Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design Fifty Shades of Blockchain “The Trust Machine”, “Distributed Trust Network”, “Bitcoin”, “Ethereum”, “Distributed Ledger”... Smart Contracts Slide 1/21 — Cong, He, & Zheng — Blockchain Disruption and Smart Contracts
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Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Fifty Shades of Blockchain
“The Trust Machine”, “Distributed Trust Network”,“Bitcoin”, “Ethereum”, “Distributed Ledger”...
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
What is Blockchain?
• Bitcoin – the original blockchain
• Double-spending, public distributed ledger• Blockchain not defined by Bitcoin.
• A database system in which parties unknown to eachother can jointly maintain and edit in a decentralizedmanner, with no individual party exercising centralcontrol.
• Cheaply maintain a robust consensus.
• Decentralized: no need to trust or rely on a centralizedauthority.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
What is Blockchain?
• Bitcoin – the original blockchain
• Double-spending, public distributed ledger• Blockchain not defined by Bitcoin.
• A database system in which parties unknown to eachother can jointly maintain and edit in a decentralizedmanner, with no individual party exercising centralcontrol.
• Cheaply maintain a robust consensus.
• Decentralized: no need to trust or rely on a centralizedauthority.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
What is Blockchain?
• Bitcoin – the original blockchain
• Double-spending, public distributed ledger• Blockchain not defined by Bitcoin.
• A database system in which parties unknown to eachother can jointly maintain and edit in a decentralizedmanner, with no individual party exercising centralcontrol.
• Cheaply maintain a robust consensus.
• Decentralized: no need to trust or rely on a centralizedauthority.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
What is Blockchain?
• Bitcoin – the original blockchain
• Double-spending, public distributed ledger• Blockchain not defined by Bitcoin.
• A database system in which parties unknown to eachother can jointly maintain and edit in a decentralizedmanner, with no individual party exercising centralcontrol.
• Cheaply maintain a robust consensus.
• Decentralized: no need to trust or rely on a centralizedauthority.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
What is Smart Contract?
• Smart contracts are digital contracts allowing termscontingent on decentralized consensus and areself-enforcing and tamper-proof through automatedexecution.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Timeline and Assumption
q realized.
t C decides entry(if not yet).
Sellers quote prices.Buyers shop sellers.
Service outcome realized.
New q realized.
t+1
Assumption 1: In traditional world, no payment can becontingent on whether service delivery occurs or not. Eachseller can only observe his own buyers and associatedtransaction information.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Timeline and Assumption
q realized.
t C decides entry(if not yet).
Sellers quote prices.Buyers shop sellers.
Service outcome realized.
New q realized.
t+1
Assumption 1: In traditional world, no payment can becontingent on whether service delivery occurs or not. Eachseller can only observe his own buyers and associatedtransaction information.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Reputation and Entry
Proposition
In a competitive equilibrium, the first time C can servecustomers is in periodτ ≡ min{t ≥ 0|πqC ,tIt ≥ max{qA,t , qB,t}} or later.Consequently, C never enters if πq < q.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
The Trust Machine
• Assumption 2: New Informational EnvironmentBlockchain enables decentralized consensus, and buyersand sellers can write smart contracts that are contingenton the service outcome associated with their owntransaction. In order to reach decentralized consensus,aggregate service activities are publicly observable onblockchain.
Proposition
With smart contracts, the entrant C enters almost surely, andfirst gets customers in periodτ = min{t ≥ 0|qC ,tIt ≥ max{qA,t , qB,t}} or earlier.
• Greater entry and competition:E[q(1)] > E[max{qA, qB}].
• Welfare and consumer (buyer) surplus are higher.Slide 11/21 — Cong, He, & Zheng — Blockchain Disruption and Smart Contracts
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
The Trust Machine
• Assumption 2: New Informational EnvironmentBlockchain enables decentralized consensus, and buyersand sellers can write smart contracts that are contingenton the service outcome associated with their owntransaction. In order to reach decentralized consensus,aggregate service activities are publicly observable onblockchain.
Proposition
With smart contracts, the entrant C enters almost surely, andfirst gets customers in periodτ = min{t ≥ 0|qC ,tIt ≥ max{qA,t , qB,t}} or earlier.
• Greater entry and competition:E[q(1)] > E[max{qA, qB}].
