Blockchain as a solution to reduce transaction costs
The difference between blockchain and centralized ledgers is that on a blockchain network, the data is complete, accurate and consistent. Members of the network are fully in control of the information and what happens to it. There is no central point of information storage, which also means no central point of attack, making a decentralized network much more secure compared to traditional centralized ledgers. Because of all these properties of blockchain networks, users can trust that the transactions will go through according to a protocol of a network and there will be no mistakes or errors. Such networks and transactions also do not need supervision from the trusted third parties because if a change to the network was to occur, it would be visible to all the participants of the ecosystems and no matter what the change, the transactions that have occurred in the past could not be changed or erased.
Blockchain and capitalist economies
Currently, most systems with centralized ledgers use third parties to monitor the ledgers. This comes at a huge cost to organizations, governments, and economies in general. Such costs are a part of what is known as transaction costs.
Transaction costs in economies with central ledgers
In economics, transaction costs describe the costs of making a decision when participating in market activities. For example, if someone wants to start a bank in the United States, they would need to make sure that the bank is properly registered and that the bank complies with all the necessary federal, state and local regulations. Many of these regulations are in place exactly because of the trust issues with centralized ledgers. The regulations exist because the government takes on itself the responsibility to protect the finances of people when people entrust their finances to the banks and other participants of the financial system.
Oliver E. Williamson is an American economist and a winner of 2009 Nobel Prize. In his works, Williamson pays a lot of attention to the differences between decision making when participating in market activities and when not participating in them. As a part of his research, Williamson has studied transaction costs extensively. He argued that case-by-case negotiations are very different from relationship-based contracts and that transaction costs play a huge role in what people choose to produce and consume in the markets. An example of a case-to-case negotiation is a farmer buying some wood for his stove at a local market once or every once in a while. Once the farmer forms a relationship with a supplier of wood, he or she may enter into a long-term contract and Williamson argues that the conditions of this new contract are likely to be very different from the conditions of a one-time deal.
Williamson’s studies of transaction costs are closely associated with the reasons and mechanics of governments and corporations creating and maintaining ledgers. Private entities create and maintain ledgers to regulate employment relationships, business processes, incoming and outgoing funds, manage intellectual property and much more. A corporation in the modern world is often described as a set of contracts and the value of the corporation is often about the structure, order and management of these contracts.
Ledgers in modern society also regulate access, describe privilege and store information about identity and responsibility. Typically, governments are the entities that citizens trust to keep records and regulate rights to travel, taxation responsibilities, and management of asset ownership. Most of the ledgers that governments maintain require enforcement and coercion, often by negative reinforcement or delayed punishment.
Before the invention of the blockchain, all these ledgers have been centralized because a centralized ledger was the only possible choice. Today both governments and private entities can use blockchains to make their operations more reliable and efficient. Blockchain can eliminate inefficiencies in internal operations of organizations and in external transactions.
Corporations and banks need to be reconciling complex transactions on a regular basis. Using blockchain networks and smart contracts, they can do that almost instantaneously and at a much lower cost compared to traditional methods because with blockchain there is no need to hire and pay a third party. Governments can use the fact that transactions on a blockchain network can’t be deleted to better maintain asset and identity records for everything and anything from vehicle titles and property registrations to citizen identity information.