Blockchain and Tokenomics Lin William Cong University of Chicago
April 2018
Two Research Themes 1
What is blockchain? How does it work? • Decentralized consensus (not just mining games in
Bitcoin). • Protocol Designs: PoW, PoS, PBFT, Private, Public,
Permissioned, etc. • Market outcomes, organization, and evolution: mining
pools, transaction fees, etc. 2
What are its economic impacts and implications? • Payments, Trade Finance, Auditing, Clearing and
Exchange, Cryptocurrencies, ICOs, etc. • What are the unique/novel insights?
Slide 1/13 — Lin William Cong — Blockchain and Tokenomics
Two Research Themes 1
What is blockchain? How does it work? • Decentralized consensus (not just mining games in
Bitcoin). • Protocol Designs: PoW, PoS, PBFT, Private, Public,
Permissioned, etc. • Market outcomes, organization, and evolution: mining
pools, transaction fees, etc. 2
What are its economic impacts and implications? • Payments, Trade Finance, Auditing, Clearing and
Exchange, Cryptocurrencies, ICOs, etc. • What are the unique/novel insights?
Slide 1/13 — Lin William Cong — Blockchain and Tokenomics
What is Blockchain? • A database system in which parties unknown to each
other jointly maintain and edit in a decentralized manner, with no individual party exercising central control. • Consensus: • Societies need robust & contractible consensus. • Centralized provision needs trust can be
fragile/expensive. • Decentralized consensus 1
Prevent single point of failure: safe, tamper-proof,...
2
No centralized authority (and hefty rents).
Slide 2/13 — Lin William Cong — Blockchain and Tokenomics
What is Blockchain? • A database system in which parties unknown to each
other jointly maintain and edit in a decentralized manner, with no individual party exercising central control. • Consensus: • Societies need robust & contractible consensus. • Centralized provision needs trust can be
fragile/expensive. • Decentralized consensus 1
Prevent single point of failure: safe, tamper-proof,...
2
No centralized authority (and hefty rents).
Slide 2/13 — Lin William Cong — Blockchain and Tokenomics
What is Blockchain? • A database system in which parties unknown to each
other jointly maintain and edit in a decentralized manner, with no individual party exercising central control. • Consensus: • Societies need robust & contractible consensus. • Centralized provision needs trust can be
fragile/expensive. • Decentralized consensus 1
Prevent single point of failure: safe, tamper-proof,...
2
No centralized authority (and hefty rents).
Slide 2/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Consensus: An Elusive Dream?
• Innovation in incentive provision: PoW, PoS, PBFT, ... • Record-keepers, miners, organization & community. • Decentralization costs/“Centralizing” forces: • Cost channel: energy consumption, social waste,
sustainability. • Legal channel, technical channel, etc. • Risk-sharing channel: Risky rewards and risk aversion • Information channel: Consensus Generation and
Distributing Information
Slide 3/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Consensus: An Elusive Dream?
• Innovation in incentive provision: PoW, PoS, PBFT, ... • Record-keepers, miners, organization & community. • Decentralization costs/“Centralizing” forces: • Cost channel: energy consumption, social waste,
sustainability. • Legal channel, technical channel, etc. • Risk-sharing channel: Risky rewards and risk aversion • Information channel: Consensus Generation and
Distributing Information
Slide 3/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Consensus: An Elusive Dream?
• Innovation in incentive provision: PoW, PoS, PBFT, ... • Record-keepers, miners, organization & community. • Decentralization costs/“Centralizing” forces: • Cost channel: energy consumption, social waste,
sustainability. • Legal channel, technical channel, etc. • Risk-sharing channel: Risky rewards and risk aversion • Information channel: Consensus Generation and
Distributing Information
Slide 3/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Consensus: An Elusive Dream?
• Innovation in incentive provision: PoW, PoS, PBFT, ... • Record-keepers, miners, organization & community. • Decentralization costs/“Centralizing” forces: • Cost channel: energy consumption, social waste,
sustainability. • Legal channel, technical channel, etc. • Risk-sharing channel: Risky rewards and risk aversion • Information channel: Consensus Generation and
Distributing Information
Slide 3/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Consensus: An Elusive Dream?
• Innovation in incentive provision: PoW, PoS, PBFT, ... • Record-keepers, miners, organization & community. • Decentralization costs/“Centralizing” forces: • Cost channel: energy consumption, social waste,
sustainability. • Legal channel, technical channel, etc. • Risk-sharing channel: Risky rewards and risk aversion • Information channel: Consensus Generation and
Distributing Information
Slide 3/13 — Lin William Cong — Blockchain and Tokenomics
Blockchain Disruption and Smart Contracts • Information Channel and IO Impact: Cong and He
(2018) • Decentralization can increase the effectiveness of
consensus. • Smart contracts are digital contracts allowing terms
contingent on decentralized consensus (and are self-enforcing and tamper-proof through automated execution). • Enhanced contractibility through smart contracts and
decentralized consensus • Encourages entry and competition.
