IEEE Blockchain Podcast Series: Episode 5

A Conversation with Shermin Voshmgir
Author of Token Economy

Part of the IEEE Blockchain Podcast Series

Episode Transcript:

Brian Walker: Welcome to the IEEE Blockchain podcast series, an IEEE Digital Studio production. This new blockchain series entitled Research Notes in Blockchain is hosted by Quinn DuPont, assistant professor at the University College Dublin School of Business, and the author of Cryptocurrencies and Blockchains. Professor DuPont is joined by Shermin Voshmgir, researcher and author of Token Economy and founder of Token Kitchen and Blockchain Hub Berlin. Shermin discusses her insights on establishing a foundation for crypto economic systems and highlights challenges faced in achieving a purpose-driven token economy. She also talks about her particular focus on sustainability-based tokens and cites how they could possibly help lower individuals’ carbon footprint.

Quinn Dupont: So, thanks for joining us. The first question I've got for you is just a real broad one. Maybe if you can tell me a little bit about your research background, especially as it informs your approach to crypto economics.

Shermin Voshmgir: Okay, so I guess I'm not a typical researcher in the sense of academic researcher. I studied and did my PhD a while ago, 20 years ago, and then was briefly working in academia. But what I actually didn't like so much was the lack of interdisciplinarity in academia in general and in computer science in particular, back then at least, and so I went off, did a number of other things, and kind of a series of coincidences led to the fact that I got the chance to set up a research institute together with my ex-Professor Taudes at my alma mater in Vienna, at the University of Economics in Vienna, and our idea or my idea back then after having established the Blockchain Hub in Berlin was to bring kind of this new technology kind of into academia because I had the impression that it was really necessary to bring well-researched or to have a tight collaboration between research and development, and so yeah, we had the idea three years ago to set up a research institute. I called it Crypto Economics because back then, I realized that blockchain was only kind of the backbone of this new web, and it was an economic web, and kind of how we design the systems in this new Web3 is an economic question. It's a social question and in addition to technical questions. So we set up this interdisciplinary research institute and was quite challenged, I have to say because academia has not set out the KPIs. The incentive systems in academia are not set out for interdisciplinary research at all, and yeah, but we had a few very interesting years. Right now, I'm not working there anymore, and I continued my applied research in a private research entity called Token Kitchen.

Quinn DuPont: Interesting. Maybe even just tell us a little bit about what Token Kitchen is up to these days as well.

Shermin Voshmgir: Like when I started the Blockchain Hub, that was 2015, and back then there was no information about what this new technology called blockchain was, and as I was investigating this myself, and kind of I was sharing my insights with the world, and that was what Blockchain Hub was about. But I think right around the time starting 2018, when we started the research institute in Vienna, I realized that it was actually the tokens that were the killer application of this new economic web, and blockchains were the backbone to settle all token transactions, and so what I'm doing now with Token Kitchen, and I wrote the book Token Economy, which is kind of less research oriented, and more kind of a, yeah, book for the general public or a good teaching book, and like with Token Kitchen, I'm focusing more on the economic design patterns that need to flow into setting up different token systems, and the Web3 is very different in its dynamics from the Web2 and its stakeholder structure and dynamics and the knowhow we need. Kind of the why did I call it kitchen? Because basically, we need to identify recipes for these new token economies, and I wanted to do it. Like using the word kitchen for me is deacademifying the whole thing, like kind of making it more hands on and less theoretical, and my particular focus with Token Kitchen is on purpose-driven economic system, purpose-driven tokens, tokens that steer network, social networks such as Steemit or kind of computing networks such as any blockchain network, right, whether it's a peer-to-peer payment network, or a computing network like Ethereum. Tokens that steer economic activities and kind of incentivize the individual towards the collective good. So if you think of Bitcoin as a peer-to-peer payment network, the bitcoin token can be seen as a purpose-driven token that steers the economic action within the network, and taking this kind of macroeconomic perspective on these socioeconomic networks that are emerging in the Web3, kind of this is what we started with the Crypto Economics Research Institute in Vienna, and now with Token Kitchen, we're trying to identify hands-on token systems. My particular focus is sustainability. So, I'm focusing on CO2 tokens. How can we incentivize sustainable action within a community, and back while I was working in Vienna, we started a project with the city of Vienna, where the city of Vienna designed the system together with us to incentivize the reduction of CO2 emission by alternative mobility behavior by not taking kind of the car. So, if you could prove that you kind of walked, or you took public transport, or you rode the bike, and we can track this in your kind of mobile device, the city of Vienna decided that that's worth something. For the community, reducing CO2 has an economic worth for the community in Vienna, and they decided to incentivize one kilogram of the proof of CO2 emission reduction. If you could prove that you saved one kilogram of CO2 with your mobility behavior, you would get a token, and for that token, you could go to cultural activities. Now unfortunately, this was one of the applied projects with it back when I was working in Vienna, and unfortunately, this is on hold right now because of the pandemic. Cultural institutions have closed. But so, the things we did on our side was to help the city identify the socioeconomic questions and the technical legal, and technical economic questions related to the design of this token system. There are many legal questions involved. But there are also many behavioral economics questions involved. So the technical question of whether to run it on a public network like Ethereum or a private Ethereum clone where nodes are run by institutions such as universities and the city, etc., these questions are important, but they're not as complex as the question of how to design such a CO2 token so we can meaningfully incentivize CO2 reduction within the community, while preventing-- at the same time, trying to prevent kind of fraud, right? You want to prevent people from taking their mobile phones and throwing it around their dog's neck and the dog runs around and kind of starts to collect tokens, right, and so designing these new token systems is quite challenging from an economics perspective, and this is what I'm focusing on with Token Kitchen, and as I said, the focus is CO2 emission reduction for me personally,

