In October 2023, Management Science (MS) published the article "Advances in Blockchain and Crypto Economics", which reviews the economics of blockchain and cryptocurrency. The article reviews the development of blockchain and cryptoeconomics in fintech innovation, emphasizing the interdisciplinary research of these technologies, including blockchain economics, crypto assets, decentralized finance, and web3 ecosystems. The article provides an overview of the key findings and presents 15 articles that contribute to the fundamentals of the field. The proposed framework emphasizes the importance of rigorous academic research in understanding the economic mechanisms, platform economics, and welfare consequences of blockchain and crypto systems, and provides guidance for future research at the intersection of technology and finance. The Institute of Financial Technology of Chinese Min University (WeChat ID: ruc fintech) compiled the core part of the research. **management science
Author | bruno biais, agostino capponi, lin william cong, vishal gaur, kay giesecke
Compile |Zhou Zixun.
1.Introduction
The advent of blockchain technology and crypto assets represents a major innovation in economic infrastructure. The consensus mechanism introduced by Bitcoin (BTC) and permissionless blockchains has fundamentally changed the way participants store and transfer value without a centralized intermediary. The possibilities of new technologies have led to a growth in experimentation and adoption in the fields of (crypto) centralized finance (CEFI), decentralized finance (DeFi), and emerging versions of Web3. However, many design choices and economic features have been relegated to a secondary position in computer science and engineering research. As economies around the world attempt to integrate blockchain-based payment tracks and financial infrastructure, this type of academic research remains essential for informed policy and technology design, as well as for increasing infrastructure design. This paper reviews the current research in this field through 15 MS thematic literatures. 2.Studies have been conducted
i.The economics behind the challenges faced by tokens
With the collapse of cryptocurrency platforms such as Terra-Luna, FTX, and others in 2022, as well as regulatory lawsuits against Binance, Coinbase, and others, the crypto industry is under tremendous pressure. But these challenges are usually economic, not technical, and involve the centralization and decentralization of blockchain platforms and web3 applications. Although decentralization is technically possible, it may not be possible in an economic equilibrium. Centralized cryptocurrency exchanges have witnessed exponential growth in the cryptocurrency market, which currently still dominates the crypto space, with many of the economic forces behind it leading to vertical integration and centralization. Not only does this go against the idea of blockchain as a form of decentralized consensus, but it can also lead to market manipulation. Given the magnitude of these issues, the first part of the feature contains three articles that address these fundamental economic issues before the rapid growth of the industry over the past two years.
Cong et al. (2023) rigorously documented the phenomenon of money laundering transactions on centralized cryptocurrency exchanges for the first time by using a systematic method to detect counterfeit transactions. Cappeni et al. (2023) further consider miners' investment in hardware and compete for mining rewards in rent-seeking games, stating that centralization grows with the heterogeneity of mining costs, but hardware capacity limitations prevent the most efficient miners from monopolizing the mining process. Garratt and Van Oordt (2023) explored the impact of fixed mining costs on proof-of-work (PoW)-based cryptocurrencies, specifically the impact of mining hardware types on the viability of profitable double-spend-using attacks, and found that cryptocurrencies with dedicated hardware were less responsive to exchange rate shocks, which helps avoid double-spender attacks.
These studies not only deepen our understanding of cryptocurrency market manipulation, the structure of the mining industry, and the importance of hardware production and investment in the process of generating decentralized consensus on blockchain networks, but also provide an academic basis for regulatory litigation against multiple crypto exchanges and warn of the market manipulation that could result from the concentration of power by CEFI entities under limited regulatory or disclosure requirements, which later became apparent in the FTX collapse.
ii.Fee mechanisms, blockchain scalability and smart contracts
Even without the various challenges associated with centralization, lack of regulation, and mining attacks, blockchain systems still face some design issues in achieving scalability while maintaining a decentralized structure. First, there is no centralized entity to price products and services, and it is unclear what type of fee mechanism a distributed network should employ to ensure long-term sustainability. The scalability of blockchain and smart contracts is a well-known bottleneck in the industry. In addition, the economic impact of blockchain and smart contracts is largely unknown. The next three articles in the feature will help fill these knowledge gaps.