Slide 4/13 — Lin William Cong — Blockchain and Tokenomics
Blockchain Disruption and Smart Contracts • Information Channel and IO Impact: Cong and He
(2018) • Decentralization can increase the effectiveness of
consensus. • Smart contracts are digital contracts allowing terms
contingent on decentralized consensus (and are self-enforcing and tamper-proof through automated execution). • Enhanced contractibility through smart contracts and
decentralized consensus • Encourages entry and competition.
Slide 4/13 — Lin William Cong — Blockchain and Tokenomics
Blockchain Disruption and Smart Contracts • Information Channel and IO Impact: Cong and He
(2018) • Decentralization can increase the effectiveness of
consensus. • Smart contracts are digital contracts allowing terms
contingent on decentralized consensus (and are self-enforcing and tamper-proof through automated execution). • Enhanced contractibility through smart contracts and
decentralized consensus • Encourages entry and competition.
Slide 4/13 — Lin William Cong — Blockchain and Tokenomics
Blockchain Disruption and Smart Contracts • Information Channel and IO Impact: Cong and He
(2018) • Decentralization can increase the effectiveness of
consensus. • Smart contracts are digital contracts allowing terms
contingent on decentralized consensus (and are self-enforcing and tamper-proof through automated execution). • Enhanced contractibility through smart contracts and
decentralized consensus • Encourages entry and competition.
Slide 4/13 — Lin William Cong — Blockchain and Tokenomics
Information Distribution • Bank of Canada Jasper Project, Chapman et.al. (2017)
“More robust data verification requires wider sharing of information. The balance required between transparency and privacy poses a fundamental question to the viability of the system for such uses once its core and defining feature is limited.” • Brazilian central bank, Burgos et. al. (2017): just
encrypting sensitive data is not a viable solution because smart contracts then cannot function properly. Using trusted nodes impairs the resiliency of the system. • “...the technology really facilitates is Cartel management
for groups that don’t trust each other but which still need to work together....”, Financial Times, May 2015 • Impact on industrial organization: greater collusion. Slide 5/13 — Lin William Cong — Blockchain and Tokenomics
Information Distribution • Bank of Canada Jasper Project, Chapman et.al. (2017)
“More robust data verification requires wider sharing of information. The balance required between transparency and privacy poses a fundamental question to the viability of the system for such uses once its core and defining feature is limited.” • Brazilian central bank, Burgos et. al. (2017): just
encrypting sensitive data is not a viable solution because smart contracts then cannot function properly. Using trusted nodes impairs the resiliency of the system. • “...the technology really facilitates is Cartel management
for groups that don’t trust each other but which still need to work together....”, Financial Times, May 2015 • Impact on industrial organization: greater collusion. Slide 5/13 — Lin William Cong — Blockchain and Tokenomics
Information Distribution • Bank of Canada Jasper Project, Chapman et.al. (2017)
“More robust data verification requires wider sharing of information. The balance required between transparency and privacy poses a fundamental question to the viability of the system for such uses once its core and defining feature is limited.” • Brazilian central bank, Burgos et. al. (2017): just
encrypting sensitive data is not a viable solution because smart contracts then cannot function properly. Using trusted nodes impairs the resiliency of the system. • “...the technology really facilitates is Cartel management
for groups that don’t trust each other but which still need to work together....”, Financial Times, May 2015 • Impact on industrial organization: greater collusion. Slide 5/13 — Lin William Cong — Blockchain and Tokenomics
Information Distribution • Bank of Canada Jasper Project, Chapman et.al. (2017)
“More robust data verification requires wider sharing of information. The balance required between transparency and privacy poses a fundamental question to the viability of the system for such uses once its core and defining feature is limited.” • Brazilian central bank, Burgos et. al. (2017): just
encrypting sensitive data is not a viable solution because smart contracts then cannot function properly. Using trusted nodes impairs the resiliency of the system. • “...the technology really facilitates is Cartel management
for groups that don’t trust each other but which still need to work together....”, Financial Times, May 2015 • Impact on industrial organization: greater collusion. Slide 5/13 — Lin William Cong — Blockchain and Tokenomics
The evolution of Bitcoin mining pool size shares
Slide 6/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Mining in Centralized Pools • Risk-Sharing Channel: Cong, He, and Li (2018) • Decentralization cannot be taken for granted. • PoW in Bitcoin makes decentralization a technological
possibility, but does not guarantee it as an economic reality. • Miners pool instead of mining solo, and mining pools
gain significant shares of global hash rates. • Risk-sharing naturally leads to centralization.
