Costello Research Blockchain

Cryptocurrency’s surprising transparency advantage

Marianne Klinker — Tue, 02 Jan 2024 18:18:45 +0000

Cryptocurrency’s surprising transparency advantage Marianne Klinker Tue, 01/02/2024 - 13:18

Despite the fears of regulators and skittish investors, clear and accurate signals of cryptocurrency quality may be hidden in plain sight.

As perhaps befits a product of the post-2008 economy, the cryptocurrency space has never known normalcy. In a mere 13 years, crypto went from an untried software innovation of mysterious origin to being touted as the future of investing by major movie stars in Super Bowl commercials. Soon thereafter, of course, came the “crypto winter” of 2022, which began well before, but was surely deepened by, the downfall of FTX and disgraced wunderkind Sam Bankman-Fried.

Forthcoming in Journal of Management Information Systems, a recent paper is the first to examine whether the intensity of developer engagement with a cryptocurrency could indeed be related to its quality.

The crypto backlash appears rooted in the belief that the sector is too rife with bad actors, and too technologically complicated, to be worthy of public trust. The consensus in the crypto community, however, is that accurate clues to crypto quality are hidden in plain sight. The majority of cryptocurrencies use open source platforms such as GitHub for the development of their software. Seasoned investors will routinely inspect the publicly available development history of a cryptocurrency as a basic aspect of due diligence.

Forthcoming in Journal of Management Information Systems, a recent paper co-authored by Mariia Petryk, an assistant professor of information systems at the Donald G. Costello College of Business at �鶹��Ƶ, is the first to examine whether the intensity of developer engagement with a cryptocurrency could indeed be related to its quality. (Her collaborators were Liangfei Qiu and Praveen Pathak of University of Florida.)

Mariia Petryk

“This paper is about how we evaluate reputation in a setting where traditional reputational instruments are not precise,” Petryk explains. “When we choose a doctor, we often rely on an endorsement from someone we trust. But in lieu of that, we look into the history of the doctor—education, training, etc.” By the same token (no pun intended), crypto investors could “judge quality based on the total effort developers made to write the code.”

Using GitHub data for 559 cryptocurrencies over the period August 2016 to December 2019, the researchers zeroed in on five open-source activities. They classed three under the heading of “quality enhancement.” Commits are code modifications submitted by developers and eventually added to the crypto source code. Before official adoption, proposed modifications exist as pull requests awaiting assessment. Issues are questions, bugs, or problems raised by developers or users for discussion within the open source platform.

The remaining two activities fall under “diffusion of software,” essentially a proxy for developer attention. Forks are mirrored copies of the original code attached to a developer’s account. Watches are a way for developers to “subscribe” in order to more closely follow the discussion within the community around a cryptocurrency.

Across the data-set, the researchers found that a one-standard-deviation increase in forks and watches would equate to a 0.56% price increase per month, or 6.7% per year.

As for the three “quality enhancement” metrics, increases in issues exerted upward pressure on token price, but pull requests and commits displayed the opposite effect. A one-standard-deviation increase in issues led to a 4.3 percent higher price over one year, while an equivalent increase in pull requests was linked to annual losses of five percent.

These contradictory results perhaps point to uncertainties about the length of time it would take for crypto admins to evaluate and implement proposed changes. It goes without saying that greater numbers of requests for revision would heighten such uncertainties and their possible implications for cryptocurrency quality.

Overall, these findings imply a “virtuous circle” whereby more promising cryptocurrencies attract more developer attention, which in turn produces quality improvements that are reflected in the token price. While the expansion of the developer community creates the potential for rising pull requests and commits to lower the token price, the price-positive impact of forks and watches was approximately six times stronger. As a general rule, then, intensity of developer attention and engagement could be viewed as a leading indicator of how the market values the tokens—with the very important caveat that broad statistical patterns may have little to no bearing on specific investment decisions.

Therefore, information from GitHub and other open-source platforms could be an important reference point for policymakers looking to evolve nuanced regulatory approaches. “One purpose of regulation is to create equal opportunity,” Petryk says. “Transparent mechanisms allow investors to learn about underlying assets and properties and make their own judgments. Open source platforms like GitHub are open to everyone, but not everyone thinks to use it. In terms of info disclosure, this could be an important factor.”

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Research

Mapping Blockchain's Frontiers

Kiel Stone — Tue, 15 Feb 2022 17:39:10 +0000

Mapping Blockchain's Frontiers Kiel Stone Tue, 02/15/2022 - 12:39

In This Story

Jiasun Li

Let’s unpack the portmanteau word “cryptocurrency.” The combination of two unlikely bedfellows—cryptography, a subfield of computer science, and currency, a topic in economics—is at the heart of the transformative potential of its underlying blockchain technology. But the uniqueness of the pairing can make it very difficult for research professionals in either field to predict, let alone positively influence, blockchain’s future development.

Jiasun Li, an assistant professor of finance at �鶹��Ƶ, is among an elite group of academics who are bridging the divide by merging relevant concepts from computer science with game theory—a subfield of economics that studies the interactions of decisions made by interdependent economic actors.

Jiasun Li

“Learning from the interaction between both economics and computer science is going to be very fruitful,” Li says. “People working in crypto already know this. The problem is that there are very few people well-versed in both fields; economists don’t understand what computer scientists are talking about, and vice versa. Part of my value-add as a researcher is that I can interpret between them.”

For example, in a 2021 Review of Financial Studies article (co-authored by Lin William Cong of Cornell University and Zhiguo He of University of Chicago), Li looked into whether the phenomenal growth of Bitcoin mining pools would lead to dangerous centralization over time—a possibility concerning to many practitioners. If too much activity were concentrated within one or a few pools, it might undermine the purpose of a decentralized system.

