3/14/2018 Byzantine political economy – Cryptoeconomics – Medium

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Posts by the team at cryptoeconomics.com.au
Oct 24, 2017 · 8 min read

Byzantine political economy

Chris Berg, Sinclair Davidson and Jason Potts are from the RMIT
Blockchain Innovation Hub, the world’s rst social science research centre
into the economics, politics, sociology, and law of blockchain technology.

. . .

F or more than three decades economists and cryptographers

have been working on the same problem.

Neither species has recognised their own work in the other.

But it turns out that the question of how to coordinate a society and
how to ensure communication can be trusted is the same question
di erently phrased.

Our argument in this essay is simple: What cryptographers call

byzantine fault tolerance and economists call robust political
economy is the same thing.

This observation turns out to have some signi cant consequences for
understanding the history of economic thought and the directions of
institutional cryptoeconomics.

But to explain why, let’s quickly revisit one of the most important
debates in the history of economics.

The socialist calculation debate

Economists from Adam Smith on have sought to explain the wealth of
nations — why some nations are prosperous and others are not. By the
twentieth century this debate had coalesced into a debate about which
of two economic systems (communist central planning or capitalist
decentralised markets) were more likely to bring prosperity.

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Smith argued that market societies were characterised by spontaneous

orders. Social order came from market incentives.

Karl Marx objected that the state (or some central coordinating
authority) could produce superior outcomes to the market through
conscious, deliberate planning.

Before the socialist calculation debate the liberal critique of socialism

focused on the problem of incentives — how could a socialist
community convince people to work hard if the product from their
labour was redistributed? (See, for example, the discussion of socialism
in Bruce Smith’s 1887 book Liberty and Liberalism.)

In 1920 the Austrian economist Ludwig von Mises published Economic

Calculation in the Socialist Commonwealth. In this essay, Mises made a
new, fundamental critique of socialist planning — the problem of
information.

In a market economy, Mises argued, prices constitute signals about the

highest value use of a good or service, providing a guide for what goods
were in demand, and which were in a glut.

But a socialist system has no prices. As one of us has described Mises’

argument,

How would [a socialist planner] decide whether to send rubber to Tyre

Factory 12 or Hose Factory 7? In a market economy, the factory that
needed the rubber most would be willing to pay the highest price. But there
is no natural price system in socialism — consumer prices are decided by
the planner, and rubber allocated according to their diktat.

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Friedrich Hayek and Ludwig von Mises

Mises’ critique of socialism was extended and elaborated by Lionel

Robbins and Friedrich Hayek. Hayek turned this argument into one of
the greatest essays in economics: ‘The Use of Knowledge in Society’,
where he described prices as a decentralised knowledge network.

Centralised computer socialism

The Mises and Hayek argument today is well known, particularly after
they seemed to be proven right by the fall of the Berlin Wall. By
contrast, their opponents in the debate are less read today.

Mises and Hayek’s criticism was answered by the Polish economist

Oskar Lange and extended by Hayek’s Russian-born student Abba
Lerner.

Lange and Lerner accepted the importance of the price system in

organising economic activity. But they argued that this system could be
simulated mathematically.

Working rmly in the equilibrium economics school Vilfredo Pareto

and Léon Walras, they imagined the price system as computational
machine. In On the Economic Theory of Socialism, published rst in
1936 and 1937, Lange concluded that a socialist economy could
simulate the e ect of the price system by trial and error.

Lange revisited his argument 30 years later. “Were I to rewrite my essay

today my task would be much simpler”, wrote Lange:

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My answer to Hayek and Robbins would be: so what’s the trouble? Let us
put the simultaneous equations on an electronic computer and we shall
obtain the solution in less than a second. The market process with its
cumbersome tâtonnements appears old-fashioned. Indeed, it may be
considered as a computing device of the pre-electronic age.

Not only could computers simulate the market but the computer could
conduct long range planning and implement that plan — “a function
which the market never was able to perform”.

How decentralised is Hayek’s

market, really?
It is typical to cast these two visions of the economy as Lange’s
centralised planned economy and Hayek’s decentralised market.

But Hayekian decentralisation still has a lot of centralisation in it.

Here the Marxists are right. Free markets have an awful lot of state
involvement in them. Property is private but its enforcement relies
heavily on public authorities — the legal system courts, sheri s, police.

But what both the Hayekians and the Marxists missed is that property
rights are not only about enforcement. They’re about the identi cation
and veri cation of property rights. And (right now) the state does most
of that.

As we argued in our previous essay, so much of what the modern

state does is endorse, manage, and verify ledgers of social
relations. The state manages the property titles register. It manages
ledgers of social security entitlements. It manages the ledgers of who is
a citizen and who can therefore participate in political bargaining.

