Blockchain Technology and Cryptocurrencies: Implications for the Digital Economy, Cybersecurity, and Government

The recent rise in interest in block-chain technology and cryptocurrencies has been associated with a fundamental misunderstanding of the opportunities and challenges this new wave of technological change entails. As with other major technological transitions, there is high uncertainty about what successful implementations of the underlying concepts may look like once the initial phase of scientific and entrepreneurial experimentation is complete. Furthermore, such uncertainty is fundamentally unmeasurable, leaving early adopters, entrepreneurs, and investors with diverging and often irreconcilable hypotheses about the future relative to the rest of society.¹ By questioning key assumptions behind how domain experts and incumbents interpret and react to the environment, and by challenging established business models and institutions, the technology attracts a fair degree of criticism, fear, and—where it reaches a sufficient scale—opposition. Conflicting incentives reinforce the separation between enthusiasts and skeptics, with enthusiasts overestimating the short-run impact of the technology, and skeptics underestimating its long-run effects. Whereas skeptics generally ignore the extent toward which the technology will improve because of recent investments in research and development by startups and academic labs, enthusiasts fail to account for how much market demand, pre-existing frictions, and the response by incumbent institutions will shape its evolution.

The objective of this paper is to abstract away from the idiosyncratic features of different, competing implementations of blockchain technology and to focus on its underlying economics in order to understand its implications for competition in the digital economy, cybersecurity, and government.

Implications for the Digital Economy

Confusion around the very definition of what blockchain technology is stems from the fact that there are different ways to implement the technology, each one posing unique trade-offs in terms of efficiency, reliance on existing intermediaries, and governance. At a high level, blockchain technology allows a network of economic agents (e.g., individuals, firms, devices) to reach consensus, at regular intervals, about the true state of some jointly maintained and shared data. Such shared data can represent exchanges of cryptocurrency (as in Bitcoin)

and other types of digital assets, making the technology applicable to multiple industry and public-sector verticals. From an economics perspective, blockchain technology is associated with a reduction in two key costs: the cost of verification of transaction attributes and the cost of launching and operating a digital platform.² This reduction in costs is achieved through a clever mix of cryptography and game theory, and heavily relies on economic incentives to ensure that a decentralized network of economic agents can coordinate and process transactions without assigning excessive control and market power to the entities operating and overseeing the marketplace.

At its core, because of its ability to support the formation of consensus about the true state of transactions and data without relying on traditional intermediaries, block-chain technology provides a novel way to coordinate economic activity on a global scale and reach "Internet-level consensus." This constitutes both its key opportunity and challenge, as depending on what the economic incentives embedded in a block-chain protocol are designed to encourage, it can have an extremely beneficial or detrimental impact on society and markets. For example, the same privacy-enhancing features of the technology that can offer consumers greater control over their digital lives and reduce the impact of data breaches can be exploited to facilitate illegal activities

such as money laundering, terrorism, and tax evasion.³ Similarly, while the technology can facilitate global trade and increase transparency and competition within financial markets, it can also allow for regulatory arbitrage and make it more difficult to impose economic sanctions on individuals and countries.

By replacing trust in an intermediary with trust in the incentives, code, and governance of a software protocol, blockchain technology unbundles part of the activities performed by traditional intermediaries, lowers barriers to entry for new types of intermediaries, and allows for the creation of new types of digital marketplaces. This change in the nature of intermediation has consequences for market structure, as it allows a marketplace to operate without assigning a disproportionate share of market power to a single entity (or a small group...