As Li’s game-theoretical models demonstrate, however, the very force driving miners to form pools—i.e. the desire to stabilize mining income via risk sharing with peer miners—acts as a drag on centralization. Optimal risk-sharing strategies for an individual miner would include distributing computing powers across multiple pools, rather than putting all their eggs in one basket. A large pool will optimally charge a higher percentage fee, so it tends to grow more slowly as miners choose to reallocate their computing power to different pools. Therefore, Bitcoin mining has a certain degree of built-in resistance to monopoly.

Li's working paper with co-author William Mann (of Emory University) has significant policy implications for initial coin offerings (ICOs) and digital tokens. Tokenization is widely considered to be the capitalization engine of many blockchain projects, yet regulators are divided on how to treat tokens. Are they securities like any other, and thus subject to existing laws such as the Securities Act of 1933?

Li’s model, incorporating a concept from game theory called forward induction, shows that purchasing a platform-specific token can signal future intention to adopt the platform, in addition to potentially supplying capital in the here and now. For example, purchasers of the FIL token can be reasoned to be future users of Filecoin’s “decentralized storage” services, which in turn motivates potential storage providers to contribute. The token serves as both a medium of exchange and a coordination tool for building—and binding together—both sides of the platform. Therefore, the researchers suggest that tokens that do both deserve their own regulatory category.

The above dynamic

presumes a token with little or no worth outside the originating platform. As the off-platform value of the token rises, its coordinating power drops because the temptation to cash in their chips becomes stronger for token holders. Therefore, the authors also recommend that entrepreneurs who seek to build successful platforms curtail token holders’ ability to engage in speculation, e.g. by offering separate security and utility tokens rather than issuing only one type of token.

Li’s most recent paper employing game theory (co-authored by Hanna Halaburda of New York University and Zhiguo He) examines the economic incentives involved when nodes within a blockchain form consensus. How well this consensus formation process works is a critical issue for blockchain systems. For example, in the application of cryptocurrencies, transaction histories must remain the same across blockchain nodes in order for the system to remain reliable. Furthermore, blockchains must have a way of reaching consensus even if some nodes do not work properly (for example, in cases of some nodes malfunctioning or being hacked).

Over decades, computer scientists have developed “Byzantine fault tolerance” (BFT) protocols to work around compromised, or “Byzantine” nodes and obtain consensus. These protocols are now widely used by almost all major tech companies for their in-house services. The permissionless nature of many blockchains, however, distinguishes them from those existing in-house applications. Since they don’t fall under one organizational umbrella, nodes in a blockchain may develop an adversarial relationship due to misaligned incentives. Hence, protocol designers must carefully specify the payoffs and penalties each node derives from successful or failed consensus. Enriching prior BFT research, Li’s game-theoretical model in this paper shows that there are many equilibria within such systems (an equilibrium of a game specifies a set of strategies by all nodes so that each does what is optimal for itself).

For example, there is always an equilibrium in which nodes fail to commit to anything at all. The model provides a framework to further analyze alternative versions of BFT protocols with explicit account of economic incentives.

Game theory is a valuable tool because it enables Li to model the “action space” of a decentralized system like in a blockchain and thus start to make sense of how it works. From there, academics can theorize about the answers to critical questions about this emerging technology.

Sources: Lin William Cong, Zhiguo He, Jiasun Li (2021). “Decentralized mining in centralized pools,” Review of Financial Studies

Jiasun Li, William Mann (2020). “Digital tokens and platform building,” working paper.

Hanna Halaburda, Zhiguo He, Jiasun Li (2021). “An economic model of consensus on distributed ledgers,” working paper.

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Examining the Untapped Potential of Blockchain Technology

Marianne Klinker — Tue, 16 Nov 2021 20:47:36 +0000

Examining the Untapped Potential of Blockchain Technology Marianne Klinker Tue, 11/16/2021 - 15:47

In This Story

Jiasun Li

The internet changed everything in our lives—from our social lives to the way we do business. The internet also created myriad ways for businesses to collect and harness vast amounts of data and, in doing so, opened doors to scams, frauds, and murky dealings. This is where blockchain technology may potentially create benefits of similar magnitude.

Jiasun Li

Jiasun Li, assistant professor of finance, is researching this new tool for internet commerce. “Blockchain is a kind of distributed ledger that could change how business activities are organized,” he says. “It essentially provides an alternative way for economic activities to be conducted.”

Blockchain is a cryptography-secured database that registers ownership and transactions. Every time a transaction is made, details are secured in “blocks,” which are linked together and replicated in multiple computers linked to the system.

The technology makes forging or tampering with these records easily detectable. In turn, this security makes the many intermediaries currently necessary to secure transactions redundant. Removing the market powers from intermediaries could potentially reduce transaction costs.

Li imagines that blockchain technologies will eventually be used not only to reduce transaction costs, but also to create new markets. He asserts that, because of the potential to revolutionize commerce, understanding this new technology is important for everyone in the world of business.

“Any business leader with an entrepreneurial mindset, or those in traditional industries facing potential opportunities or threats from these new markets, should gain a better understanding of blockchain technology,” he says.

Li’s interest in blockchain grew out of his curiosity about new technologies, including Bitcoin, which was created by the same individual or group as blockchain under the moniker “Satoshi Nakamoto.” Blockchain has great potential, Li says, but he warns against getting excited too early.

“Blockchain technology is still in its early days,” he says. “We should, on one hand, avoid hype and be patient with its progress and be objective with its current bottlenecks. On the other hand, we should avoid being overly dismissive and missing the possibilities.”