Bitcoin, markets and information symmetry

You’ve probably heard the story of the market for “lemons” – not fruit, I’m talking about shoddy consumer durables. In his seminal paper, economist George Akerlof showed that information asymmetry about good used cars and “lemons” (sellers knowing more than buyers) ultimately drive down the price and drive the right cars, because the owners of them wouldn’t sell them at an unfairly low price. This, in theory, should drive the price down even further and eventually kill the market.

The thesis has received a lot of criticism over the years, especially from people who rightly point out that the used car market is far from dead, but it raises an important thought experiment: that does the person I buy from know that I don’t know?

Noelle Acheson is the former Head of Research at CoinDesk and Genesis Trading. This article is excerpted from her Crypto is a macro now newsletter, which focuses on the overlap between the changing crypto and macro landscapes. These opinions are her own and nothing she writes should be considered investment advice.

Akerlof’s co-Nobel Prize winner Michael Spence extended this to the labor market, introducing signaling theory and overreliance on credentials. Many have looked at the impact of this situation on the stock and bond markets, and information asymmetry is one of the main concerns of the Securities and Exchange Commission. Asset issuers almost always know more than their target market, and when trading, sellers have different motivations (and presumably different sets of information) than buyers.

This is not the case with bitcoin and similar crypto assets.

With bitcoin, there are no closed-door management meetings to make decisions that will affect future earnings. With bitcoin, nothing gets changed without everyone knowing immediately, and no code changes go through unless there is broad consensus.

In this sense, bitcoin is a commodity. Wheat is wheat, gold is gold: we all know what they are and accept that their properties are not changing anytime soon. With bitcoin, as with wheat and gold, you know exactly what you are getting.

Read more: Noelle Acheson – Shift Crypto’s Center of Gravity

It is important for the regulations. The SEC is correct in thinking that some crypto assets should be treated as securities (like tokens tied to projects heavily reliant on a small management team that hopes to profit from its efforts). But bitcoin doesn’t have a leadership team – some may claim the core developers are leaders, but they serve the community and don’t maintain the network. In addition, financial information rules are designed to standardize investors’ access to relevant information. It’s hard to imagine a more open book than decentralized blockchain networks.

Information symmetry also matters a lot for market structure. Take loans, for example. In traditional finance, borrowers have a clearer idea of ​​what they plan to do with the requested funds, and this may be different from what they tell the lender, who compensates for this lack of transparency by requiring a ton of paperwork and/or applying math to credit profiles. Even when a guarantee is required, there is uncertainty: is this house, this yacht or this painting really worth its evaluation? The compensation for this risk results in the interest rate to be applied.

With crypto lending, beyond counterparty risk (painfully topical these days), there is no information asymmetry. The open source code can be confirmed, the rightful ownership of digital bearer assets is relatively simple to determine, and their market value is easy to determine 24 hours a day, seven days a week, every day of the year.

Crypto collateral can be more volatile than more traditional collateral (although nowadays not necessarily so). But this can be offset by high loan-to-value ratios. And the relative ease with which this guarantee can be transferred, even programmatically through a smart contract escrow if certain conditions are triggered, removes another layer of uncertainty as well as hassle.

This is a huge point. Loans based on high-quality crypto collateral have the potential to be safer, more efficient, and more open than those based on traditional assets, largely due to information symmetry. What went wrong last year were failings in risk management and safeguards, often due to lack of experience and/or oversight. We can hope that lessons have been learned and standards have been raised. Regulation can also play a role, requiring crypto lenders to publish loan-to-value and collateral management policies.

Read more: Noelle Acheson – Code versus Values: The Cryptographic Twist on “Trust”

By stepping back, we can begin to see how market infrastructure might evolve if it could focus more on liquidity and service, and less on compliance requirements designed to compensate for unequal access to information. information. In addition to allowing regulators to devote more freed-up resources to combating intentional crimes, assets incorporating full disclosure could end up reducing transaction costs and improving capital efficiency for savers and builders.

I am by no means suggesting that networks such as Bitcoin are the solution to all information asymmetry problems. I do believe, however, that the transparency, decentralization, and open source nature of some distributed systems can change the way certain market-based activities are conducted, removing layers and adding new kinds of simplicity.

These new systems could also end up influencing economic theory by showing that not all markets need to involve intangible expectations, and that pricing those expectations need not always rely on thick veils of trust. As the “market economy” becomes more and more the “information economy”, transparency and verifiability play an increasingly important role in defining transaction habits.

Obviously, these are sweeping statements, and the crypto market has its share of lemons. Some projects are run by small teams that can modify token characteristics, some blockchains are not decentralized, some assets are not reliably backed, and some tokens are based on untested incentives. But established networks such as Bitcoin offer another way of thinking about the “credible disclosure” problem, with limited technology and human risk.

So, to give Bitcoin its place in the fruit basket of market slang, I thought of the opposite of a lemon. Many economists use “peach”, but they bruise easily, wrinkle quickly, and I don’t like them very much. I’m going to opt for “raisins”. They are sweet while lemons are sour, open to the air while lemons are wrapped in protection, and firmly anchored to the vine while lemons are quite easy to pick.

I don’t really see that taking hold since the concept of “lemons” never caught on in the digital age anyway. In an age that generates and collects more information than we know what to do with, ironically today’s markets are hampered by information asymmetry as much as ever. For the first time, we now have technology that reliably embeds simple asset information into the asset itself. The subset of assets for which this simplicity is sufficient is small for now – but its impact is already being felt in the merchant services being built today. And its evolution could end up shaping the structure and expectations of tomorrow’s merchant services.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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