrating Linux into the Windows operating system. Over the past few years, Linux has evolved from a small open source project to the most common operating system for web servers and now supports Android, the world’s most popular mobile operating system. If Linux is so successful as an open source project, how much more can we expect from public blockchain networks where incentives for innovation are even higher?
Relief from “Bullshit Jobs”
Incentives to work in open environments are constantly expanding and becoming ever more persuasive. Walled-off companies and traditionally-organized bureaucracies will struggle to compete with open source alternatives instead, since incentives here seem to be deteriorating at the margins. More and more people are complaining about their traditional workplaces being out of line with what they actually want to do.
One reason for this might be the fact that the number of zombie companies continues to grow in today’s zero interest rate economies. These are companies whose income does not even cover the interest on their loans, which means that they cannot service their debts except through new loans. According to estimates by the Bank for International Settlements—a kind of central bank for central banks—the share of zombie firms in 14 developed economies rose on average from around 2 percent at the end of the 1980s to around 12 percent in 2016.
At a zero-interest rate such companies continue to exist because they can take out new loans virtually free of charge to ensure their survival. Since such companies live on mechanistically-obtained loans and are not very dependent on good customer service, the result is a widening gap between the company and its consumers. However, the less responsive the company is to its customers, the less it is clear to any employee what their work at the company is good for, leading to sagging internal morale. Anthropologist David Graeber defined this kind of job as a bullshit job, any occupation that is so meaningless, unnecessary, or harmful that even the worker cannot justify its existence, and which make no meaningful contribution to society. An employee’s conscience, named by neurologist and psychiatrist Viktor Frankl the “meaning-organ,” will come knocking at the door sooner rather than later to complain about a lack of meaning in a job that consumes most of one’s waking time on this earth. Who could blame these workers for their desire to find a meaningful alternative?
As economists say, people will start dedicating themselves at the margin to crypto networks and their seemingly endless possibilities when hunting for new jobs. That doesn’t apply to everyone, but it does apply to an increasing number of workers with specialized skills. Already, stories abound about people leaving Facebook, Google and the like for crypto projects. How much more are people in less esteemed companies (and less well-compensated positions) likely to leave their old jobs behind?
Without meaningful work, it is no wonder that real innovation seems to be stagnating in traditional organizations. This thesis about the lack of innovation is supported by two popular figures including Garry Kasparov, former chess world champion, and Peter Thiel, one of the most important entrepreneurs from Silicon Valley. They argue that a growing number of companies generate their sales through protective regulation, subsidies granted by the state, and through bond purchases by central banks rather than through generating truly innovative ideas and products. Even if it may be a bit of a sweeping generalization, the idea that the global economy is increasingly stultified and encrusted by rent seeking behavior is not. In contrast, open source forks and public blockchain networks promise a more positive vision for a future with improved incentives and more meaningful employment.