Money, Blockchains, and Social Scalability

The secret to Bitcoin’s success is certainly not its computational efficiency or its scalability in the consumption of resources. Instead, the secret to Bitcoin’s success is that its prolific resource consumption and poor computational scalability is buying something even more valuable: social scalability.

An institution is just a relationship or shared endeavor among participants. Social scalability is the ability to overcome shortcomings in the human mind that limit who or how many can participate in an institution. Institutions generally use customs, rules, or other features to constrain or motivate participants’ behaviors. Social scalability is about technology that allows the variety and numbers of participants in those institutions to grow. It’s about human limitations, not technological limitations or physical resource constraints. Without institutional and technological innovations of the past, participation in shared human endeavors would usually be limited to at most about 150 people—the famous “Dunbar number.”

One way to estimate the social scalability of an institutional technology is by the number of people who can beneficially participate in the institution. Another way to estimate social scalability is by the benefits an institution bestows on its participants as it grows versus the costs it imposes. The cultural and jurisdictional diversity of people who can beneficially participate in an institution is also often important—especially in the global Internet context. The more an institution depends on local laws, customs, or language, the less socially scalable it is. In the internet era, new innovations continue to scale our social capabilities.

Innovations in social scalability involve institutional and technological improvements that move function from mind to paper or mind to machine. They lower cognitive costs while increasing the value of information flowing between minds and reducing vulnerability. They also lower the cognitive costs of searching for and discovering new, mutually beneficial participants. Civilization advances by extending the number of important operations which we can perform without thinking about them.

A wide variety of innovations reduce our vulnerability to fellow participants, intermediaries, and outsiders. They reduce our need to spend our scarce cognitive capacities worrying about how an increasingly large and diverse number of people might behave. They also allow information to flow between minds through spoken and written words, custom (tradition), the contents of law (its rules, customs, and case precedents), a variety of other symbols (i.e. “star” ratings common in online reputation systems), and market prices, among many others. These kinds of innovations have over the course of human history improved social scalability. They have made our modern civilization with its vast global population feasible.

Matchmaking is probably the kind of social scalability at which the Internet has most excelled. Matchmaking is facilitating the mutual discovery of mutually beneficial participants. Social networks like Usenet News, Facebook, and Twitter facilitate the mutual discovery of like-minded or otherwise mutually entertaining or mutually informing people. After they have allowed people to discover each other, social networks then facilitate relationships at various levels of personal investment, from casual to frequent to obsessive. eBay, Uber, AirBnB, and online financial exchanges have also enhanced social scalability through great improvements in commercial matchmaking: searching for, finding, bringing together, and facilitating the negotiation of mutually beneficial commercial or retail deals. These and related services also facilitate “performance” (such as payment, shipping, and verification that the other obligations undertaken by strangers in these deals have been performed). They also communicate the quality of such performances with “star rating” systems, Yelp reviews, and the like.

Whereas the main social scalability benefit of the Internet has been matchmaking, the predominant direct social scalability benefit of blockchains is trust minimization. Trust minimization is reducing the vulnerability of participants to each other’s, outsiders’, and intermediaries’ potential for harmful behavior. Most institutions have undergone a lengthy cultural evolution, such as law (which lowers vulnerability to violence, theft, and fraud), that reduce (on balance) our vulnerabilities to, and thus our need to trust, our fellow humans. In most cases, a sufficiently trustworthy institution (such as a market) depends on its participants trusting another sufficiently trustworthy institution (such as contract law). These trusted institutions in turn traditionally implement a variety controls that make them sufficiently trustworthy (i.e. accountants, lawyers, regulators, and investigators).

A blockchain can reduce vulnerability by locking in the integrity of some important “performances” (i.e. the creation and payment of money) and some important information flows. In the future it may also reduce the vulnerability of the integrity of some important matchmaking functions. Trust in the secret and arbitrarily mutable activities of private computation can be replaced by verifiable confidence in the behavior of a generally immutable public computation. However, an innovation can only partially take away some kinds of vulnerability (i.e. reduce the need for or risk of trust in other people). There is no such thing as a fully trustless institution or technology.