Quinn Dupont: That's a really interesting perspective because when you first said CO2 emission reduction, I was thinking of course, that you'd be heading towards a carbon trading approach, but you've done something really quite different here. So maybe let's just talk a little bit more about the Crypto Economic center involved in this system. When you're developing the token, so you talked about sort of attack vectors, the idea that somebody might commit some sort of kind of fraud with exactly putting it on their dog or something. What are the kind of considerations that you need to think about when you're developing this as a whole system?

Shermin Voshmgir: Exactly. That's a very good question. So, what I've identified in my research is that first and foremost, you need to ask yourself, “What's the purpose of the network?” When we think of Bitcoin, the purpose is to have a peer-to-peer payment network, and proof of work was quite revolutionary because it came up with a mechanism to prevent fraud. Now if you take a different example where the purpose is different, for example, Steemit, the purpose of Steemit was to have a peer-to-peer social network without centralized kind of institutions like Facebook, Twitter, etc. Steemit was very successful, had a lot of traction in the first years. The problem with Steemit, the main purpose-driven token that was supposed to incentivize action in the system, Steem Power, they had a three-tier token system. It’s too complex to explain it now. I wrote it in my book. But the main token in the end was Steem Power, and that was supposed to be a reputation token in the network. So, the way it worked was, when you kind of contributed, when you upload a post that somebody else liked, both you and the person curating that post would get Steem tokens, Steem Power, and the system was designed in a way that it would incentivize contributions by posting and by curating, but the contributions would get incentivized as a function of the amount of Steem Power that you had. So if you have more Steem Power in the system, having more stake in the network would mean that you have more incentives to contribute to the overall quality of the network. That was the assumption, but the token was designed like money, so anyone can buy Steem Power, and sell Steem Power. It wasn't tied to your identity. That reputation token wasn't tied to your identity. What happened because of that was that because it wasn't tied to your identity, you could basically buy reputation with money you had, and if you had more money, external money or internal money, your vote would be worth more because the amount of tokens you get would get rewarded was a function of the person curating your posts. So, if somebody with a lot of Steem Power would like your post, you would get more tokens, proportionally more tokens than somebody with less Steem Power. Now I would say one of the things that happened is that over time, the late movers in the network, late adopters in the network, they didn't have a chance of making real money because the income disparity within the networks was very big. Like less than 10% of the token holders had 90% of the Steemit tokens, which meant that basically, newcomers had no chance of making meaningful money in the network. For a while in 2016, ‘17, I knew two people who could pay part of their rent by contributing with posts. But they couldn't do that anymore because the income disparities grew, and so what we learned from Steemit is while Steemit as a use case was one of the greatest use cases having a decentralized social network that incentivizes for you for network action is great, but you cannot tie this-- kind of you cannot create it like money, and the initial creators of Steemit, they come from finance. Their assumption was that people would have the long-term benefits of the network in mind. But what really happened was that people would transfer their tokens to bots, voting bots that would optimize kind of voting power to optimize the outcome, and in the end, the posts that got most uploads would be kind of memes. So instead of having quality content, the network was less and less used. So, what we can see here is that we need a great deal of behavioral economics and game theory in the mechanism design of these token systems, and I think we're at the very beginning of starting to design these token systems.

