New research shows Bitcoin economics is improving and moving toward mainstream business

Economic experts from the University College London Blockchain Technology Center, the German Central Bank, the University of Wisconsin, the New School, and others published a paper titled "Economic Progress of Bitcoin" to extract and analyze network payment relationships.

The economists concluded that the Bitcoin economy has grown and matured from an early prototype stage, through a second growth stage characterized by “sin” (i.e., gambling, black markets), to a third stage that has deteriorated dramatically, away from “sin” and toward legitimate enterprise.

The conclusion is not surprising: only a few years ago, blockchain-related headlines used to be dominated by Mt. Gox and Silk Road. Today, it tends to be banks, exchanges and even central banks that are beginning to take steps to learn how to use Bitcoin technology. However, it is interesting to see how this conclusion is reached through in-depth economic analysis.

Bitcoin Magazine spoke with Paolo Tasca, Director of the UCL Centre for Blockchain Technologies, to learn more about the research and the issues surrounding it. Tasca is a fintech economist specializing in peer-to-peer financial systems and systemic risk, former senior research economist at the Deutsche Bundesbank, and author of the book Beyond Banking and Money.

Tasca explained: “Our research begins by aggregating the smallest units of Bitcoin identity (individual addresses) and proceeds to group them into similar business entities, using a testing technique from the literature, which we call ‘superclusters’. A supercluster can be thought of as a similar business entity that captures many individual addresses that are commonly owned or controlled for a specific economic purpose for the same beneficiaries. Most of these important clusters are initially unknown and unclassified.”

“The novelty of our study comes from the Pure User Group (PUG) and Transaction Pattern (TP) analysis, through which we can attribute superclusters to specific business categories and outline the network payment relationship graph.”

The researchers identified four main business categories in the Bitcoin economy: miners, speculative services, black markets, and exchanges. It also includes the three institutions mentioned above: early prototypes, "sin," and legal businesses.

The researchers studied transaction behavior patterns among business categories and their users. The result of this study is a quantitative assessment of the systemic importance of categories in the Bitcoin economy and online payment relationships, with relevant public policy conclusions: the use of Bitcoin for illegal transactions may be exaggerated at present, and any such transactions are likely to be further reduced as the Bitcoin economy continues to mature.

The Centre for Blockchain Technologies (CBT) at University College London (UCL) is a cross-departmental, industry-oriented unit that aims to fund new interdisciplinary research areas in consensus distributed ledgers. UCL CBT - currently comprising over 30 researchers and seven funding departments with three major areas of competence: science and technology, economic and financial policy, and law and regulation - aims to become Europe's leading industry research centre focusing on the impact of Bitcoin technology on socio-economic systems, and promoting a secure, systematic development and adoption of blockchain-based platforms.

Tasca was not free to share information due to confidentiality restrictions. However, he confirmed that UCL-CBT is involved in a UK government program to develop and deploy blockchain technology.

Tasca noted that “specifically, the UCL-CBT is an interaction between: 1) a concrete case study of the work sector and pensions on payment systems, 2) the BoE, FCA on the use of smart contracts for algorithmic regulation and on the design and issuance of digital currencies by central banks, 3) the UCL-CBT is an outgrowth of the Whitechapel Think Tank on distributed ledger technology, and CBT involves several projects at the Alan Turing Institute.”

Tascca pointed out that for blockchain-based fintech, it is best to discuss the timing and challenges. This issue is complex because blockchain technology can be applied in different fields. However, so far, most of the interest has come from the financial industry, and Tasca expects to see more future activities in other industries such as energy, telecommunications, media and healthcare.

“New opportunities will emerge to redesign their business logic,” Tasca told Bitcoin Magazine.

“The main threat I see so far is a lack of ‘technological literacy’: a lack of ability to understand how blockchain works in the world, which hinders the development and spread of the technology. Therefore, a more important educational effort is needed to help blockchain become a mainstream technology used for different business processes: this represents the long-term goal and the objective of UCL-CBT.”

To advance this important educational work, UCL-CBT will host the 2016 International Symposium on P2P Finance in September. Tascca said: “This is the second p2pfisy symposium and it is a unique event in Europe as it brings together academics, regulators and practitioners interested in addressing issues of practical significance of digital currencies and blockchain technology, P2P lending and crowdfunding, digital remittances, mobile banking and mobile payments.

Tasca declined to comment on the recent mishaps surrounding Ethereum and the DAO. He believes that blockchain represents a new technological system, especially through smart contracts, which automate the data access of agents.

Tasca told Bitcoin Magazine: “Speculation (or moral hazard if you will) is a difficult market friction that is currently addressed through traditional organizational structures (which leverage incomplete contracts) and bilateral agreements (which require trust between parties). Now blockchains, smart contracts, and DAOs can eliminate speculation or compete with traditional forms of organizational structures and bilateral agreements. They have many use cases, including trusts, voting, and repossessions. The combination of blockchain and smart contracts creates a platform where individuals can trade, make, and execute contracts of considerable complexity and cost. Through the proper use of automated processes (which are inherently standardized), they can potentially evolve and lead to a loss of market integrity.”

Tasca said, “I just want to point out that our society has been accustomed to failure since the beginning of barter in prehistoric times, and these have not stopped with the advent of more advanced technology and markets. In fact, now, thanks to technology, businesses can be run independently without human intervention in the decision-making process - by machines, which can be intervened by machines, but not without the possibility of failure as a source of business risk.

“It has to be said that in the specific case discussed, many Ethereum developers are also involved in the DAO to some extent, which presents a huge conflict of interest, as those who have the power to change the Ethereum protocol own a stake in one of the main applications, the DAO. The fact that Ethereum is controlled primarily by Vitalik Buterin through his private non-profit organization based in Switzerland, which has received proceeds from Ethereum auctions and the majority of Ethereum development funding to date, could own or control the results of the work.

In summary, the conflict of interest led to a lose-lose outcome: Ethereum, which was also a stakeholder in the DAO, decided to bail out businesses that were “too big to fail.” By releasing it to the market without entering into a debate about the quality of the code review process, this bailout set a precedent that will not be easy to deal with in the future due to speculative moral hazard behavior.

“Perhaps, to bring more transparency, the governance structure of the entire Ethereum community with explicit provisions between all stakeholders should be redesigned according to the pure principles of decentralized autonomous organizations.

“As a side note, the methods used in our study can be applied to the Ethereum blockchain to develop payment networks and include smart contracts and DAOs.

The Bank of England (BOE), which has been much discussed recently, recently published a paper titled “The Macroeconomics of Central Bank-Issued Electronic Money”, which “focuses on the macroeconomic consequences of issuing central bank digital currencies (CBDCs) and shows that digital currencies are truly moving towards mainstream application.

Tasca noted that the article implicitly references the ideas of George Danezis and Sarah Meiklejohn (2015), borrowing from a cryptocurrency framework that decouples the generation of money supply from the maintenance of a transaction ledger, and suggests that central bank certification agencies should act as verifiers. However, as it has been modeled, CBDC is more akin to a "digital cash" solution than a P2P digital currency, and the generation of digital currency is not explicitly stipulated to be issued by the central bank.