Blockchain and institutional complexity: an extended institutional approach

Summary of JOIE article (First View, 16 June 2020) by Danil Frolov, Faculty of Economics and Management, Volgograd State Technical University. The complete article is available on the JOIE website.

Blockchain is a digital technology for maintaining a replicated distributed ledger. It ensures the implementation of transactions in a digital format without the involvement of intermediaries. Blockchain-enabled changes are mainly related to the decentralization of transactions, their automation (more precisely, algorithmization, since blockchain is based on consensus algorithms), and a drastic decrease in transaction costs. 

Distributed ledger technology illustrates obvious limitations and deficiencies of institutional economics in studying highly complex phenomena. Complexity is an insurmountable barrier for modern institutionalism; all the institutional concepts and tools are ‘sharpened’ for the study of industrial (‘pre-network’) capitalism’s institutional structures. We often forget that theories of transaction costs and institutions as ‘rules of the game’ were created in the late 1980s and early 1990s (Williamson, 1985; North, 1990), before the widespread proliferation of the Internet, which radically transformed the entire institutional system. These theories are inadequate when analyzing Internet era institutions. 

The main problem is that the institutional theory of blockchain-arising institutions has an explicit one-sided character. On the one hand, as an institutional technology, blockchain is considered only in a Coasian sense, from the point of view of minimizing transaction costs. On the other hand, the system of blockchain-related institutions is regarded as a homogeneous system based on an algorithmization of contracts, ‘code-ification’ of law (De Filippi, Wright, 2018), and decentralization of transactions. I argue this is a one-sided and simplistic picture of the blockchain economy. Instead, scholars should move toward using more complex frameworks given an increasingly complex institutional environment.

I show that only studying blockchain through the theory of transaction costs, as Sinclair Davidson, Primavera De Filippi and Jason Potts do (Davidson et al., 2018), offers a highly distorted view of blockchain; it requires the addition of transaction value theory. Besides, blockchain-based institutions research suggests applying the institutional assemblages theory approach. This approach will shift the focus to heterogeneity, hybridity, modularity, fragmentation, and fluidity as critical properties of the economic institutions of capitalism today, especially after the pervasive introduction of blockchains. These new theoretical approaches are part of the arsenal of Extended Institutional Approach – the alternative direction of institutional research – revising methodological conventions and dogmas of institutional economics from the standpoint of their adequacy for studying the institutional complexity of modern economic and social systems. I call these approaches extended institutional analysis to emphasize how they move beyond standard institutional methodology. The transaction value approach extends standard transaction-cost economics by focusing on institutions to improve the quality of transactions and to create maximum value for actors. Assemblage theory extends the standard theory of institutional structures, shifting the emphasis to conflicting and re-assembling interrelated institutional logics.

Recognition that blockchain reduces transaction costs comprehensively is still not enough to understand its real complexity. Focusing on only one (cost-minimizing) side of transactions is a serious logical and theoretical error. Therefore, the other, value-creating side of transactions, is no less important. The transaction value concept is about improving the quality of transactions, such as speed, convenience, security, transparency, variability, and relevance. 

From a transaction value standpoint, the massive drawdown of intermediaries is more of an illusion, although the scope and forms of intermediation will certainly undergo significant change. Blockchain technology will lead to a sharp drop in demand for many intermediary services related to obtaining the primary results of transactions (for example, transferring money, obtaining a loan, making notarized copies of documents etc.). Nevertheless, even if blockchain dominates, many intermediaries will be able to add value to participants in transactions, and their additional transaction services can be quite widely demanded. However, this will depend on the ability of intermediaries to add transaction value. Moreover, under the conditions of ‘blockchaining’ of the primary results of most transactions, it is precisely the additional results (effects) of transactions that will be central to competition. It is in this direction (creation of additional transaction value) that banking and insurance innovations are now intensified, in particular.

