When Money Becomes Programmable – Part 1

Michael Casey is chief content officer at CoinDesk. The following is part of “The Token Economy,” an essay in Alex Tapscott’s new book “The Financial Services Revolution.”

Blockchain technology, and the cryptocurrencies, tokens and other digital assets it has engendered, may be moving us toward a model of programmable money that incorporates an automated internal governance of common resources and encourages collaboration among communities. Digital scarcity, when applied to these tokens, treats our increasingly digitized economy differently from the pre-digital one. It raises the possibility that our money itself becomes the tool for achieving common outcomes.

Developers of new decentralized applications are tokenizing all manner of resources – electricity and bandwidth, for example, but also human qualities such as audience attention for online content or fact-checkers’ honesty. Whereas media coverage has focused on the billions of dollars these token issuers have raised, it’s the radical new economic design that promises a lasting impact on society. Once a community associates scarce tokens with rights to these resources, it can develop controls over token usage that help manage public goods. It’s dynamic money whose role extends beyond that of a unit of exchange, money that’s direct tool for achieving community objectives

Throughout 2016 and the first eight months of 2017, developers of decentralized software applications raised almost more than $1.6 billion via a new tool dubbed the ICO that was first launched in early 2014. By late July 2017, secondary-market trading in the tokens they’d issued had given the pool of cryptocurrencies, cryptocommodities, and cryptotokens to which they belonged a combined value of $95.6 billion, up from $7 billion at the start of 2016. 

We may be moving toward a model of programmable money that can deliver a more automated system of internal governance over common resources.

The phenomenon has made many developers and cryptocurrency enthusiasts very rich and revealed a new crowdfunding model that some see as a threat to Silicon Valley’s venture capitalists. Skeptics, on the other hand, make comparisons to the South Sea Bubble, in which shares in an 18th-century British trading company rose rapidly on hype and speculation, only to collapse when the returns didn’t live up to the hype. A chasm has emerged between those who see a game-changing shift, not only in fundraising activity but also in economic strategy, and those who warn of reckless ICO scams and of an impending regulatory crackdown. Both deserve to be considered.

If token fans are right, something quite profound is at stake: a new economic system that challenges the basic tenets of 20th-century capitalism. These negotiable tokens blur the lines between “product,” “currency,” and “equity.” In theory, their in-built software can regulate how users behave with each other so that computer owners can trade excess storage across a decentralized network, for example, or social media users can earn income for their content and attention. They combine self-interest and market pricing signals with a governance system that protects a common good.

For tokens to be viable, however, we need a major overhaul of our auditing processes and commercial regulations to keep issuers honest. If those goals can be met, this emerging token economy offers society an entirely new paradigm of money and value exchange.

A solution to the Tragedy of the Commons?

In his influential essay, “Tragedy of the Commons,” about 19th-century farmers grazing their cows on common land, the ecologist Garrett Hardin posited that communities that depend on a shared, unregulated resource will ultimately deplete it as individuals are incentivized to pursue self-interest to the detriment of the common good. Hardin recognized a coordination problem caused by a lack of trust, where well-meaning actors can’t avoid overusing a common resource due to their concern that others might “free-ride” on their goodwill.

Ever since that 1968 essay, the word commons has come to refer not just to natural resources such as land, water, and food supplies, but also human-created resources such as public infrastructure, and even intangible concepts such as free speech. It is now used frequently in the context of designing policies to ensure free, public access to those resources.

Over the years, Hardin’s thesis has been used to justify the role of external governance – that is, the state – in regulating and protecting scarce resources that constitute a public good. Yet, more recently, some economists have demonstrated that his rather cynical view of human nature doesn’t always hold true. In particular, the late Elinor Ostrom, who won a Nobel Prize in 2009 for her work studying how fishermen in Maine self-organized to develop ingrained norms of behavior that helped protect the region’s lobster fishery, argued that various communities have proven capable of coming up with effective internal governance to manage resources. However, while there are many instances of such common-interest practices around the world, their success relies more on art than science. Internal governance is often contingent on common cultural practices and close personal ties within a community.

Developing a universal model for internal governance has been challenging, especially within the many micro-economic settings in which it is difficult to identify and practically regulate misuse of the common resource. Now, with the advent of blockchain technology and the cryptocurrencies, crypto tokens, and other digital assets that it has engendered, we may be moving toward a model of programmable money that can deliver a more automated system of internal governance over common resources. 

Once a community incorporates programmable software into its shared medium of exchange, it can embed usage rules straight into the monetary unit itself. We can use it for some transactions but not for others, and we can program its value to rise in concert with proof of an improvement in the state of the public resource. Tokens thus offer a way to codify into money itself a function that executes the community’s expectations regarding people’s distinct rights to common property and the associated obligations that come with those.

