Decentralized Crypto-Finance: Blockchains, Automatic Markets, and Algorithmic Trust

A revolutionary set of concepts and underlying technology enablement has arisen in the form of blockchain technology. Blockchains allow the digital payments layer the Internet never had, and more broadly contemplate an era whereby all forms of secure value transfer could take place via the Internet. This includes all monetary assets (the cash or spot market) and all assets and liabilities over any future time frame (the futures and options market, mortgages, debt and equity securities, treasury issuance, and public debt).

The implication is not just that all modes of financial activity could be modernized, but that the very application of finance could be rethought. Scarcity has been the assumption for structuring economic systems for the production and distribution of scarce material goods. This no longer holds in an era of digital services, non-rival goods, and complementarity. Likewise, the governing assumption for the organization of financial systems has been the control or at least prediction of the future value of assets and liabilities. This too could change per the advent of decentralized technology like blockchains. A more rooted assumption that could also change is that any project requires financing, which would necessarily be in the form of debt capital.

One aim is to challenge the monolithic philosophical foundations of financial and economic systems. Within this context, another aim is to investigate the concept of synecdoche as applied to developing a theory of cost, pricing, and valuation that is not derivative of and so many layers away from, but more closely linked to the underlying asset or liability. My thesis is that new mechanisms such as algorithmic trust and automatic markets could allow departure from the mode of finance as currently conceived to alternatives that emphasize access over ownership, topological ranges over point values, and assurity over insufficiency.

Blockchain Financial Networks: Rethinking Risk and Finance with Automated Value Transfer

Internet transfers Information, and now Value
Blockchains are important because they constitute the next phase of the Internet, not just transferring information, but now transferring value: money, assets, and contracts. Blockchains are secure distributed ledgers, which can be implemented as globally-distributed financial networks. Ultimately, blockchain financial networks could automatically and independently confirm and monitor transactions, without central parties like banks or governments.

Fast-moving Crypto-economy
The crypto-economy is evolving quickly and it is crucial to watch and actively participate because
the uptake of blockchains could be extremely rapid, particularly by institutions. The crypto-economy is important to watch because:

1. whereas a year ago crypto-technology was heresy, it is now becoming commonplace
2. blockchains as a modernizing technology have a pervasive reach – including all cash, financial instruments, and contracts in economics and finance; and all legal, legislative, political, and governance operations 
3. the decentralized structure of crypto-technology implies a reorganization of the existing financial system; and eventually, political system

The key benefit of blockchains as a modernizing technology is that they allow assets to be transferred immediately, not taking 3 days to settle (t=0, not t+3). This has a number of efficiency improvements including decreasing counterparty risk, reducing cost, improving liquidity, and instilling trust in the system.

Figure 1. Crypto-economic Theory: Blockchain Financial Networks

Rethinking Risk
Blockchains, crypto-economics, and decentralization invite an explicit reconsideration of risk. Four risk regimes can be identified ranging from 1) traditional mutuality risk models (Lloyd’s of London) to 2) classical portfolio theory (CAPM, efficient frontiers, trinomial tress, value-at-risk) to 3) black swan risk models (more frequent unpredictable outsized events) to now 4) decentralized risk models. As we rethink the world of science through complexity, now too complexity is a model for rethinking risk. Part of the more robust consideration of risk is moving to a conceptualization of causality that is not exclusively straightforward and linear. Complexity math allows a rethinking of risk in decentralized network models of consensus trust.

Rethinking Finance
An institutional crypto-economy also calls into question the definition of finance. Finance can be seen as a spot and future contingency management system for assets and liabilities. In this definition, blockchains are improved form of contingency management, with greater precision, automation, and lower-risk. The Internet becomes a contingency management system with programmable money, smart contracts DACs, and distributed ledger transactions, all contributing to automated value transfer.

Figure 2. Transition: Labor Economy to Automation Economy

Realizing the Automation Economy
Distributed ledgers allow a more serious move into the Automation Economy, via secure value transfer previously unavailable with the Internet. Internet 1.0, the ‘non-secure’ Internet allowed the automation of several sectors such as news, information, entertainment, manufacturing, and to some extent health. Now Internet 2.0 seen as secure value transfer networks could facilitate the automation of the entire economic, money, finance sectors, as well as government, politics, and legal services. What is at stake is a fair and orderly transition from the Labor Economy to the Automation and Actualization Economy.

Automated value transfer is the bigger project of decentralization, algorithmic trust, and the automation economy.