• Welfare and consumer (buyer) surplus are higher.Slide 11/21 — Cong, He, & Zheng — Blockchain Disruption and Smart Contracts
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Trust-Machine for Collusion
• Collusion using smart contract:
• The same consensus and automated execution can helpincumbents.
• Punishment upon deviation→ any collusion can be sustained.
• Likely prohibited by anti-trust laws.
• Greater public information on service activities.
• Based on the aggregate information, aggregate noisecan be filtered out.
• Can more accurately punish deviations usingcontinuation value.
• Punishment phase: no buyers conditional on buyers’presence.
Proposition
The discount threshold δBlockchain3o ≡ inf f̂ {δBlockchain3(∞,f̂ ) } is
well-defined and satisfies δBlockchain3o < 1. For allδ > δBlockchain3o , there exists a collusion equilibrium withblockchain such that the consumer surplus is lower than thatin any equilibrium in the traditional world.
• Punishment phase: no buyers conditional on buyers’presence.
Proposition
The discount threshold δBlockchain3o ≡ inf f̂ {δBlockchain3(∞,f̂ ) } is
well-defined and satisfies δBlockchain3o < 1. For allδ > δBlockchain3o , there exists a collusion equilibrium withblockchain such that the consumer surplus is lower than thatin any equilibrium in the traditional world.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Blockchain Disruption
Proposition
For m ≥ n ≥ 2, if λ < n−1n , then δTraditional ,no > δBlockchain,mo ,
where m and n indicate the number of colluding sellers withand without blockchain respectively. Consequently for allδ ∈ [δBlockchain,mo , 1), there is no collusion in the traditionalworld with n incumbents, while there can be collusion withblockchain with m sellers that reduces consumer surplus.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Blockchain Disruption
Theorem
The discount threshold δBlockchain3a ≡ supf {δBlockchain3(∞,f̂ ) } is
well-defined and satisfies δBlockchain3a < 1. For allδ > δBlockchain3a , any consumer surplus and welfare attainablein the traditional world can be attained with blockchain, andsome additional equilibria with higher or lower consumersurplus or welfare can also be sustained.
Corollary
The most collusive equilibrium with blockchain, whichgenerates the highest payoff to the sellers, improves socialwelfare but results in strictly lower consumer surplus,compared to any equilibrium outcome in the traditional world.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Blockchain Disruption
Theorem
The discount threshold δBlockchain3a ≡ supf {δBlockchain3(∞,f̂ ) } is
well-defined and satisfies δBlockchain3a < 1. For allδ > δBlockchain3a , any consumer surplus and welfare attainablein the traditional world can be attained with blockchain, andsome additional equilibria with higher or lower consumersurplus or welfare can also be sustained.
Corollary
The most collusive equilibrium with blockchain, whichgenerates the highest payoff to the sellers, improves socialwelfare but results in strictly lower consumer surplus,compared to any equilibrium outcome in the traditional world.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Private Qualities and Allocative Inefficiency
q is privately observed in addition to uncertain authenticity.
Lemma
In the traditional world, sellers will post the same pricepi = k , and the buyer will select (randomly) one of them fortransaction need. The expected buyer’s surplus and socialwelfare per period is E[q]− k .
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Private Qualities and Allocative Inefficiency
q is privately observed in addition to uncertain authenticity.
Lemma
In the traditional world, sellers will post the same pricepi = k , and the buyer will select (randomly) one of them fortransaction need. The expected buyer’s surplus and socialwelfare per period is E[q]− k .
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Equilibrium Contracts and Economic Outcomes
q is privately observed in addition to uncertain authenticity.
Proposition
The smart contracts the sellers offer in equilibrium are all ofthe form (p, p − 1), where p is the price a buyer pays uponsuccess, and 1− p is the compensation a buyer receives uponfailure.
Corollary
Smart contracts fully resolve informational asymmetry in anymarket equilibrium, and welfare and consumer surplus areindependent of whether seller qualities are private or not.
Intro & Background Traditional World Blockchain World Info Asym & Contracts Regulation & Design
Equilibrium Contracts and Economic Outcomes
q is privately observed in addition to uncertain authenticity.
Proposition
The smart contracts the sellers offer in equilibrium are all ofthe form (p, p − 1), where p is the price a buyer pays uponsuccess, and 1− p is the compensation a buyer receives uponfailure.
Corollary
Smart contracts fully resolve informational asymmetry in anymarket equilibrium, and welfare and consumer surplus areindependent of whether seller qualities are private or not.