NATIONAL BUREAU OF ECONOMIC RESEARCH

## Economics of Energy Use in Transportation

The NBER's conference on Blockchain, Distributed Ledgers, and Financial Contracting took place May 2-3 in Cambridge. Research Associates Dean Corbae of University of Wisconsin-Madison, Zhiguo He of University of Chicago, and Robert Townsend of MIT organized the meeting, sponsored by the Puelicher Center on Banking at the University of Wisconsin. These researchers' papers were presented and discussed:

Jonathan Chiu, Bank of Canada, and Thorsten V. Koeppl, Queen's University

The Economics of Cryptocurrency -- Bitcoin and Beyond

How well can a cryptocurrency serve as a means of payment? Cryptocurrencies need to overcome double spending by using costly mining and by delaying settlement. Chiu and Koeppl formalize this insight through an incentive constraint that rules out double spending and pins down the welfare costs of a cryptocurrency. They find that it is optimal to use seignorage rather than transaction fees to finance costly mining. The researchers estimate that Bitcoin generates a large welfare loss that is about 500 times as large as a monetary economy with 2% inflation. This welfare loss can be lowered in an optimal design to the equivalent of a monetary economy with moderate inflation of about 45%.

Simon Janin and Akaki Mamageishvili, ETH Zurich, and Arthur Gervais, Imperial College London

FileBounty: Secure and Efficient File Exchange in Rational Adversarial Environment

Nick Arnosti, Columbia University, and Matt Weinberg, the Ohio State University

Bitcoin: A Natural Oligopoly

Although Bitcoin was intended to be a decentralized digital currency, in practice, mining power is quite concentrated. This fact is a persistent source of concern for the Bitcoin community.

Arnosti and Weinberg provide an explanation using a simple model to capture miners' incentives to invest in equipment. In their model, n miners compete for a prize of fixed size. Each miner chooses an investment q_i, incurring cost c_i q_i, and then receives reward \frac{q_i^\alpha}{\sum_j q_j^\alpha}, for some \alpha \geq 1. When c_i = c_j for all i,j, and \alpha = 1, there is a unique equilibrium where all miners invest equally. However, the researchers prove that under seemingly mild deviations from this model, equilibrium outcomes become drastically more centralized.

When costs are asymmetric, if miner i chooses to invest, then miner j has market share at least 1-\frac{c_j}{c_i}. That is, if miner j has costs that are (e.g.) 20\% lower than those of miner i, then miner j must control at least 20\% of the mining power. In the presence of economies of scale (\alpha > 1), every market participant has a market share of at least 1-\frac{1}{\alpha}, implying that the market features at most \frac{\alpha}{\alpha - 1} miners in total.

Arnosti and Weinberg discuss the implications of our results for the future design of cryptocurrencies. In particular, their work further motivates the study of protocols that minimize "orphaned" blocks, proof-of-stake protocols, and incentive compatible protocols.

Leonid Kogan, MIT and NBER

Economics of Proof-of-Stake Payment Systems

Kogan develops a valuation framework for a Proof-of-Stake (PoS) payment system. Active network participants (proposers and validators) are required to stake tokens, and receive payments in return for their services. This property of the PoS system connects cash flows to token holdings, and allows for valuation using conventional methods. As an application of the framework, Kogan analyzes security properties of the PoS system. Kogan shows that while high token valuation relative to the flow of transactions is central to network security, valuation bubbles have adverse security implications. State-contingent token supply policies can be used to alleviate this problem.

Sean Cao and Baozhong Yang, Georgia State University, and William Cong, University of Chicago

Financial Reporting and Blockchains: Audit Pricing, Misstatements, and Regulation

To understand the implications of blockchains for financial reporting and auditing, Cao, Cong, and Yang analyze auditor competition, audit quality, client misstatements, and regulatory policy all in a unified framework. They demonstrate how collaborative auditing using a federated blockchain can improve auditing efficiency for not only transactions recorded on proprietary databases, but also cross-auditor transactions through zero-knowledge protocols that preserve data privacy. Consequently, the technology disrupts conventional audit pricing and effort focus: Auditors charge competitive fees based on clients' counter-parties' auditor association and corresponding transaction volume instead of client size. Blockchains also reduces clients' incentives to misreport and auditors' sampling costs, allowing auditors to reallocate effort from transaction-based auditing to discretionary account auditing. Importantly, auditors' technology adoption is costly and exhibits strategic complementarity, hence a regulator can help select an equilibrium with lower endogenous misstatements, audit sampling, and regulatory costs.

Tetiana Davydiuk, Carnegie Mellon University; Deeksha Gupta, University of Pennsylvania; and Samuel Rosen, Temple University

De-crypto-ing Signals in Initial Coin Offerings: Evidence of Rational Token Retention

Davydiuk, Gupta, and Rosen provide evidence that entrepreneurs use retention to signal their type to investors in the presence of asymmetric information using the market for initial coin offerings (ICOs) as a laboratory. Using a detailed dataset on 4,524 ICOs, the researchers show that ICOs that retain a larger fraction of their tokens are more successful in their funding efforts. Token retention is positively correlated with ex-post measures of success. The researchers develop a model of ICO markets with asymmetric information between informed entrepreneurs and uniformed investors. In equilibrium, high-type entrepreneurs use retention to signal their quality to investors. In line with model predictions, the researchers find that when there is more noise in the market, the correlation between token retention and ICO quality increases.

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