Money and Markets

Money and markets directly benefit the participants in each particular trade. They match a buyer with a mutually beneficial seller using a widely acceptable and standardized “counter-performance” (money). We use markets here in the sense Adam Smith used the term: not as a specific place or service where buyers and sellers are brought together (although it might sometimes involve these), but rather the broad set of typically pairwise exchanges whereby the supply chain that makes a product is coordinated.

Money and markets also incentivize creation of more accurate price signals that reduce negotiation costs and errors for participants in other similar exchanges. The potent combination of money and market thereby allowed a far higher number and variety of participants to coordinate their economic activities than previous exchange institutions, which more resembled bilateral monopolies than competitive markets. Markets and money involve matchmaking (bringing together buyer and seller), trust reduction (trusting in the self-interest rather than in the altruism of acquaintances and strangers), scalable performance (widely acceptable and reusable medium for counter-performance), and quality information flow (market prices).

The greatest early thinker about money and markets was Adam Smith. At the dawn of the industrial revolution in Britain, Smith observed in The Wealth of Nations how making even the most humble of products depended, directly and indirectly, on the work of large numbers of a variety of people:

Observe the accommodation of the most common artificer or day-laborer in a civilized and thriving country, and you will perceive that the number of people whose industry a part, though a small part, has been employed in procuring him this accommodation, exceeds all computation. The woolen coat, for example, which covers the day laborer, as coarse and rough as it may appear, is the produce of the joint labor of a great multitude of workmen. The shepherd, the sorter of the wool, the wool-comber or carder, the dyer, the scribbler, the spinner, the weaver, the fuller, the dresser, with many others, must all join their different arts in order to complete even this homely production. How many merchants and carriers, besides, must have been employed in transporting the materials from some of those workmen to others who often live in a very distant part of the country! How much commerce and navigation in particular, how many shipbuilders, sailors, sail makers, rope makers, must have been employed in order to bring together the different drugs made use of by the dyer, which often come from the remotest corners of the world! What a variety of labor, too, is necessary in order to produce the tools of the meanest of those workmen! To say nothing of such complicated machines as the ship of the sailor, the mill of the fuller, or even the loom of the weaver, let us consider only what a variety of labor is requisite in order to form that very simple machine, the shears with which the shepherd clips the wool. The miner, the builder of the furnace for smelting the ore, the feller of the timber, the burner of the charcoal to be made use of in the smelting-house, the brick maker, the brick layer, the workmen who attend the furnace, the millwright, the forger, the smith, must all of them join their different arts in order to produce them. Were we to examine, in the same manner, all the different parts of his dress and household furniture, the coarse linen shirt which he wears nest his skin, the shoes which cover his feet, the bed which he lies on, and all the different parts which compose it, the kitchen grate at which he prepares his victuals, the coals which makes use of for that purpose, dug from the bowels of the earth, and brought to him perhaps by a long sea and a long land carriage, all the other utensils of his kitchen, all the furniture of his table, the knives and forks, the earthen or pewter plates upon which he serves up and divides his victual, the different hands employed in preparing his bread and his beer, the glass window which lets in the heat and the light, and keeps out the wind and the rain, with all the knowledge and art requisite for preparing that beautiful and happy invention, without which these northern parts of the world could scarce have afforded a very comfortable habitation, together with the tools of all the different workmen employed in producing those different conveniences; if we examine, I say, all these things, and consider what a variety of labor is employed about each of them, we shall be sensible that without the assistance and co-operation of many thousands, the very meanest person in a civilized country could not be provided, even according to what we may falsely imagine the easy and simple manner in which he is commonly accommodated.

And this was before the many successive waves of industrial revolution and globalization between 1776 and now that refined, elaborated, and extended the division of labor many times more. Rather than trusting in the unlikely altruism of so many strangers, markets and money create many pairings of mutual benefit and thus motivate this large network of mutually oblivious people to act in our interests:

In civilized society man stands at all times in need of the cooperation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons… In contrast to other animals, man has an almost constant occasion for the help of his brethren, and it is vain for him to expect it from their benevolence only. [Exchange is the] manner in which we obtain from another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard for their own interest.