‘The middleman sells reductions in transactions costs’ (Munger, 2018: 75) – this is the axiom of the contemporary institutional system of capitalism. But in the blockchain-based future, there will be a new axiom: ‘the middleman creates and sells additional transaction value.’ It is precisely upon this principle that the economic institutions of digital capitalism will be based.

I show that, in principle, a blockchain cannot be systematically described by any discrete institutional alternative separately. Blockchain does not generate a homogeneous institutional system, but rather a multifaceted, heterogeneous, hybrid institutional system. Therefore, another complexity-oriented institutional approach is promising: the theory of institutional assemblages.

The assemblage is a ‘roomy’ interdisciplinary term introduced by the philosophers Gilles Deleuze and Felix Guattari in the 1970s and 1980s. Unlike standard systems with their unitarity, solidity, and homogenization, assemblages are characterized by other key properties: heterogeneity, redundancy, modularity, interchangeability, multifunctionality, hybridity, fragmentation, entanglement, and plasticity. In my definition, institutional assemblages are hypercomplex systems of institutions based on parallel existing institutional logics (the sets of fundamental values, principles, and beliefs that underlie institutions). The confusion of parallel institutional logics, including those that are poorly compatible, fundamentally different, and even alternative, is a source of constitutive features and internal contradictions of institutional assemblages since connections between their elements are created across different domains. 

Institutions based on the blockchain will have pronounced assemblage features and properties. Blockchain is not just introducing a new ‘pure’ mode of coordination and governance. Blockchain-based institutions will be hybrids of conflicting institutional logics. Blockchain will create functionally redundant institutional systems based on parallel alternative modes of coordination. Moreover, these modes of economic coordination will not only adapt to one another but also constantly compete and be in conflict. First of all, blockchain is a naturally messy hybrid of decentralization and arbitrage. According to many experts, blockchain is, in its essence, a decentralization technology (Davidson et al., 2018). This is largely a consequence of the hype around Bitcoin, which belongs to decentralized models of blockchain. However, the illusion of disappearing centralized actors replaced by blockchains must be challenged. 

In blockchain systems, the dominant players who may well abuse their status have already become a reality. Although the blockchain (like the Internet) was originally created as a non-mediated technology, a number of third parties have emerged in the modern blockchain ecosystem. They are engaged in a profitable business on intermediary services: for example, software developers, cryptocurrency wallet providers, Blockchain-as-a-Service providers, and also oracles (intermediaries who enter information into blockchains). The decentralization technologically embedded in blockchain is already combined with an active concentration of power. Therefore, institutional ideas about the blockchain should be recognized as naïve, high-tech versions of libertarian utopias. As institutional assemblages, blockchain-based decentralized collaborative organizations will never be completely horizontal and will inevitably include significant hierarchical features. They will not create a new economic order associated with dis-intermediated peer-to-peer interactions based on automatic enforcement of rules through smart contracts. Anonymity will be partial, equality will be undermined by new elites, and blockchain’s ‘invisible hand’ will get out of hand.

Instead of the institutionalist mantra on the importance of institutions, extended (complexity-centered) institutional approach proposes a new motto: ‘Institutional complexity matters!’ An extended institutional research program is still being developed, but it is clear that the development of methodologies and theories for analyzing institutional complexity is a top priority and a critical challenge for all institutional economists.


References

Davidson, S., P. De Filippi and J. Potts (2018), “Blockchains and the Economic Institutions of Capitalism,” Journal of Institutional Economics, 14: 639-658.

De Filippi, P. and A. Wright (2018), Blockchain and the Law: The Rule of Code, Cambridge: Harvard University Press. 

Munger, M. C. (2018), Tomorrow 3.0: Transaction Costs and the Sharing Economy, Cambridge: Cambridge University Press.

North, D. C. (1990), Institutions, Institutional Change, and Economic PerformanceNew York: Cambridge University Press.

Williamson, O. E. (1985), The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting, New York: Free Press.

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