#55 - Why Crypto Matters: Control, Liberation, Expansion

Rethinking crypto as an institutional innovation driving trust, reducing costs, and shaping new forms of economic coordination

Stanford Blockchain Review
Volume 6, Article No. 5

Author: Michael Li - Monad

Technical Prerequisite: Beginner

This is an opinion piece by Michael, an ecosystem associate at Monad Labs. All views are his own!

https://x.com/mrjasonchoi/status/1664909943760359424

https://x.com/peter_szilagyi/status/1820432038882652562

Introduction

Two tweets recently struck a chord with me. Jason from Tangent asked, “How exactly does web3 increase output?” Peter Szilágyi, a core developer of Ethereum, openly wondered if he might be in the wrong industry.

While trolls might quickly dismiss these musings with a snide: "getting rich, that’s the utility." But these thoughts actually hit at the core of a discomfort a lot of us have been grappling with being in crypto. We often speak of a grand future built on a trustless, permissionless internet. Yet, the prevailing perception remains that crypto and web3 are little more than a vast casino, devoid of meaningful contribution. When we step back to look at the bigger picture, we need to confront some difficult questions: Are we genuinely building something of lasting value, or are we just playing a high-tech game of chance? How can we measure the value of crypto beyond market speculation? What are the real, tangible benefits to society?

Those who pointed out the reflexive and mostly speculative purpose of crypto are not wrong. Yet, I can’t shake the feeling that we’re on the brink of something important. Going into an intellectual rabbit whole, I seek to re-evaluate my assumptions and try to see crypto from a different perspective.

What is a blockchain, really?

Blockchain can be thought of as a system for maintaining a trustworthy record of information, relevant to society and economy, that everyone can agree on. It works like a digital ledger, but instead of being kept in one place, it is spread across multiple locations. Each of these locations, called nodes, holds a copy of this ledger. When new information, or a “block,” is added, it gets linked to previous information, forming a chain. This linking process is governed by rules that everyone in the network follows, ensuring all the nodes agree on what is added. This is done without needing a central authority.

In simpler terms, blockchain establishes rules and procedures for recording and validating information that everyone in the network sees as legitimate and true. It's creating a common ground for understanding and verifying what counts as valid social and economic interactions. The process and the rules shape and define what's acceptable or valid in the digital world. A blockchain is in essence, a codified truth-verification machine that has the ability to commoditize trust through a protocol on a decentralized network. 

With these concepts in mind, we can explore further why such a truth-verification machine matters.

Shifting the perspective: Schumpeter vs Coase

In crypto we are often confronted by outsiders or sceptics with: what’s the use case? What’s the utility? For such questions, common answers cited include stablecoins, lending protocols, NFTs, Digital IDs, and, more recently, DePIN. Many thought leaders have explored these topics in depth, including comprehensive analyses on Not Boring and Vitalik's blog [1][2].

The question has nothing wrong in itself but it does reflect a preconceived notion and a narrow view on how we assess the value of innovations these days. We tend to fixate on the idea that new inventions are primarily as “disruptive technologies” that will replace existing methods in our daily lives. Usually these are tangible things we can easily grasp, like the shift from pagers to mobile phones, and the subsequent transition from mobile phones to smartphones, or the technological leaps from 3G to 4G & 5G, each offering faster speed. 

But some innovations affect our lives in more subtle and less visible ways. Here I point to the works of Sinclair Davidson, Professor of Institutional Economics at the RMIT. Davidson examines blockchain through the lens of economic institutions and capitalism, a perspective that is not widely recognized but is essential for understanding the broader implications and true potential of blockchain technology.

To appreciate this perspective, it is important to understand two distinct economic schools of thought. Below I explain the Schumpeterian and Coasian views respectively, each offering a different approach to understanding progress and growth.

The Schumpeterian view, derived from economist Joseph Schumpeter, sees innovation as the main driver of economic growth. Schumpeter introduced the concept of  “creative destruction,” which describes the process by which new technologies and innovations disrupt and replace outdated ones, thereby driving economic progress [3]. This view emphasizes visible, disruptive changes like the rise of automobiles over horse-drawn carriages or how e-commerce impacts brick-and-mortar retail. Because these shifts are obvious and have clear, measurable effects, they are easy to recognize and understand. As a result, there is a tendency for us to value new inventions based on the Schumpeterian perspective since its impact is immediate and tangible.