Basu et al. (2023) proposed "stablefees", a fee setting mechanism based on a unified auction that aims to reduce fee volatility and prevent user and miner manipulation. Benhaim et al. (2023) examined how committee-based consensus (CBC) affects the speed and security of blockchains, finding that small committees improve scalability but may also reduce security. Chen et al. (2023) analyzed the impact of U.S. state laws on the adoption of blockchain technology and found that blockchain technology can help alleviate contract incompleteness, promote corporate innovation, and reduce reliance on vertical integration.
iii.Tokenomics (tokenomics): Venture finance, governance, and platform vulnerability
"Tokenomics" is an emerging field that explores the use and valuation of (crypto) tokens. It was first proposed by Cong et al. (2021) in their work in 2018** and progressively developed through a series of studies. This area encompasses both theoretical and empirical research, covering the various types and functions of cryptocurrencies. Blockchain platforms provide a new avenue for financing and monetization by issuing native tokens that serve as an alternative to traditional convertible** or equity and fee or commission contracts.
Malinova and Park (2023) point out that while revenue-based token contracts may be economically inferior to equity, optimally designed token contracts can generate returns similar to equity and debt. Research by D**ydiuk et al. (2023) shows that entrepreneurs mitigate the problem of information asymmetry by keeping tokens. Shakhnov and Zaccaria (2023) illustrate how tokens can be discriminated against to extract consumer surpluses. Barth et al. (2023) analyzed the role of analysts in the ICO market and found that their assessments may be biased by interactions. Gan et al. (2023) examined the utility of tokens versus platform commissions in overcoming moral hazard. Sockin and Xiong (2023a) discuss the role of cryptocurrencies as utility tokens in facilitating transactions, and how token re-tradability affects the stability of the platform. These studies provide a wealth of insights into the field of tokenomics, particularly on topics such as token financing, market signals, network effects, and platform governance.
iv.Centralized Finance (CEFI), Decentralized Finance (DeFi), and Crypto Innovation
While there are concerns about the current form of CEFI, a modified CEFI design in the decentralized network may still be sustainable. In addition to cryptocurrency exchanges, CBDCS are one of the most active developments in CEFI (e.g., AUER et al.).2022), while stablecoins and decentralized exchanges are the main applications of DeFi. The last three articles of the special feature cover the evolution of innovation in CEFI, DeFi and crypto products and their economic insights.
Chiu and D**oodalhosseini (2023) examined the macroeconomic impact of CBDCs and found that cash-like CBDCs promote consumption and welfare more than deposit-like CBDCs, and may increase bank intermediation and market share. Park (2023) discusses the conceptual flaws of decentralized automated market makers (AMMS), stating that liquidity-invariant pricing allows for sandwich attacks, increasing transaction costs and threatening the long-term viability of the DeFi ecosystem. Augustin et al. (2023) studied the impact of derivatives on the spot market through the introduction of Bitcoin contracts, and found that contracts help improve efficiency, market quality, and liquidity. These studies provide a new perspective for understanding the economic effects of financial innovation.
3.Future outlooki.Blockchain forensics, cybersecurity, and regulation
Fintech poses a number of challenges to the regulation of the financial system. An urgent challenge is how to regulate emerging blockchain-based (CEFI and DeFi) entities relative to traditional financial institutions. While some countries have made progress, the reality is that crypto regulation is still vague or absent in much of the world. Some have argued that it is desirable to regulate on the basis of activities rather than entities in order to balance the playing field and ensure that entities engaged in similar activities are treated the same way. Others propose to eliminate the industry altogether. Regardless, the importance of both areas of research has emerged as regulators around the world have increasingly focused on combating crypto market manipulation and cybercrime, and have launched a range of other regulatory initiatives. The first is the development of statistical analysis and blockchain forensics tools in order to detect and combat the dark side of the industry and ensure market integrity. Research on forensic accounting and finance has proven useful in the field of traditional finance and continues to play a role in CEFI and DeFi (Foley et al.). 2019, cong et al.2023a, Griffin and Kruger 2023), specifically with regard to crypto-related cybercrime and market manipulation. The second is to understand economic incentives to equilibrium outcomes and demonstrate "intent" in various regulatory processes, to which many articles have contributed. By extension, rigorous economic research is necessary to inform and assist regulators in establishing a clear framework for protecting investors and consumers from fraud and criminal activity, without becoming too stringentonStifling innovation.
ii.Design distributed systems
On the premise that the various protocol designs are taken for granted, researchers have been analyzing various equilibrium results based on blockchain networks (e.g., Halaburda et al.). 2022, amoussou-guenou et al. 2023）。However, there is a growing recognition that these designs may be case-specific and suboptimal. As a result, mechanism design and information design in blockchain and web3 protocols constitute areas where economists can make a unique contribution. Equally important is the design of tokenomics, which requires knowledge of monetary economics, asset pricing, and corporate finance. Exploring various system designs can help get information from users (for crowdsourcing and voting, etc.; See, for example, Benhaim et al2023b), improve the recording of information (e.g., consensus mechanisms), incentivize the coordination of users' contributions, and raise capital (e.g., through ICOs).