Smith goes on to describe how division of labor, and thus labor productivity, depends on the extent of the network of pairwise exchange. As the exchange network around a country and around the globe grows, involving a greater number and variety of producers, so grows the division of labor and thereby labor activity.

Money facilitates social scalability by increasing the opportunities for this exchange. By lowering coincidence problems via a widely acceptable and reusable form of wealth storage and transfer, money greatly lowered transaction costs, making possible more exchanges of a greater variety of goods and services involving exchanges and other wealth transfer relationships with a much larger number and much wider variety of people.

Money, markets, and the resultant price networks further facilitate social scalability. One of the most knowledgeable observations of the price network produced by markets and money can be found in Friedrich Hayek’s essay, “The Use of Knowledge in Society”:

In a system in which the knowledge of the relevant facts is dispersed among many people, prices can act to coordinate the separate actions of different people . . . In any society in which many people collaborate, this planning, whoever does it, will in some measure have to be based on knowledge which, in the first instance, is not given to the planner but to somebody else, which somehow will have to be conveyed to the planner. The various ways in which the knowledge on which people base their plans is communicated to them is the crucial problem for any theory explaining the economic process, and the problem of what is the best way of utilizing knowledge initially dispersed among all the people is at least one of the main problems of economic policy—or of designing an efficient economic system . . . The mere fact that there is one price for any commodity—or rather that local prices are connected in a manner determined by the cost of transport etc.—brings about the solution which (it is just conceptually possible) might have been arrived at by one single mind possessing all the information which is in fact dispersed among all the people involved in the process . . . The marvel is that in a case like that of a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; i.e., they move in the right direction . . . The price system is just one of those formations which man has learned to use (though he is still very far from having learned to make the best use of it) after he had stumbled upon it without understanding it. Through it not only a division of labor but also a coordinated utilization of resources based on an equally divided knowledge has become possible . . . a solution is produced by the interactions of people each of whom possesses only partial knowledge.

Blockchains and Cryptocurrencies

Scalable markets and prices require scalable money. Scalable money requires scalable security, so that a greater number and variety of people can use the currency without losing its integrity against forgery, inflation, and theft.

An individual or group communicating under the name “Satoshi Nakamoto” brought Bitcoin to the Internet in 2009. Satoshi’s breakthrough with money was to provide social scalability via trust minimization: reducing vulnerability to counterparties and third parties alike. By substituting computationally expensive but automated security for computationally cheap but institutionally expensive traditional security, Satoshi gained a nice increase in social scalability. A set of partially trusted intermediaries replaces a single and fully trusted intermediary.

Decentralization per computer science is much more automated and secure than traditional security. When we can secure the most important functionality of a financial network by computer science rather than by traditional accountants, regulators, investigators, police, and lawyers, we go from a system that is manual, local, and of inconsistent security to one that is automated, global, and much more secure. Cryptocurrencies, when implemented properly on public blockchains, can substitute an army of computers for a large number of traditional banking bureaucrats. These block chain computers will allow us to put the most crucial parts of our online protocols on a far more reliable and secure footing. They make possible fiduciary interactions that we previously dared not do on a global network.

The characteristics most distinctively valuable in blockchain technology in general, and bitcoin in particular—for example:

  1. Independence from existing institutions for its basic operations
  2. Ability to operate seamlessly across borders

—come from the high levels of security and reliability a blockchain can maintain without human intervention. Without that high security, it’s just a gratuitously wasteful distributed database technology still tied to the local bureaucracies it would have to depend upon for its integrity.

Since the mid-20th century, computing has increased in efficiency by many orders of magnitude, but humans are using the same brains. This has created plenty of possibility for overcoming human limitations by replacing some human functions with computational ones.

Computers and networks are cheap. Scaling computational resources requires cheap additional resources. Scaling human traditional institutions in a reliable and secure manner requires increasing amounts of accountants, lawyers, regulators, and police, along with the increase in bureaucracy, risk, and stress that such institutions entail. Lawyers are costly. Regulation is to the moon. Computer science secures money far better than accountants, police, and lawyers.