Quinn DuPont: That's such an interesting case study. I was familiar with Steemit, but I didn't know the details and the background there. So, it's ironic that on your assessment the problem with Steemit was this interest in making it financial, of money backing, which opened up a bunch of opportunities for activities that weren't beneficial for the broader network. How would one go about defending this? What would be some of these behavioral economics or crypto economic kind of ideas that might help make a more robust version of this?

Shermin Voshmgir: First of all, we need to start by defining like properties of tokens. This is a thing that we didn't do that in the Crypto Economics, the foundations paper. I did this in my book though. I have this chapter on what a token is and the properties tokens can have, and I will focus on this topic in my next book. So tokens can have different properties. One of it is fungibility, and whether a token is kind of-- the unique properties a token can have, and one kind of attribute could be tying a token to your identity, right, or giving the token limited fungibility. Tokens are programmable money, but we have to redefine money because when we created money or invented money in the analog world, it was really hard to give money multiple attributes, but in a token contract, with a simple smart contract you can add a number of attributes, and what is like what we're seeing now with this NFT craze happening around us. People now think-- like mass media now is reducing NFTs to art tokens, and this is not true. NFTs are anything that have more attributes than simple money, and Bitcoin was designed as simple money, and the first blockchain tokens are kind of money like. This is why we call them cryptocurrencies because they don't have more complicated attributes. But if I, for example, identify and design a token to, for example, have limited transferability. This is what we did in the use case of the Vienna token. One of the things we decided with the city of Vienna and with a bunch of lawyers, for multiple reasons, we decided to have no transferability of the CO2 token, or the tokens that you could collect in the Vienna system wouldn't be transferable. So only you can spend those tokens, and it was designed that you could only collect six tokens. You would have to spend them before you could collect more tokens. Why? (a) because of tying it to your identity and not making it transferable means that you’re not classified as money, right? The city of Vienna would have had a much bigger problem in launching this new system if they would have created a parallel currency in the legal sense, right? So this was one of the reasons to have limited or tied to your identity. The limited transferability had liability issues because the city of Vienna wanted to avoid that you could collect a lot of tokens, and then maybe claim them in 20 years, so there was an expiry date connected to the tokens, or there was a question of connecting an expiry date to the token, but also in limiting the amount of tokens that you can collect. So very often it’s-- so you have to-- depending on what the purpose of the token is, and who you're designing this token kind of system for, and what the legal implications of kind of also, or the legal framework is, these factors, all these factors will determine your token design from legal factors, but then also from behavioral factors. Yeah. So there is a myriad of factors that you need to take into account when designing a token system, and these factors depend on geographical locality, the type of token that you're designing. So there is not a one size fits all solution. This is what I'm trying to say. So, what we're trying to do in our research with Token Kitchen is to define interaction patterns, common patterns for social media tokens, common patterns for CO2 tokens, etc. We're still in the very, very early stages of this new token economy and we don't know what these common patterns are.

Quinn DuPont: Yeah, it's very interesting. I like this idea of patterns, and as you're very clearly aligning this through a kitchen metaphor with recipes because I think this has been a challenge with just maybe, I don't know, more generally, smart contracts are-- I get the sense that there's a lot of work we need to do to understand how to develop them safely and transparently, such that people can deploy smart contracts that have sort of known legal ramifications and known technical ramifications. It sounds like that's kind of what you're driving towards.