iii.Balance between concentration and decentralization
Decentralization does not come without a price, nor does it equate to permissionless blockchains (Bakos et al.). 2021)。Decentralization just for the sake of decentralization is a topic for ideologues and lovers of extremism. As economists, we should consider the trade-offs involved. If blockchain and cryptocurrencies are to be promoted, they need a reliable, scalable infrastructure like the internet in order to be used for most economic activities. One possible outcome of the co-evolution of CEFI, DeFi and TradFi is that an optimal and sustainable network will combine all of their elements. So, in the discussion of how to overcome the challenges of blockchain scalability (eg., Buterin 2017, Abadi and Brunnermeier 2022), through local centralization is still very important. In addition, a formal attempt was made to introduce Web3 reputation, beyond heuristic discussions (Weyl et al.).2022, Tong 2023) remains a promising field where economists can make unique contributions, given the extensive scholarly literature on ratings, reputation, and contracts. Blockchains that support confidential AMM-based DEXs to solve the problem of various attacks (e.g., sandwich attacks) also require further economic analysis.
iv.Learn from your data and practice
Many people outside of the blockchain and crypto economy space complain that blockchain and web3 are just hype. We should let the facts speak for themselves. There is a need to know more about whether this field is becoming a reality or can become a reality. This effort begins with documenting fundamental empirical patterns, such as the return dynamics of crypto assets (e.).g., Liu and Tsyvinski 2021), Functions and Classification (Cong et al.2022a), and the impact on the real economy (Benetton et al 2023)。With the advent of non-fungible tokens (NFTs), decentralized applications (DApps), and decentralized autonomous organizations (DAOs), empirical research that provides researchers with information on the state of the system may be valuable (Borri et al.). 2022, falk et al. 2022)。*Bank digital currencies (CBDCS) and stablecoins are perhaps the most promising large-scale applications of blockchain and smart contracts. Although there is a wealth of theoretical contributions to their design and economic principles (e.).g., Gorton and Zhang 2023), but quantitative or empirical research is just beginning (eg., chiu et al. 2023)。Another important condition for mass adoption is interoperability – a simple and reliable way for digital assets to be freely exchanged and enable more industries to integrate blockchain into their day-to-day operations. Also, as Chen et alThe potential unlocking of smart contracts, which requires the flow of value and information between the off-chain and on-chain worlds (possibly via IoT sensors) described in 2023a, has only just begun (eg., bakos and halaburda 2023, cong et al. 2023d)。
v.Applications that go beyond financial markets
Blockchain applications have gone beyond the fields of business economics and finance, and are gradually emerging in the fields of governance, blockchain, games, and healthcare. Yermak (2017) and Erwin & Yang (2023) * on the use of blockchain in governance and sustainability. In addition, blockchain is effectively used to improve the transparency of the chain (e.).g., chod et al., ma et al.2022), which has had an impact on blockchain adoption and competition (Sristy 2021, Iyengar et al.). 2021, 2023)。CUI and Gaur (2022) discuss how blockchain differs from cryptocurrency networks in blockchain applications and illustrate the use of blockchain in blockchains. The authors also present recent success stories and analyze their potential to create value through company interviews and secondary publications. These applications include process efficiency improvement, chain optimization, and the creation of new and innovative use cases, which vary in ease of implementation and range of benefits, but all benefit from economic analysis.
vi.Blockchain-based data analysis
Blockchain technology provides a promising foundation for secure multi-party computation (MPC), blending transparency and privacy. Despite the inherently transparent nature of blockchain, data can be verified and integrated without revealing sensitive information by employing methods such as zero-knowledge proofs. This technique is especially important in scenarios where privacy needs to be protected while ensuring data integrity and verifiability.
Early economic research has been devoted to the application and impact of blockchain in areas such as auditing, financial reporting, stability analysis, and entrusted investment. In addition, the combination of blockchain with artificial intelligence (AI) and big data analytics can improve performance in areas such as content generation, privacy protection, financial inclusion, fraud detection, and identity verification.
In addition, AI's ability to optimize smart contracts** could lead to more innovation and widespread adoption of blockchain technology. This synergy between AI and blockchain not only enhances the efficiency of secure MPCs and decentralized applications (dApps), but also creates favorable conditions for technological advancement and the redefinition of computing paradigms.
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