In computer science, there are fundamental security vs. performance tradeoffs. Bitcoin’s automated integrity comes at high costs in its performance and resource usage. These necessary tradeoffs—sacrificing performance in order to achieve the security necessary for independent, seamlessly global, and automated integrity—mean that the Bitcoin blockchain itself cannot possibly come anywhere near Visa transaction-per-second numbers and maintain the automated integrity that creates its distinctive advantages versus these traditional financial systems. Instead, a less trust-minimized peripheral payment network (possibly Lightning) will be needed to bear a larger number of lower-value bitcoin-denominated transactions than Bitcoin blockchain is capable of. The Bitcoin blockchain would then be used to periodically settle with high-value transaction batches of peripheral network transactions.

When it comes to “small-b” bitcoin (the currency), there is nothing impossible about paying retail with bitcoin the way you’d pay with a fiat currency—bitcoin-denominated credit and debit cards, for example, with all the chargeback and transactions-per-second capabilities of a credit or debit card. And there are also clever ways to do peripheral bitcoin retail payments in which small value payments happen off-chain and are only periodically bulk-settled on the “Capital-B” Bitcoin blockchain. That blockchain is going to evolve into a high-value settlement layer as bitcoin use grows, and we will see peripheral networks being used for small-b bitcoin retail transactions.

Money requires social scalability in its design, via security. For example, it should be very hard for any participant or intermediary to forge money (to dilute the supply curve leading to undue or unexpected inflation). Gold can have value anywhere in the world and is immune from hyperinflation because its value doesn’t depend on a central authority. Bitcoin excels at both these factors and runs online, enabling somebody in Albania to use Bitcoin to pay somebody in Zimbabwe with minimal trust in (and no payment of quasi-monopoly profits to) intermediaries or third parties.

Bitcoin’s socially scalable security, based on computer science rather than police and lawyers, allows, for example, customers in Africa to pay suppliers in China seamlessly across borders. A private blockchain cannot accomplish this feat nearly as easily, since it would require an identification scheme, certificate authority, and PKI shared between these various jurisdictions.

Satoshi’s brilliant tradeoff is to greatly sacrifice computational scalability in order to improve social scalability. It is brilliant because humans are far more expensive than computers and that gap widens further each year. And it is brilliant because it allows one to seamlessly and securely work across human trust boundaries (i.e. national borders), in contrast to “call-the-cop” architectures like PayPal and Visa that continually depend on expensive, error-prone, and sometimes corruptible bureaucracies to function with a reasonable amount of integrity.

The rise of the internet has seen the rise of a variety of online institutions, among them social networks, “long-tail” retail (i.e. Amazon), and a variety of other services that allow small and dispersed buyers and sellers to find and do business with each other (i.e. eBay, Uber, Airbnb, etc.). These are just the initial attempts to take advantage of our new abilities. Due to the massive improvements in information technology over recent decades, the number and variety of people who can successfully participate in an online institution is far less often restricted by the objective limits of computers and networks than it is by limitations of mind and institution that have usually not yet been sufficiently redesigned or further evolved to take advantage of those technological improvements.

These initial Internet efforts have been very centralized. Blockchain technology, which implements data integrity via computer science rather than via “call the cops”, has so far made possible trust-minimized money, and it will let us make progress in other financial areas. Generally speaking, it will let us make progress in areas where transactions can be based primarily on data available online.

This is not to say that adapting our institutions to the new capabilities will be easy, or in particular cases, anything short of difficult and improbable. Utopian schemes are very popular in the blockchain community, but they are not viable options. Reverse-engineering our highly evolved traditional institutions, and even reviving in new form some old ones, will usually work better than grand planning and game theory. One important strategy for doing so was demonstrated by Satoshi—sacrifice computational efficiency and scalability to reduce and better leverage the great expense in human resources need to maintain the relationships between strangers involved in modern institutions such as markets, large firms, and governments.