Cryptoeconomics and Mechanism Design

5 ways humans will interact with cryptocurrencies differently than fiat.

Psychologists will need to spend more time assessing the unique cognitive quirks that govern the realm of cryptoeconomics. To be sure, the same mental heuristics that gave rise to behavioral economics will ring true of digital currencies. Still, dismissing the usefulness of behavioral cryptoeconomics as a sub-discipline would be foolish. I’ve outlined five important aspects of digital currencies that represent a point of departure from how humans are likely to interact with fiat currencies.

1. Privatized utility tokens will be common.

Many view digital currencies today as a speculative asset. They are the stuff that rich people risk “investing” in to hopefully make long-term gains. Generally, however, lay people are risk averse, preferring small, immediate gratifications over long-term gains.

Risk aversion: the tendency, when choosing between alternatives, to avoid options that entail a risk of loss, even if that risk is relatively small.

Temporal discounting: the tendency to prefer small rewards received sooner to larger ones received later

Because of this, coins which can be used for the immediate exchange of value with a particular digital goods retailer may flourish early on. Specifically, these digital goods must be ubiquitous, so that token purchasers don’t feel there will ever be a substantial fall in demand. I predict that stable digital goods that are ripe for tokenization include bandwidth, storage, computation, and the media that drives demand for them.

We are already seeing much of this taking place. Bitcoin’s second developer, Martti ‘Sirius’ Malmi is developing a new cryptocurrency, AXE, which tokenizes bandwidth. FileCoin is tokenizing storage. Even pirates are gearing up to tokenize movie bounties. These sorts of utility tokens are likely to be interacted with regularly, while general-purpose coins, such as Bitcoin, will be used as a medium to exchange between utility tokens.

Behavioral cryptoeconomists will need to study the effects of risk aversion and temporal discounting in the adoption of speculative cryptocurrencies, as well as non-speculative utility tokens. To what degree do these phenomena predict the differential adoption of these distinct types of currencies?

2. Debt, in the current sense, will be out of fashion.

Cryptocurrencies that are under-girded by the blockchain did the hard work of fixing the double-spending problem. The side effect, however, is that debt cannot be created. How will people interact with digital currencies that no longer enable institutional debt? This may push loans to the fiat margins. Ironically, if fiat becomes a dumping ground for debt, the tables may turn and fiat may take on the volatile, magic dust, based-on-nothing connotation that Bitcoin once carried. Within the context of programmable money, however, people may be nudged to make more responsible financial decisions. Self-awareness is a powerful tool for behavioral change, and the immediacy of financial transactions on a public ledger and private wallet are a good recipe. People will likely check their digital wallets in real time to ensure that their transaction won’t be embarrassingly denied in a check-out line.

But, deeper than that, it removes the effects of delayed discounting and the mental gymnastics of compounding interest that currently plague the majority of financially illiterate Americans. If inflation is not an issue, making decisions about retirement and savings are far more straightforward. These mechanics mean that the rich and the poor are on a level playing field when it comes to wealth distribution, and that economic classes are more fluid than fiat economies currently allow for. To what degree does the removal of debt impact the experience of economic stereotype threat from those in poverty?

Stereotype threat: an individual’s expectation that negative stereotypes about his or her member group will adversely influence others’ judgments of his or her performance and that a poor performance will reflect badly on the member group. This expectation may undermine the individual’s actual ability to perform well.

3. Digital currencies can embrace additive-only ledgers.

I have predicted before that cryptocurrencies will give rise to additive-only economies. By this I mean that transactions will look like an addition of currency to the goods distributor without any subtraction of currency from the goods consumer. You go into a store to pick up milk, the store gets currency points, and you walk out with the same amount of currency points as before, plus you have milk. This may sound far away still, but you are likely transacting with the making of such economies already.

Let’s say that you post on Reddit a bunch. Over time, your contributions give you a certain amount of reputational power. This reputational power represents a value store that can be tapped into infinite times within the network. On StackOverflow, if you contribute enough, you gain access to upvoting rights that you can use repeatedly, without reputation points being subtracted. Or, if you travel on Carnival Cruise Lines enough, you can become a platinum Travel Club member that gives you priority access to the ship and free water bottles every single time you travel. You don’t lose the priority by “cashing it in.”

