With a market capitalization of approximately $12 billion and with the price of Bitcoin reaching towards its 2016 high, Bitcoin is both the most established and the most secure cryptocurrency. Its ascendancy has triggered both a great deal of enthusiasm and a fair share of concern.
On the utopian side, optimistic proponents assert that cryptocurrencies will free consumers from the tyranny of their domestic currencies, will force out entrenched financial players and payment systems, will reduce transaction costs for businesses and fees for consumers.
On the dystopian side, pessimistic opponents argue that cryptocurrencies may undermine traditional monetary policy, support illicit activity, or simply cannot meet the speed, scale and privacy requirements of real-world financial applications and marketplaces.
And whatever side of the debate you come out on, cryptocurrencies are here to stay. Bitcoin, although the first, is unlikely to be the last.
In a new MIT working paper written with my colleague at the University of Toronto, Joshua Gans, we argue that cryptocurrencies will affect two key costs in the economy:
- the cost of verifying transactions, and
- the cost of running a network, platform or marketplace.
Markets facilitate the exchange of goods and services between buyers and sellers. For exchanges to be executed correctly, participants need to be able to rely and verify transaction attributes at multiple points in time. Blockchain can lower the cost of performing these audits by automating the process through a well-designed software protocol. When it is combined with a token as in Bitcoin, a blockchain also becomes a powerful way to organize economic activity without the need of traditional intermediaries. Bitcoin is an excellent example of how, as the cost of verification drops dramatically thanks to blockchain technology, new types of transactions, intermediation and business models will become available.
While most intermediaries are here to stay – as they add substantial value to the economy – some of them will have to rethink how they add value to transactions. For example, intermediaries that mostly make money by processing payments may face increased competition from these distributed networks of exchange.
Even central banks will have to reimagine how they achieve their goals in a world where cryptocurrencies are available as an alternative, and in which they can redesign everything from taxation to monetary policy using distributed ledgers. Most of these changes will take a long time to unfold, although recent events like India’s demonetization of the 500 and 1000 rupees notes could fuel growth among digital currencies.
In the long run, blockchain technology has the potential to challenge existing revenue models, incumbent’s market power, and to offer novel opportunities for governments to implement regulation, identity and reputation systems, and the provision of public goods.
Christian Catalini is the Fred Kayne (1960) Career Development, Professor of Entrepreneurship, and Assistant Professor of Technological Innovation, Entrepreneurship, and Strategic Management at the MIT Sloan School of Management.