Blockchain Technology for Traditional Finance

Blockchain technology as embodied in cryptocurrencies like Bitcoin and Ethereum is comprised of both (a) a novel data structure and (b) a novel trust model. This paper analyzes the potential gains for traditional finance from an idealized version of the novel data structure on its own, with trust instead anchored in traditional sources such as rule of law, reputations, relationships, and collateral. Our framework has two parts. First, we analyze potential improvements for financial transactions that are already taking place. We identify three categories of improvement: (i) reducing real resource costs, (ii) improving balance sheet efficiency, and (iii) reducing intermediation rents. While the value of such improvements is hard to quantify precisely, we estimate that potential gains could be significant, especially the reduction in rents. Second, we analyze the potential for the technology to facilitate new transactions. We identify three channels: (i) making it more technologically difficult to cheat, (ii) making it easier to punish a cheating counterparty in a static sense, and (iii) making it easier to punish a cheating counterparty in a dynamic sense. Our key insight is that the potential gains are large if and only if there is a long tail of relatively low surplus, relatively infrequent transactions for which traditional forms of trust are insufficient. Last, we apply our framework to stablecoins. We conclude that if there are large gains from stablecoins for legal actors they are most likely to come from stablecoins putting pressure on intermediation rents or inefficient regulation, or from the programmability of stablecoins facilitating a large number of small transactions that otherwise would not have been trustworthy.