In contrast, the Coasian view, named after economist Ronald Coase, focuses on the concept of transaction costs and the role of institutions in reducing these costs to facilitate economic activity [4]. Coase argued that economic systems and institutions exist to minimize the costs of transactions and coordination between individuals and organizations. This perspective draws attention to the less obvious but equally critical infrastructure that supports economic efficiency. Improving these institutional frameworks can lead to significant economic gains, though these gains may not be immediately apparent.

While crypto (and most inventions today) is often discussed through a Schumpeterian lens, focusing on its potential to disrupt traditional industries and create new markets, it would be equally important to evaluate them through a Coasian lens. 

Blockchain, at its core, is an institutional innovation. Blockchain represents a novel coordination mechanism, generating trust and fostering collective consensus through established rituals and norms. It creates a shared surface for truth-formation, effectively giving rise to a new institutional framework that supplants traditional belief systems. By focusing on how blockchain can improve the underlying economic infrastructure (i.e. making systems more transparent, efficient, and decentralized), we can better appreciate its true potential. 

Control, liberation, expansion

To understand why blockchain as an institutional technology matters, we first need to define what we mean by “institution.” Institutions are essentially the rules of the game in society. They shape how we interact, trade, and build systems of trust. Over time, these institutions have evolved from religious structures that governed social order, to political systems that dictated laws, to corporate entities that have defined modern capitalism. Each of these institutions has had its own set of rules and methods for organizing human activity. Various institutional economists have explored this concept in depth.

Economist Douglas North defined institutions as the “non-technologically determined constraints that influence social interactions and provide incentives to maintain regularities in behavior.”  In other words, they are the humanly devised constraints that structure political, economic, and social interaction [5]. John R. Commons, another economist building on the works of Coase and North, offers a more precise definition. He describes an institution as “collective action in control, liberation, and expansion of individual action.”

To put simply, institutions represent the organized ways in which societies manage collective action. These institutions control, liberate, and expand individual behaviors within a structured environment. Institutions can take the form of unorganized customs—such as social norms and traditions—or organized entities, such as corporations, governments, and trade unions. The principle common to all institutions is their role in governing what individuals “can, must, or may do” within the confines of collective action. Let’s unpack the three elements of institutions according to Cmmons in more depth:

• Control: Control refers to the way institutions set limits on individual actions to maintain order and manage conflicts of interest. Control involves rules and regulations that dictate what individuals "can, must, or may not do." These rules are enforced through collective action, such as legal systems, social norms, or corporate policies. The purpose of control is to create predictability and stability by managing behaviors that could otherwise lead to disorder or conflict. For example, a law prohibiting theft controls individual action by imposing legal consequences on those who violate the rule, thereby protecting property rights.

• Liberation: While control imposes constraints, institutions also liberate individuals by providing a structured environment where they can operate free from certain uncertainties and risks. Liberation occurs through the protection offered by institutions against coercion, discrimination, or unfair competition. By establishing a predictable framework of rights and duties, institutions enable individuals to engage in economic activities with a degree of security and confidence. 

• Expansion: Commons views expansion as the ability of institutions to extend the scope of individual action beyond what would be possible in the absence of collective organization. Collective action enables individuals to benefit from capacity-building that increases both individual and collective agency. Expansion occurs when institutions provide the infrastructure and rules that enable individuals to engage in more complex or large-scale activities. 

With these definitions, we can see how blockchain represents a new institution technology:

• Control: Blockchain enforces control through a decentralized set of rules and protocols that dictate the behavior of all participants in the network. Consensus mechanisms, such as Proof of Work (PoW) and Proof of Stake (PoS), determine how transactions are validated and added to the blockchain ledger. These mechanisms ensure that only legitimate transactions are processed, thereby preventing fraud and preserving the integrity of the network. Unlike traditional institutions that rely on centralized authorities for enforcement, blockchain's distributed nature allows for self-regulation through its code and consensus.

• Liberation: Blockchain provides liberation by protecting individuals from centralized control and censorship. It establishes property rights in the digital space, allowing users to own and control their digital assets without relying on intermediaries. Additionally, blockchain offers protection from being deplatformed by centralised services, as it does not depend on a single authority or corporation. This decentralization supports free speech and ensures that individuals can participate in the digital economy without fear of arbitrary exclusion or censorship.

