Research / BFI Working PaperJun 27, 2022

Trust at Scale: The Economic Limits of Cryptocurrencies and Blockchains

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.

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