According to Ostrom and Schlager’s taxonomy, these may include distinct rights of access, withdrawal, management, exclusion, and alienation. If we can capture these quasi-legal notions in a token, it becomes a meta-asset, a thing of value that is simultaneously a governance vehicle. It’s money with a dynamic use that extends beyond its role as a stable and exchangeable unit of value, to a direct means of achieving community objectives. The great promise of the token economy is that it might solve the Tragedy of the Commons.

What bitcoin wrought

Both the enthusiasm for meta-asset investing [in the ICO boom] and their potential to tackle the Tragedy of the Commons can be traced to bitcoin, the very first crypto token. Not only did this invention turn the imagination of thousands of developers toward designing applications for a decentralized, dis-intermediated economic future, it also established a precedent for the software-driven internal governance of a scarce public resource. In coming up with the blockchain, a distributed public ledger that a community of currency users could share as their record of the truth, bitcoin’s pseudonymous founder, Satoshi Nakamoto, created a public good, a commons in need of protection. 

Its integrity had to be assured despite the possibility that individual validators of that ledger, known as bitcoin miners, might be incentivized to act maliciously and enter false data that would allow them to “double-spend” their bitcoin balances – in other words, to engage in digital counterfeiting. There was no centralized authority to keep all the actors honest, no external governance, which had been the failure point for all prior attempts to create a decentralized currency with no centralized authority in charge. Without such an authority, a permissionless ledger that did not require identification of the user was always vulnerable to these abuses. Like the cattle herders on the commons, individual actors could not trust other people to act honestly.

Satoshi Nakamoto beat this limitation. By embedding a unique set of software-driven rules into the bitcoin protocol, he incentivized the otherwise unidentified participants in the network to maintain the ledger’s integrity for the good of the whole while simultaneously seeking profits out of self-interest. The key was a special proof-of-work (PoW) algorithm that compelled miners to perform an electricity-burning computation task before they could earn the right to receive bitcoin rewards. That “skin in the game” made it prohibitively expensive to take over the network and doctor the results. It incentivized them to come to a consensus on a truthful ledger with all the other miners. It was a unique marriage of self and common interest. With it, Nakamoto achieved something remarkable: he solved the Tragedy of the Commons.

In addition to its PoW consensus system, which compels even unidentifiable rogue players to act honestly, there’s another powerful idea behind bitcoin that has helped frame new ideas around how crypto tokens can help communities manage common resources: that of “digital assets.” Because PoW assures the integrity of the (uppercase B) Bitcoin ledger and protects against double-spending of (lowercase b) bitcoin currency, each unit of that currency can be treated as a unique item. For the first time, we have a form of digital value that cannot be replicated – unlike a Word document, an MP3 song, a video, or any other software vehicle for transmitting value that pre-existed bitcoin. In one fell swoop, Nakamoto created the concept of digital scarcity and brought digital assets into existence.

The implications of imbuing digital money with policy and incentives are far-reaching.

Digital scarcity, when applied to a token such as bitcoin or some other digitally tokenized medium of exchange, allows a new approach to managing our increasingly digitized economy and its micro-economies within. With scarce digital tokens, communities with a common interest in value generation can embed their shared values into the software’s governance and use these meta-assets as instruments of those values. Once they associate scarce tokens with rights to scarce resources, they can develop controls over token usage that help manage that public good.

Here’s one hypothetical example: A local government that wants to reduce pollution, traffic congestion, and the town’s carbon footprint might reward households that invest in local solar generation with negotiable digital tokens that grant access to electric mass-transit vehicles but not to toll roads or parking lots. The tokens would be negotiable, with their value tied to measures of the town’s carbon footprint, creating an incentive for residents to use them.

It’s an example of a direct, token-led strategy for promoting conservation of the natural environment. It’s also potentially a way for economists to put a price on externalities such as pollution. But the concept extends far beyond managing resources in the natural environment. With tokens that mediate the exchange of spare computer storage across a decentralized network, we could share use of otherwise wasted disk space on people’s hard-drives. Or with “reputation tokens” that reward adjudicators for making provably honest judgments about prediction market outcomes, we could promote and protect the public good of “honest judgments.”

Tokens as powerful incentives

The implications of imbuing digital money with policy and incentives are far-reaching. The concept aligns with the goals of a circular economy, where all participants in a supply chain have incentives to minimize waste and constantly recycle parts and materials. Designers of new social media platforms could encourage pro-social behavior and accurate information by requiring skin-in-the-game tokens that put a computing tax on bots and other automating tools of fake news.