Consider the win-win incentives involved here. Future digital currencies know that their value is highest when their network is large. So, they want you to enter and stay in their network. By giving you cumulative currency points, they incentivize you to stay and enjoy all the perks that your involvement has unlocked. The more people that stay and are active in the currency network, the more attractive the currency network is to others as well.

This eradicates loss aversion in the traditional sense of the term. Behavioral cryptoeconomists need to explore whether upward social comparisons of wealth represent any sense of loss in the consumer. If I make someone richer, do I experience the shifting relative wealth between the two of us as a loss? Or, what does human exchange look like when scarcity and loss are no longer relevant? Are humans superstitious of post-scarce exchanges? Will people avoid additive-only economies because it places too heavy of a moral burden on their sense of reciprocity? Or, will free-riding plague the system? Is there a line between exchanges versus gifts, and how will this blurry line effect mental accounting?

Reciprocity: the social standard that people who help others will receive equivalent benefits from them in return.

Mental accounting: people track their income and expenditures by grouping them into categories which influence how their economic activities are perceived. For example, a person who finds that a $10 bill is missing while waiting in line to buy a $10 theater ticket is likely to buy the ticket anyway, whereas the same person might be unwilling to spend another $10 to repurchase a lost theater ticket.

4. Digital currencies will concern themselves with brand loyalty and network effects.

In the past, (unless you were a professional money trader) people really only switched currencies when travelling. Currency network effects are taken for granted because governments demand that everyone pay in taxes in fiat. No matter what part of the country someone is in, you know they need USD every April or October. Until the government accepts tax payments in other forms of currency, there will continue to be a demand for fiat.

Network effect: when present, the value of a product or service increases according to the number of others using it.

Because privatized utility tokens will not have the sort of monopoly that the government enjoys, these currencies will need to compete with one another to adopt and maintain users. Still, the value of a currency is only as strong as the saturation of the network it exists in. As stated before, I predict that tokens built on top of the most ubiquitous goods will fare the best. Amazon Coin may have to compete with the hypothetical future WalMart Coin, and WalMart Coin will be demanded less in a town with no WalMart. Because of these issues, it may not be long before currencies themselves become advertised by the greatest shareholders of those coins.

The lines between goods and money will blur once again. Currently, behavioral economists are thinking about which framing techniques increase sales of a product. But, behavioral cryptoeconomists will also have to factor in the framing of the currency itself. How do the mere-exposure effect and the endowment effect (with respect to a specific coin, not a specific product) impact transactions? How will the most successful coins use the bandwagon effect to their advantage?

Mere-exposure effect: individuals show an increased preference (or liking) for [something] as a consequence of repeated exposure to that [thing].

Endowment effect: people place a higher value on items once they own them.

Bandwagon effect: people in social situations may align themselves with the majority opinion and do or believe things because many other people appear to be doing or believing the same.

5. Consumers will be prosumers.

Prosumer: a person who consumes and produces a product.

Because utility tokens represent an immediate store of value in a private company, consumers will virtually own part of a company by being in their network. Similar to the point above, a drop of just one person from a saturated network represents an exponential loss. Currently, if a scandal comes to light at a company I am a customer of, and I get angry and leave, the company experiences a loss of just myself. However, if the company’s value is drawn largely from a private, utility token network and I leave (effectively saying “I no longer accept Bad Company Coin for payment”), this represents an exponential loss for them. In addition to your sell-out, friends who can no longer exchange Bad Company Coin with you will need to translate into some other currency, and this too decreases the value of Bad Company’s network. The idea that you vote with your money is far truer in decentralized token economies than it is in dollars.

How will consumers leverage currency options for social action? Humans do a great many irrational things — even taking a resource hit — in order to see the punishment of bad actors through. While a US citizen cannot fully boycott USD today, they can certainly boycott Bad Company Coin if things go south.

Schadenfreude: the gaining of pleasure or satisfaction from the misfortune of others.

Although the mental heuristics that gave rise to behavioral economics will remain the same, the currencies we interact with will not. As currencies change, our economic decision-making will change as well. If we are to actively shape the future into something desirable and democratized, we need to identify and adapt to the inevitable changes, and we need to carefully consider the ethical and behavioral results of the architecture underlying digital currencies.

Disclosure: I work for AXE’s parent company, ERA. We’re building the decentralized web, because we believe that all are welcome to the internet, and that only you own your identity. If you enjoyed this article, please give it a clap and follow me on Medium and Twitter!