• Centralization vs Decentralization • A Modigliani-Miller-type insight on diversification. • Concentration-limiting force due to IO.
Slide 7/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Mining in Centralized Pools • Risk-Sharing Channel: Cong, He, and Li (2018) • Decentralization cannot be taken for granted. • PoW in Bitcoin makes decentralization a technological
possibility, but does not guarantee it as an economic reality. • Miners pool instead of mining solo, and mining pools
gain significant shares of global hash rates. • Risk-sharing naturally leads to centralization.
• Centralization vs Decentralization • A Modigliani-Miller-type insight on diversification. • Concentration-limiting force due to IO.
Slide 7/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Mining in Centralized Pools • Risk-Sharing Channel: Cong, He, and Li (2018) • Decentralization cannot be taken for granted. • PoW in Bitcoin makes decentralization a technological
possibility, but does not guarantee it as an economic reality. • Miners pool instead of mining solo, and mining pools
gain significant shares of global hash rates. • Risk-sharing naturally leads to centralization.
• Centralization vs Decentralization • A Modigliani-Miller-type insight on diversification. • Concentration-limiting force due to IO.
Slide 7/13 — Lin William Cong — Blockchain and Tokenomics
Decentralized Mining in Centralized Pools • Risk-Sharing Channel: Cong, He, and Li (2018) • Decentralization cannot be taken for granted. • PoW in Bitcoin makes decentralization a technological
possibility, but does not guarantee it as an economic reality. • Miners pool instead of mining solo, and mining pools
gain significant shares of global hash rates. • Risk-sharing naturally leads to centralization.
• Centralization vs Decentralization • A Modigliani-Miller-type insight on diversification. • Concentration-limiting force due to IO.
Slide 7/13 — Lin William Cong — Blockchain and Tokenomics
Empirical evidence: results
Slide 8/13 — Lin William Cong — Blockchain and Tokenomics
Empirical evidence: results
Slide 8/13 — Lin William Cong — Blockchain and Tokenomics
Tokenomics: Dynamic Adoption and Valuation • Cryptocurrency and Token Valuation: Cong, Li, & Wang
(2018a) • Required means of payments for
platforms/decentralized networks. • Network externality. • Security token versus utility token. • Capitalization of future system growth as a store of
value. • Feedback loop accelerates adoption and technology
progress.
Slide 9/13 — Lin William Cong — Blockchain and Tokenomics
Tokenomics: Dynamic Adoption and Valuation • Cryptocurrency and Token Valuation: Cong, Li, & Wang
(2018a) • Required means of payments for
platforms/decentralized networks. • Network externality. • Security token versus utility token. • Capitalization of future system growth as a store of
value. • Feedback loop accelerates adoption and technology
progress.
Slide 9/13 — Lin William Cong — Blockchain and Tokenomics
Coin Pricing Formula
A dAt = At µA t dt + At σt dZt ,
dPt = Pt µPt dt + Pt σtP dZt , 1
Pt =
At M
β
Nt user base
r−
1−β µPt price appreciation
Slide 10/13 — Lin William Cong — Blockchain and Tokenomics
Z
r
∞
eu
θ −θu2 du e π
!
ut average participant productivity
,
Adoption Dynamics with and without Coins
Slide 11/13 — Lin William Cong — Blockchain and Tokenomics
Moderation of Community Size Volatility
Slide 12/13 — Lin William Cong — Blockchain and Tokenomics
Tokenomics: Coin Offerings and Business Acceleration • Initial Coin Offerings: Cong, Li, & Wang (2018b) • Tokens can accelerate platform growth and ensure
continuity. • Incentives for investors and (dispersed) contributors to
improve anchoring technology. • Benchmark: angel/venture investing, not IPOs. • Limited signaling through retention, pooling equilibria,
and frauds. • Speculative bubbles and stable coins.
Slide 13/13 — Lin William Cong — Blockchain and Tokenomics
Tokenomics: Coin Offerings and Business Acceleration • Initial Coin Offerings: Cong, Li, & Wang (2018b) • Tokens can accelerate platform growth and ensure
continuity. • Incentives for investors and (dispersed) contributors to
improve anchoring technology. • Benchmark: angel/venture investing, not IPOs. • Limited signaling through retention, pooling equilibria,
and frauds. • Speculative bubbles and stable coins.
Slide 13/13 — Lin William Cong — Blockchain and Tokenomics