We could tokenize everything from electricity to bandwidth. All of that would potentially bring new market efficiencies down to micro-transaction levels, enabling an Internet of Things economy to silently, automatically manage our economic activities with far more precision and less waste than was ever conceivable in the world of non-programmable, analog money.

Previously, the development of the important base-layer open protocols that underpin the Internet’s open network infrastructure was a not-for-profit undertaking. Network software such as the transmission control and Internet protocols (TCP/IP), which manage the Internet’s core packet-switching function, or the hypertext transfer protocol (HTTP) for websites and the simple mail transfer protocol (SMTP) for e-mail, were developed by universities and nonprofit bodies. Commercial, for-profit private entities weren’t directly incentivized to work on these protocols. Where they did partner with nonprofit labs, it was largely motivated by the development advantages of having access to the underlying technology and the engineering talent working on it.

For the most part, however, for-profit companies steered their resources toward the commercialized proprietary applications that ran on top of the open protocols. The problem for the nonprofit entities was that those commercial players had deeper pockets, which made it hard for the former to compete for talent. In the end, the biggest companies got to shape, indirectly, the development of open protocols since it was their donations that kept the universities moving ahead. 

As Albert Wenger and Fred Wilson from Union Square Ventures argue, we may be entering the “golden age of open protocols” in which value is captured by those who develop the most used open platforms. A case in point: the soaring value of the Ethereum protocol’s native token, ether, due to the popularity of the Ethereum-based ERC-20 token standard for ICOs.

These permissionless open protocols, upon which anyone with a token can start developing any idea, are another form of a public good, a commons. That’s what TCP and IP have been, and their maintenance has required stewardship by a range of international bodies acting in the public interest. By steering funds directly to the developers of these protocols, the token economy could now more directly incentivize the build-out of this vital architecture. In other words, tokens address the Tragedy of the Commons for both those using Dapps to change economic outcomes and those developing the infrastructure on which those Dapps run.

Yet here, too, there is a need for caution. The biggest risk according to Lucian Tarnowski, CEO of BraveNew, an online community-building platform, is that developers become too powerful, leaving the communities that depend on their software as “slaves to the algorithm.” He worries about engineers’ inclination to build monolithic, math-based blockchain protocols that cannot accommodate the great many ways real human beings lead their lives. “Rigidity is really dangerous as it creates this master-slave dependency,” Tarnowski said. 

One group of token developers is focused on this problem. The Economic Space Agency (ECSA), which is supported by an array of technologists, economists, anthropologists, and other social theorists, is building systems that would be secure from fraud without depending on validation by an overarching global blockchain such as bitcoin or ethereum – instead applying a narrow, peer-to-peer form of computer security that’s based on the least-authority principles of object capabilities.

In theory, that should allow groups of people, however small, to jointly issue their own unique tokens based on localized smart contracts that captured their community’s interests and weren’t beholden to the developer-established rules the global protocol. ECSA founder and CEO Akseli Virtanen wants the system to be so simple that it promotes the “ritual of the ICO,” in which people and entities are constantly making newly tokenized offerings of their services to others.

Whether they lie in ECSA’s complicated object-capabilities technology or within the cross-ledger interoperability of Ripple Labs’ Interledger project, Cosmos’ “Internet of Blockchains,” or Polkadot’s “Parachain,” solutions are emerging that drive the process away from the “maximalist” notion that all economic activity must gravitate to a dominant blockchain. If so, then we’re moving to a multi-token world where not only is the Dapp behind each token unique but the distributed trust governance system is also greatly varied and a matter of user choice.

Putting a reliable market value on all these tokens may still require a centralized reference currency but, depending on how efficiently they can be traded, their prices might one day simply refer to each other. It’s possible, in other words, to envisage a future of digital barter in which different assets are traded directly and people no longer need to store a common currency like the dollar or bitcoin. It might even free people from the economic distortions and periodic crisis that centralized monetary systems have experienced through the centuries.

Of course, the fiat currency-dominated world monetary system is a very long way from such a decentralized structure. Nonetheless, the rapid change of this current period suggests that we may be entering one of those 200-year turning points when humanity’s system of money goes through radical change. The ever-growing pool of interested investors, developers, and potential users in these tokens and meta-assets is only accelerating the innovative drive behind them. There may well be a setback if and when regulators start collectively cracking down. But the token phenomenon has piqued the collective imagination of hundreds of thousands of intelligent people who are now pouring new ideas into the space. We cannot predict where this orderless process of iterative innovation will take us, but we would be unwise to assume that a significant, highly disruptive change is not looming.