“Decentralized” and “Good” Are Not Synonyms

Think about how much trust you place in your grocery store. You trust that the food it sells you will be safe — it’s your only point of contact on the supply chain of what you eat. You trust that the products it selects to sell are the types of food you most want to purchase. These are pretty important things But the alternative would be to locate and procure each of your desired food items from its source, at a tremendous cost of time and from a set of choices too large to fully cover. So we employ a trusted intermediary.

Over the past few years, the crypto community has made the idea of decentralization almost a religion. It’s become pretty close to synonymous with “good” (“Honey, these pancakes are so decentralized!”). The benefits to not having to work with an intermediary can be huge, in terms of cost savings, control over products and their handling, or issues of trust. But the costs can be significant too. Centralization, at least where there are economies of scale, implies lower costs. Almost by definition, blockchain-based applications have to be more expensive than centralized ones — there are many more computers processing any given transaction. The applications of blockchain technology that will most likely succeed are those where the benefits of some type of decentralization outweigh the cost.

I did some work on small businesses where people often make the opposite mistake. People have a preconception that businesses like local groceries can’t compete with large, centralized firms like Walmart. Even the movement to support small businesses sounds like the shopkeeper down the block needs help rather than business. The assumption is that because of its economies of scale, Walmart can charge lower prices. But a bunch of small business managers and owners told me about the advantages of being small: able to fill product niches, better knowledge of local market conditions, connections in the community. Small businesses are basically Hayek’s “man on the spot,” having knowledge at a level of granularity that a central planner or corporate CEO could never consider.

As a technology, blockchain generally reduces the cost of decentralization (in fact, supply chain applications let consumers know where their food came from at vastly reduced cost). Before cryptocurrencies, the only decentralized payment was to hand someone cash in person, and that is often prohibitively expensive. Blockchain digitized the world of decentralized payment and made it much, much cheaper. But if everyone used a cryptocurrency like Bitcoin where technology stands today, there would be potentially prohibitive costs in using such a payment system. The cost of decentralization has been diseconomies of scale in transaction processing. So we go on trusting our big banks and credit card companies to broadcast payment to others.

This could change with technology or decisions made by those governing the currency (miners, in a decentralized fashion, of course). In fact, owning Bitcoin today is almost a bet on that happening. In the meantime, digital currencies and other blockchain applications should show there are reasons to be decentralized (i.e., not have to trust a single central intermediary) rather than assuming decentralization is good for its own sake.

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Max Gulker, PhD

Max Gulker joined AIER in 2015. His primary research areas are applied microeconomics and industrial organization. Max previously worked as an economist for Keystone Strategy, supporting expert testimony for antitrust and intellectual property litigation in high tech industries. Prior to that, he worked on financial litigation matters with NERA Economic Consulting. Max holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Follow @maxgAIER.