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Blockchain and agency risk The code is the law and the code is the primary risk

· 3 min read
NEST Protocol

Introduction

People who are new to blockchain often fall into a perplexity as to what kind of economic language to use to describe the significance of blockchain. Some say it's about cost, but don't see the cost of which industry has improved because of blockchain; likewise, some say it's about trust, and don't see trust quantifiable under blockchain described. So many people turn to the idea that the value of blockchain lies in immutability. These are all very superficial understandings; in the language of economics, blockchain essentially changes agency risk in principal-agent relationships.

Agency risk in real world.

Agency risk is everywhere. You entrust someone to do something for you and they may not fulfill it; you send something to someone that is not looked after; or you pay for a service that ends up going wrong, these are all agency risks. What is really worrying is that your assets entrusted to someone else are caused a huge loss, for example, we invest in funds, we invest in P2P, etc. Agency risk is the risk that the agent does not have the ability or does not follow the rules to fulfill the principal-agent relationship.

The code is the law, and the code is the primary risk.

All of the above seems very common and has nothing to do with blockchain; but in fact, the real meaning of blockchain is here: the algorithmization of agency risk is realized through public ledger and decentralized consensus. That is, the agency risk is implicit in the code, which is open source and deterministic to begin with, so the agency risk is completely known. This is the real value of blockchain. De-trust means to remove the agency risk in the general sense: the risk of trust in people and institutions. Reducing cost means avoiding the risk of various adverse selection, which brings down the social cost. So blockchain is essentially a matter of principal-agent framework. The change in technology has brought about a revolution in principal-agent, and we no longer put the core risk on some third-party institution. The code is the law, and the code is the primary risk.

conclusion

In a world full of agency risk, we have established a whole set of incentive systems based on laws, systems, etc. to maintain the effectiveness of the principal-agent structure so that the world can function properly. But the cost is also enormous. Imagine all kinds of corporate scandals and regulatory corruption, which are inevitable risks of past models, and no matter how well designed our incentives are, they cannot eliminate this fundamental risk. One could say that the evolution of human society is the story of constantly shifting models to deal with agency risk. However, this change, brought about by blockchain technology, has the most radical dissipation of agency risk; there is no longer any need to trust any third party, be it authority, hero, or saint, but only the code! Trust the algorithm! It was a dazzling moment in financial history that deserves a deep and comprehensive excavation.