Shermin Voshmgir: Yeah, it's technical, legal, but it's economic. Why are we creating token systems? Because we want people like all over the world to interact with each other, right? We want people to have a meaningful social network where we can ideally prevent fake news, or we can ideally incentivize people for quality contributions in the network. Now quality contribution probably is subjective. Why is it kind of so hard to create reputation systems? Because in social networks reputation can be very subjective. What is quality content to someone like me might be not so much quality to you because our tastes differ, or our interests differ, etc., or we have a generational gap, and so this is often a question of behavioral economics, and social science, economics, and social science, or as part of social science, much more than a technical question. So, in a technical question we ask ourselves-- if we look at token engineering and this is one of the things I wrote in my book. From my perspective, I identified four pillars of token engineering. One is the most obvious. It’s technical engineering. It’s like which kind of DLT do I use? Which blockchain network or distributed ledger system do I want to use and kind of how do I come from a from a technical point of view? Which token standard do I use? Do I need to create a new standard? What are the attributes? And here probably the most important from a technical perspective, the most important questions are security, scalability, privacy, and here you need to make sure that you also are compliant. Very many use cases, for example, in the financial industries, but also in real estate, etc., highly regulated industries, so you can't just do-- designing a token system for DIFI is a very different thing than designing Gitcoin, right, maybe, or designing a social network because regulatory framework is different. So, we have the technical engineering. Then we have legal engineering, and technical engineering and legal engineering needs to go hand in hand because whatever you design are the technical system, needs to be probably legally compliant if you want to attract mass markets. Today, a lot of use cases that could be-- are technically feasible, but they're legally not compliant, or it's unclear what the regulatory, so we have to make the regulatory framework compliant, or we have to make the technical kind of design of the token system compliant with the regulatory framework. So this is where we see that lawyers and software developers need to work hand in hand much more than before even. But then we have the economic questions, and economics, it’s like a set of different economic questions from microeconomics to macroeconomics, to behavioral economics, to ecological economics, etc. So it's very funny because we did a token project with a blockchain network, quite a famous one. It's I signed an NDA, so I can't say what it was, and they came to us back then when we were at the university, and they wanted to kind of design their monetary policy of their blockchain network. So they wanted to do it fast because they had an upcoming kind of token sale, and they mixed up questions of microeconomics and macroeconomics, and then we did the project and at least in the first phase, and one of the questions they asked us after we did the first-- finished the first project phase was that they didn't realize that they need to hire an economist now. Now at that time, this blockchain project, they had 200 people working for them, right? So, they wrote a job description for an economist, sent it to us, and asked us what we thought of it, or one of my colleagues, and he came to me, and he said, “Shermin, they sent me this job description, and basically they're looking for eight people in one, and it's not like one economist that can resolve this.” It's like you need a set of different economists with different backgrounds. Right? It's like an IT person is not a software developer. You have different-- along the software stack, you're a full stack developer or only a front-end developer. It's the same with economics. We have various schools of economics with various perspectives of designing economic systems, and we have the microlevel, the macrolevel, the mezzo level. We have the behavioral and then we have the game theory. There are so many different perspectives. So basically, what we answered them is, what you're looking for doesn't exist. That person does not exist. You would need to hire eight people probably, or 10 people, but they only hired one, right? So they have 100 software developers, and then a few admin people and marketing people, etc., and then they hire one economist, and I think we need to understand that what blockchain networks are, and what this new Web3 is. It allows us to have socioeconomic interaction patterns, and that kind of by designing purpose-driven tokens that steer economic systems, socioeconomic systems that incentivize individual behavior towards a collective goal, right, we need complex economic thought going into the design patterns of the system. So I think what we need to understand from a software development point of view is that we need-- and Silicon Valley used to say, “When you get funding, you need to allocate 50% to software development and 50% to marketing.” So, what I'm saying is that when you get funding now, you probably need a third for software development, a third for marketing if you want to get a lot of traction, but a third for a set of economists and lawyers to help you design those tokens system because when we were designing the Vienna token, we didn't have one lawyer. We had working groups with 20 lawyers in the room from different research backgrounds. A tax lawyer only has a tax perspective or of what the tax implications of a CO2 token are. But then you have kind of the capital market implications, et cetera, et cetera, and then you have the privacy implications. So, you need a set of different lawyers with all those different perspectives. Tying this back into why we started the Research Institute of Crypto Economics or for crypto economics back in 2018 was back then I already saw that the questions that we needed to ask ourselves when designing blockchain networks and the applications running on top of them, we need an interdisciplinary set of knowhow that goes into designing these token systems, and I'm sure that over time, over the next years, we will identify these common interaction patterns, depending on the goal of your system, and we might reduce the workforce or research force we need for designing those token systems. But it is very much an interdisciplinary approach, and I think what the Web1 and 2 lacked because it was steered out of Silicon Valley, it had this very get you done attitude of programming a front end that that was usable, and functional, and could get very fast return on investment, and while some people early on, they already said that privacy would be an issue and the data economy would be an issue. But most people started to understand the implications around privacy and who owns our data after the big scandals of Cambridge Analytic, etc. But the problem is that once you have this big machinery, like a social network, Facebook that is listed on a stock exchange, it's really hard to change their value proposition if it's based on data, and there is no transparency of what happens in our data in the Web2, and I think we're seeing that in the Web3 because it's economic systems, it is probably much more important to ask the more difficult questions, the long-term implications of like protocol design, and token system design. Because once we have bias in the protocol, it's hard to get it out of the system because you need a hard fork for that, right? You need to have consensus of all network actors, and that is hard to get, and we can see this from the Bitcoin ecosystem. We can see this in the Ethereum ecosystem, and we can definitely see it in this use case of Steemit because it went through kind of the network split up into Steemit and now the Hive network.

