Cryptoeconomics — Part I

This is the first release of my blog series “Cryptoeconomics”. This time, I will attempt to lay out the core ideas of the Austrian School of Economics and its influence on the development of Cryptoeconomics.

It’s no secret to anyone (unless you were living under a rock for the past 10 years) that Vienna, the capital of Austria, is constantly on the top of the lists of the most livable cities in the world. This recognition is something that has its merits and considering that I have been living in the city for the past 6 years, I can testify about its validity.

Most of those lists describe the social achievements of the city, however, few of them address the economic ideas that helped the country reach this status.

“The city is home to one of the most compelling schools of economic thought, known as the Austrian School of Economics.”

Located at the heart of Europe, Austria is one of the wealthiest countries in the European Union and besides having significative competences in business with Eastern European countries due to the capital's historical role as the center of the Habsburg Empire, the influence of the Austrian School of Economics and the focus of the policy-makers on the individual is, in my opinion, one of the main reasons why the city’s social policies have been so successful, and most probably will maintain its position as the best city to live in the world.

Austrian School of Economics

The city is home to one of the most compelling schools of economic thought, known as the Austrian School of Economics. It is relevant to point out that the Austrian School of Economics is not an ideology but a way of scientific thinking.

The Austrian School of Economics originated in late-19th and early-20th century in Vienna, with the work of several important economists like the Nobel Prize Winner Friedrich August von Hayek, who made pioneering work in the theory of money and economic fluctuations, performing deep analysis of the interdependence of economic, social and institutional phenomena. The School has its origins at the University of Vienna, being one of the best universities in middle Europe, we can find 15 Nobel Prize Laureates Winners between its alumni.

The Austrian School of Economics focuses on the study of purposeful human action, everything happening in an economy is driven by human beings thus all the outcomes of the economy should be viewed as “casual realism”. Ludwig von Mises, another important economist of this school, insisted that economists shouldn’t use the methods of physicists by coming up with hypotheses and subjecting them to empirical tests. On the contrary, Mises thought that the core body of economic theory could be logically deduced from the axiom of “human action” i.e., the insight or viewpoint that there are other conscious beings using their reason to achieve subjective goals. At every moment we make decisions upon which we act, but economics is not concerned with the psychology of such choices but with which actions were actually chosen. Carl Menger (its founder), during his first research years, he was able to interact directly in the economy by talking to entrepreneurs and investors, this gave him the insights which he put forward in his work about the “Subjective theory of value”.

There are three main contributions of this school of thought:

1. Methodological individualism

Methodological individualism is the methodological framework in which individuals are seen as the agents of actions and values that form social phenomena.

2. Value is subjective

Value is subjective, the values are based on subjective preferences which we can not measure, thus mathematical models are useless to predict human actions. For those actions are called “demonstrated preference” or “revealed preference”.

3. Time preferences

Time preferences refer to the intensity of our desires to satisfy our “wants” now over satisfying our “wants” in the future.

Being a school of thought that promotes free market and low government intervention, it has become very popular between the Blockchain community.

The surging of a new type of Economy

150 years after the founding of the Austrian School of Economics, due to the rise and potential of the blockchain technology, many governments, companies and academic institutions around the world are gathering research teams that allow them to understand the technical and economic implications of this technology, considering that after the invention of the internet, it is said that Blockchain is causing the fourth industrial revolution, and of course, Austria couldn’t be the exception.

The University of Vienna has recently opened the Research Institute for Cryptoeconomics, which is currently being lead by Dr. Shermin Voshmgir and Prof. Alfred Taudes. Prof. Taudes also leads the world’s largest Blockchain Competence Center, which has been recently approved and supported by the Austrian Research Promotion Agency (FFG).

Another research institution that is making great progress in blockchain research is the RIAT institute, which is an independent institute working with future cryptoeconomics, privacy technologies and open hardware. Matthias Tarasiewicz, RIAT’s Director, mentions the following sentence in their Future Cryptoeconomics Magazine Issue #1:

There is a strong need for “cryptoeconomic literacy”, but more importantly there must be an emphasis on the interaction and communication between both institutions and informal communities (“where the action is”) to further the research into and development of new amalgamations of social and organizational structures.”

Robby Schwertner and enliteAI prepared a very nice overview of companies and organizations that are leading the development of blockchain solutions in Austria (2018):

Behavioral Cryptoeconomics

Behavioral Cryptoeconomics usually refers to the study of human action within tokenized systems, and to the different incentive models that can be implemented in order to guarantee a healthy, sustainable, low volatile ecosystem.

Generally, the prices of cryptocurrencies or tokens are determined by the standard economic laws of supply and demand. However, it is obvious that other factors like news and rumors affect the behavior of the cryptocurrency market in general.

Wikipedia

As the demand for a token increase, the price goes up. In contrast, the greater the supply and the lower the demand and thus, the lower the price of the token will be. This is a theory that works under controlled environments, however, in the current cryptocurrency market, this does not apply as expected due to the different decisions of each of the participants, and for the distortion caused by lack of information.

In finance, Reflexivity Theory explains why the markets behave the way they do. The core idea of the reflexivity theory says that 1. The participants of an ecosystem have a distorted view of the world. These distortions influence the decision making of the individuals leading to wrong views thus causing wrong actions.

Incentive Models

Satoshi Nakamoto understood perfectly that the only way to create an ecosystem that is sustainable in the long term, there has to be an incentive system that keeps the involved participants motivated to participate in it. In the case of Bitcoin, “mining” was the chosen instrument. Below you will find the top 3 Incentive Models that can be applied to basically any distributed system.

Tokens: The active participants that contribute to the blockchain receive cryptocurrencies for their efforts. They can be obtained by mining, airdrops, ICOs, and other strategies.
Rights and Responsibilities: Actors and holders of tokens get decision-making rights which gives them the right for example to vote.
Punishments: Participants have to pay a monetary fine or they have their rights taken away for behaving badly or attempting illegal moves.

Conclusion

After the recent popularity, within the blockchain community, of the ideas put forward by the Austrian School of Economics, where the individual plays the main role in the economy, it is clear that Austria is still committed to continuing with its tradition of supporting innovative research and development, by betting for a decentralized future. This will certainly be putting the country in the frontline of the most innovative countries in the European Union.

Further Reading

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Economist, researching crypto.