• Expansion: Blockchain expands the potential for collective action and new organizational forms that were not possible before. It enables the creation of Decentralized Autonomous Organizations (DAOs), which allow participants to collaborate and make decisions without centralized leadership. For example, initiatives like ConstitutionDAO demonstrate how blockchain can be used to crowdfund and channel collective efforts toward a common goal. Blockchain thus facilitates new ways of organizing and mobilizing resources on a global scale.

What this means is that institutions are vital in capitalism because they create a stable environment where people feel confident to invest and trade. They help to overcome the limitations of human behavior and decision-making by providing a predictable framework for interaction, which is essential for economic growth and development. 

This is in the same spirit as Nick Szabo’s concept of  “social scalability”, which implies that as institutions become more effective, they can support more complex and widespread economic activities, making it easier for a larger number of people to cooperate and participate in the market.

While we have discussed at a high level why institutions matter in fostering economic stability and growth, we have not yet explored the specific mechanisms through which they achieve these outcomes. One key way institutions contribute to economic development is by reducing what economists call “transaction costs” (or friction costs).

There’s a hidden cost for everything 

When we talk about economic transactions, it’s easy to think only in terms of prices, which is what we pay to buy a product or service. But there are actually many hidden costs involved in making any transaction happen smoothly. These are what economists refer as “transaction costs,” and they encompass all the additional time, effort, and resources needed to complete an exchange. For instance, consider the process of purchasing a home. Beyond the sale price, buyers incur various ‘friction costs’, such as hiring a real estate agent, conducting property inspections, securing mortgages from banks, and navigating legal processes for title searches and transfer documentation. Each of these steps requires time, money, and coordination, all of which contribute to the overall cost of the transaction.

Transaction costs can be substantial in certain areas, often deterring specific economic activities from taking place. Ronald Coase argued that businesses are structured to minimize these costs, as high transaction costs can make certain transactions too costly or impractical to execute from the market. For example, companies may choose to handle tasks like sourcing materials or managing supply chains internally to avoid the repeated expenses and complexities of dealing with external suppliers. However, even within firms, transaction costs remain a challenge due to the need to coordinate teams, enforce contracts, and ensure quality standards. When these costs are too high, businesses may forgo certain transactions or projects altogether, limiting economic opportunities.

Here’s where blockchain technology comes into the picture. One of the core promises of blockchain is its ability to significantly reduce transaction costs by removing the need for intermediaries and creating a transparent, tamper-proof ledger of all transactions. In a blockchain-based system, many of the steps that currently require trust such as verifying the authenticity of a transaction or ensuring the terms of a contract are met are automated and decentralized. This can lower costs and reduce friction in a way that traditional systems struggle to achieve.

Blockchain thus acts as a digital protocol that simplifies complex transactions. It enables new forms of economic coordination that were previously too costly or complex to manage. By reducing these hidden costs, blockchain has the potential to unlock new economic opportunities, especially in areas where traditional institutions are inefficient or lacking. In regions with weak institutions, blockchain can provide a more reliable and cost-effective way to conduct transactions, build trust, and foster economic activity.

Economists have long studied how to make economies work better, often focusing on numbers and models. However, they haven't always paid enough attention to the importance of institutions which are the underlying rules that help reduce the costs and friction of doing business.  The development and success of an economy depend significantly on its institutions' ability to lower these transaction costs. When institutions are effective and efficient, they make it cheaper and easier to do business, leading to a more prosperous economy. 

The bigger picture is this: while blockchain might have not yet become the ‘disruptive innovation’ that completely replaces existing institutions, it offers a new framework that makes economic interactions simpler, cheaper, and more transparent. By lowering transaction costs, blockchain could encourage more economic activities since people are incentivized to trade and invest knowing that the rules of the game are clear and fair, which in turn stimulates economic growth.

Enabling new products, but also modes of production

To hone in on the point of blockchain as an institutional tech, let’s look at a specific example. Stablecoins are often highlighted as one of the most practical and widely adopted use cases for blockchain. Pegged to fiat currencies like the US dollar, stablecoins provide a stable store of value on the blockchain, making them a useful tool for payments, remittances, and hedging against volatility.

However, while blockchain enables the existence of stablecoins by providing a decentralized and secure ledger as the foundation, the actual method of creating and managing these stablecoins can vary significantly depending on the institutional framework used.

To illustrate how blockchain functions as an institutional technology, let's examine the production of fiat-backed stablecoins by different entities. Companies like Circle and Tether, which issue USDC and USDT respectively, are the most important players in the stablecoin market. These companies operate as traditional firms within the established financial and regulatory systems. In contrast, the production of stablecoins can also be done through a decentralized protocol that lives on the blockchain directly. M^0 Protocol is precisely such a project that aims to create and manage stablecoins using a different institutional model, different then the traditional firm model. 