Quinn DuPont: Very interesting example of the challenges of getting this multi-interdisciplinary project off the ground. I agree with you. This is the challenge that people in the blockchain space really need to think hard about. I just want to go back a little bit though to you mentioned, micro, mezzo, and macroeconomics, and one of the things that I thought was really fascinating about particularly your Foundations of Crypto Economic Systems article was that you talk about how this analysis across these multiple scales gives insight into emergent properties, and I'm just wondering if you can say a little bit more about the-- I guess it's the analytical challenges of understanding these emergent properties.

Shermin Voshmgir: Yes. So, what does emerging properties mean for maybe non-CPS people? So basically, let's stick to like a real-life example, right? So, the Bitcoin network is based on-- steered by a protocol design. The Bitcoin protocol was designed based on certain game theoretical assumptions, and it resolved the problem of how to steer peer-to-peer network in an attack resistant way, and now the protocol was designed, and it worked very well for a while. But then we realized that oh, actually, people, a lot of people, much more than maybe the initial designers of the system thought, Satoshi, whoever it was, thought, all of a sudden there was a scalability problem in the blockchain network, in the Bitcoin network. So as you might remember, for those who followed the discussions, there was a long debate over years within the kind of developer community of how to resolve the scalability problem, the so-called block size debate. This block size debate added a different kind of-- there were different ringleaders with different opinions of how to-- or approaches of how to resolve kind of the scalability problem, and without deep diving into the technical questions of what was discussed, in the end, you had people, a community that were using, that were designing and using the system who had different interests and opinions about-- probably different interests because miners had the interest in keeping their incentive reward structure high, while users wanted to have lower fees, while developers might have had their own interest, depending on whether they had tokens in the system or not, or what kind of political stance they had within the system, etc., and then you had different proposals, and nothing really happened for years because we need the majority of the network to agree on how to upgrade the system, and this is the emergence that we try to describe is that as time evolves, the system evolves into a direction that might have not been foreseeable, and especially in complex systems, you never know how one attribute can determine the outcome of the whole system. So as this bitcoin system evolved over time, it became necessary to upgrade it, but then people have different opinions, were not on the same page, and now the problem was that, yes, you can fork the system, but by splitting the network in two halves, you also make the network less safe. So it took a while until kind of a proposal upgrade went through, and when it did, it also made the network split into several sub kind of forked chains of people who had different opinions, and so this governance of these crypto economic systems is partly automated. But then as the system evolves over time, there is this emergence that we need to upgrade the systems, and how we upgrade it, and who decides on that, and who writes the code, and when it is put actually into code, and then we have this feedback loop of governance design of these systems.

Quinn DuPont: Right. Yeah, governance is clearly very important. In your paper, you talk a little bit about the need for polycentric governance and even with purpose-driven tokens that there might be no one social optimal. Is this something you've you found already in some of the real-life work you've been doing in Vienna there?