This is a very big, important, and largely unappreciated function that

the state ful lls. The state does is in charge of these crucial ledgers
because it is a large ‘trusted’ entity. But of course how much we can
trust the state is questionable.

The invention of the blockchain presents us with new institutional

choices.

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A new typology of political economy

In our new typology of political economy, political ideas are arranged
in a grid of centralised and decentralised economies, and decentralised
and decentralised ledgers.

In Lange’s computer socialism, the economy is centralised and the

ledger is centralised — the state is a planning machine, both managing
the ledger and executing a global plan.

In pre-Marxist communalism, such as the scheme devised by the

Welsh utopian socialist Robert Owen, economic planning is centralised
but the relevant jurisdiction — that is, the ledger-providing authority —
consists of subnational groups of voluntary, socialistic communities.

Hayekian distributed capitalism has a decentralised economy —

planning is done by individuals rather than the state — yet the state still
organises, records, veri es and updates the ledgers of identities, rights,
obligations, and entitlements.

By contrast, in a cryptoeconomy both the economy and the ledgers

are decentralised. Blockchains take the state out of both planning and
veri cation.

Information and incentives

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Markets work because they align incentives into productive work

and they harness distributed information productively.

In the second half of the twentieth century the public choice school
extended the incentives critique to encompass the incentives of the
planners themselves. How could a socialist commonwealth ensure that
planners worked in society’s interest, rather than their own personal
interest?

Today, what scholars now call a ‘robust political economy’ (see Mark
Pennington’s book and this paper by Peter T. Leeson and J. Robert
Subrick) is an economic system structured to deal with the twin
problems of information and incentives. How can we coordinate
action — make exchanges, build relationships and communities — in a
world of incomplete information and potential rentseeking?

Turns out, cryptographers and computer scientists have been working

on these two problems as well.

The Byzantine Generals’ Problem

Distributed computing systems have to deal with what is known as the
Byzantine Generals’ Problem.

This problem was rst expressed in 1982. Imagine a Byzantine army

surrounding an enemy city.

Illustration from the 12th century Madrid Skylitzes, a history of Byzantium between 811 and 1057

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The army consists of divisions, each headed up by a general, and they

need to establish a consensus about when exactly to launch their attack
on the city.

Centralised command is out of the question. No individual general has

line of sight to all the generals — or the authority to impose consensus
on the whole army at once. They can only communicate by messenger.

So there’s an information problem. The generals need a system — an

algorithm — that allows all generals to agree on a consensus.

The problem is made even harder because it’s not certain that all
generals are loyal. Some have been paid o by the enemy, and are
actively trying to disrupt the plan. The traitorous generals don’t want
the loyal generals to come to a consensus.

Thus Byzantine Generals’ Problem describes the challenge of a)

achieving consensus in distributed, decentralised systems b) when
information ows imperfectly, and c) in the presence of adversaries.

Blockchains achieve Byzantine fault tolerance in part by treating it

as an incentive problem. The Bitcoin proof-of-work mechanism
incentivises good behaviour, makes it extremely expensive to attack the
network, and reduces the payo s for a successful attack.

The so-called ’51 per cent’ attack on Bitcoin — the possibility that a
majority of hashing power could coordinate and then undermine the
network — is what would happen if more than half the generals were
traitors. (Of course, that itself would be hard to coordinate.)

Two elds together

A decision to attack a city simultaneously is just a narrow slice of the
general economic problem: how to coordinate activity in when
information is incomplete, communication is imperfect, and people can
be lazy, opportunistic, and self-interested.

What computer scientists have been trying to solve algorithmically,

economists have been trying to solve constitutionally.

Where cryptographers have found their solutions in public key

cryptography and proof of work mechanisms, economists have found

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solutions in markets, regulation, and institutions.

Blockchains bring these two elds together. They turn constitutional

questions into algorithmic questions, and algorithmic questions into
constitutional ones.

Byzantine political economy

One way to see this is as a curious historical instance of two largely
unrelated elds (computer science and economics) somewhat
simultaneously working on a structurally similar problem
(decentralised coordination) and arriving at the same type of solutions
(consensus protocols and market institutions).

But a more interesting perspective is that blockchain technology

actually joins these worlds together in reality. Blockchains can
provide the secure fault tolerant decentralised layer for property rights
information and its veri cation and updating whenever that
information changes, which can support a decentralised economic
layer of markets.

The socialists were wrong in their hopeful quest that (centralised)

computers would replace markets. Actually, it is decentralised
computers (blockchains) than can replace governments.

Markets always need governance, and the limits of a market society

were always the ability of the state to provide those services of record
keeping, validation and veri cation of transactions in property rights.
In return, the state levied taxation to fund these services. Blockchains
are a new technology of fault tolerant governance that can furnish the
governance to underpin a market economy and society.

We call this Byzantine Political Economy.

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