Circle and Tether: Stablecoin Production by Firms

Circle and Tether are centralized companies that issue stablecoins backed by reserves of traditional currency or equivalent assets. These firms function like any other corporation with hierarchical structures, centralized decision-making, and accountability to shareholders and regulatory bodies. They manage issuance, ensure liquidity, and provide redemption services for their stablecoins, relying on trust built through transparency, audits, and compliance with financial regulations. 

In this model, the production of stablecoins involves several layers of coordination and transaction costs. Circle maintains extensive reserves and undergoes regular audits to ensure they can redeem their stablecoins at par value. This requires a significant investment in legal, regulatory, and financial oversight. As a firm, Circle is a centralized entity. This means it is vulnerable to risks associated with central points of failure such as regulatory crackdowns, operational mishaps, or financial mismanagement. All these factors could impact the stability and trust in Cricle’s USDC.

M^0 Protocol: Stablecoin Production by Decentralized Protocol

M^0, on the other hand, represents a fundamentally different approach to stablecoin production. It is a decentralized protocol designed to create and manage stablecoins without the need for a centralized corporate structure. Instead of relying on a single entity to oversee reserves and manage issuance, M^0 employs a network of participants including Minters, Validators, and Earners that coordinate through a set of smart contracts and decentralized governance mechanisms.

This model reduces transaction costs and risks through a different method of coordination. M^0 removes the need for a central authority by using blockchain’s inherent immutability, and decentralized consensus. This reduces the costs associated with maintaining trust, as the system’s rules are enforced automatically by code, not by corporate governance. Because M^0 operates on a decentralized network, it is more resilient to single point of failures and can scale more effectively. 

It is not to say one model is inherently better. Both production methods for stablecoins have their unique transaction costs and benefits. Traditional firms like Circle offer stability, regulatory clarity, and more responsive decision making but at the cost of higher operational expenses and centralized risks. Protocols like M^0 provide a more resilient and open-access alternative, reducing some types of costs associated with trust and verification but introducing new governance, smart contract security and coordination challenges.

The key point here is not just that blockchain enables the creation of stablecoins, but how it also enables their creation through a new form of economic coordination. Circle demonstrates how traditional firms can produce stablecoins within a centralized framework. However, M^0 illustrates that the same product can be produced through a decentralized protocol, representing a new modality for collective action.

Conclusion

In Chris Dixon's “Read, Write, Own", the shift from "read and write" (web1 and web2) to "own" (web3) signifies a deep transformation that goes beyond productivity gains. 

"Asking 'What problems do blockchains solve?' is like asking 'What problems does steel solve over, say, wood?' You can make a building or railway out of either. But steel gave us taller buildings, stronger railways, and more ambitious public works at the outset of the Industrial Revolution. With blockchains we can create networks that are fairer, more durable, and more resilient than the networks of today."

Traditional institutions are built and maintained by human agency, evolving through religious doctrine, mythologized scriptures, norms, and practices over time. In contrast, blockchains are technological constructs that, while designed by humans, function autonomously once deployed. 

It is important to remember that the internet itself took decades to reach its current form. We are only 15 years into the creation of the first blockchain. Just as industrial technologies needed time to mature, institutional technologies like blockchain may require even longer to fully realize their impact. 

What we can be quite certain about is that an economy with blockchain is institutionally richer, more diverse and more sophisticated than one without it. By recognizing blockchain as an institutional technology and a new mode of coordination, we can better understand the specific problems it is best suited to solve.

About the Author

Michael is an Ecosystem Associate at Monad Labs. Prior to joining Monad, he worked as a Strategy Associate at a global cryptocurrency exchange. He also contributes to The Blockcrunch, producing research memos on crypto projects. Additionally, he writes about crypto, economics, and policy. Connect with him on Twitter: @michael_lwy.

References

[1] https://www.notboring.co/p/web3-use-cases-the-future

[2] https://vitalik.eth.limo/general/2022/12/05/excited.html

[3] https://www.cmu.edu/epp/irle/irle-blog-pages/schumpeters-theory-of-creative-destruction.html

[4] https://www.investopedia.com/terms/c/coase-theorem.asp

[5] https://link.springer.com/article/10.1007/s40803-016-0028-8