Shermin Voshmgir: Yeah. It's what is social optimal, right? People with different desires, and different political beliefs, and different kind of utility functions, we would say from an economics point of view, come together. What is the social optimal? That's a philosophical question. This is why we have so many different schools of economics, right? Mainstream economics is still based on the old classical economics that assumes that we as humans try to maximize and that's the sole motivator. That’s the sole thing that motivates us is maximizing our economic function, our income. But behavioral economics has shown that this is not true, and we have various schools. One of the things we wrote in our Foundations of Crypto Economics paper, yeah, the evolution of corporations’ perspective is that, while the proof of work is built on game theoretical mechanisms or assumptions from very old game theoretical assumptions of the let’s say the ‘50s or ‘60s where we assumed that the only goal of human beings are to maximize their income, but if we look at behavioral economics and behavioral game theory, we know that there are so many other cooperative behaviors that people have, and that profit maximizing, individual profit maximization is only one of many behaviors of human being. So what we would need to include in designing crypto economic networks, including blockchain networks, would be understanding that people have other motivations other than maximizing their bottom line, and maybe a research question could be, is proof of work so expensive-- and so also energy consumption kind of expensive in energy consumption because it's based on profit, the assumption of profit maximization, and what would happen if we would extend proof of work, or create a new game theoretical mechanism that would account for other things that motivate human behavior? That would be a very interesting research question.

Quinn DuPont: So, it's interesting that we've spoken a lot here about ways of controlling people, behavioral economics, mechanisms that are designed to reinforce and prohibit certain kinds of behaviors. But then there's also an interesting, and I think largely an underexplored avenue looking at new social dynamics, and in your paper, you talk about computational social science.

Shermin Voshmgir: That's a very good, timely question because I wanted to refer to this now. I mean if you think about blockchain networks, there are crypto economic systems, and they are data-driven economies. So, what was really hard for me is that I could get so little enthusiasm of our researchers, economics researchers on this topic, probably maybe because they were overwhelmed with their day-to-day research, and teaching, and activities, etc. But basically, blockchain networks and the applications that build on top of them are data-driven economic systems. So, we can do a bunch of data science on the real-time data science on what is happening in this economic system and have real-time steering of these economic systems. If you think of our current economy, like our real economies, national economies and how they're being steered, they're being steered on old data. That data can be a year old. If it's new, it's only a year old, or a census data that is collected once every 10 years. This is crazy. We live in the computer age already. Yet the policy design of our economic systems on a nation state level is done based on old data. Now in the internet and especially in the Web3, we have real time, public data on all economic activities in the network. Now this public data can be shielded or not shielded, but we can do-- even if we use kind of-- we could use privacy preserving multiparty computation stuff, but still do big data on privacy preserving networks. But if you think of the amount of data that we have on every single economic activity that happens within the Bitcoin network or within the social networks such as the Steemit network, it's not data that is behind the walled garden of the Facebook servers, right? It's public data. So, all the data in the Steemit network is public, which is why many decentralized applications started to emerge that were feeding the Steemit ecosystem, which was why the Steemit ecosystem was very, very successful, before it failed because of its poor economic design or incentive design of its reputation token. But so what we can do in this data-driven economy is how we can steer these economies in real time, maybe also computer aided with machine learning algorithms aiding us in the steering of the systems. This opens a new era of kind of economic design, and the challenge right now that we have is that those who understand blockchain networks from a computer science perspective, probably all the listeners of your podcast now, usually don't have economics knowhow, and economics people don't have enough or any computer science knowhow. The overlap of people who are economists who have computer science knowhow and vice versa is very low. So what we try to do, and one of the researchers that I very really appreciate is Jamsheed Shorish who was a-- he's an economist that has been very early on, since actually I think 20 years, focusing on computational social science. But he's an outlier. He was an outlier 20 years ago, I guess, or even 10 years ago, and unfortunately, he still is an outlier now. So what we need to generate is a new class of researchers on the intersection of economics and computer science, but also on the intersection of the law and computer science. So this is why I'm really happy that you invited us to speak because unless we don't have this intersection, we will never have meaningful computational social science, and we really hoped, and this is why we put so much, Michael and I, effort into this paper, that we could create an understanding for the magnitude of this new generation internet that is ahead of us, and this is why we called it Crypto Economics, a combination of cryptography which is computer science and economics. Yeah.

Brian Walker: Thank you for listening to our interview with Shermin Voshmgir. To learn more about the IEEE Blockchain initiative, please visit our web portal at blockchain.ieee.org.