The initial enthusiasm for implementing blockchain in financial markets has been dampened considerably by its collision with economic realities. Though the author warns against avoiding the Panglossian trap of viewing ours as the best of all possible worlds, he reminds us that trusted institutions have evolved and emerged in a competitive environment as a means of economizing on transaction costs. Such costs arise from the nature of transactions, including crucially the information environment in which they take place. Though new technologies such as blockchain have the potential to reduce some of these costs, they often do so without fundamentally changing the underlying economic conditions that give rise to them. And as a result, institutions such as banks and exchanges that technologists scoff at may well prove surprisingly competitive and durable in the face of technological challengers.
The most successful implementation of blockchain—Bitcoin—solves a very basic transactional challenge peculiar to cryptocurrency: the double spend problem. But it does so in a very expensive way, and many other transactions pose far more complex challenges. The three cautionary tales provided by the author—the first involving securities and derivatives trading and clearing, the second commodity trading, and the third proposals to “equitize” assets—all demonstrate the need to confront “Chesterton’s Fence” when evaluating the potential of blockchain in any particular application. In other words, to understand the value of a new technology for a given set of functions, one must understand the economic forces that have shaped the processes and institutions that currently perform those functions. When such forces are considered, it often becomes apparent that new technologies like blockchain will not prove superior to existing practices—and may even create adverse unintended consequences that offset and perhaps even eliminate its beneficial effects.