Browsing Tag: principal-agent

    agency risk
    DeFi

    Dazzling moment in financial history: blockchain technology will completely eliminate agency risk!

    June 27, 2020

    People who have just come into contact with blockchain are often at a loss. What kind of economic language is used to describe the meaning of blockchain.

    Some people say it’s cost, but they don’t see which industry’s cost has changed because of blockchain; others say it’s trust, and they don’t see the quantifiable description of trust under blockchain, so many people think the value of blockchain is that it can’t be tampered with.

    These are very superficial understandings. In the language of economics, blockchain essentially changes the agency risk in the principal-agent relationship.

    Agency risk is everywhere.

    When you entrust someone to do something for you, he fails to fulfill it; when you leave something in someone else’s place, he fails to take good care of it; or when the service you pay for goes wrong, it’s all agency risk. What’s really worrying is that your assets are entrusted to others, resulting in huge losses, such as our investment fund, our investment in P2P and so on.

    Agency risk refers to the risk that an agent has no ability or fails to perform the principal-agent relationship in accordance with the rules.

    Code is the law

    All of the above seems to be common and has nothing to do with blockchain; but in fact, the real meaning of blockchain is here: the algorithmic realization of agent risk through public ledger and decentralized consensus, that is, agent risk is implicit in the code, and the code is open-source and determined at the beginning, so agent risk is completely known. This is the real value of blockchain, and de trust refers to the agency risk in a general sense: the trust risk to people and institutions. Cost reduction is to avoid the risk of all kinds of adverse selection, thus bringing the decline of social cost.

    Therefore, the essence of blockchain is a problem of principal-agent framework. Technological changes have brought about a revolution of principal-agent. We no longer put the core risk on a third-party organization. Code is the law, and code is the main risk.

    Here are a few examples:

    Case 1: Bitcoin

    Through Bitcoin, in an ideal situation, we do not rely on any third party to save or transfer assets, which is also what many people say, through cryptography, we guarantee the “inviolability of private property”.

    BTC

    There is not no risk in this. For example, the code is also likely to make mistakes (although it has been tested for 10 years, it can’t be said that it’s impossible). But the code is open-source at the beginning. For everyone, this risk is completely informed and cannot be modified (except for bifurcation); more importantly, in this process, an individual or institution has no impact on BTC transfer Maybe, we can reliably complete point-to-point payment.

    Bitcoin, a major technological innovation, has completely changed the past economic model and brought us to a new era of trust algorithm rather than individual.

    Case 2: USDT

    USDT is the digital dollar issued on Ethereum. Although USDT is on the blockchain, the system to ensure the value of USDT is off the chain, that is, the issuer Tether company promises that each USDT is equal to one dollar.

    Although Tether company has done a lot of work to ensure the effectiveness of this commitment, such as trusteeship and audit of bank accounts, we must trust Tether company, audit institution, trusteeship bank, etc. in order to truly and smoothly implement the whole process, which is quite different from BTC’s full trust in the calculation method. Although blockchain is used, its value includes huge agency risk. Once Tether company and other companies do not honor, USDT becomes a string of codes, rather than a dollar.

    Case 3: Platform currency

    Blockchain industry has a special kind of assets, called platform currency, which embodies the service fee reduction, transaction pricing, profit return and other values of an exchange platform. This kind of asset, such as BNB, as token of the coin security platform, whether or not it uses blockchain technology, essentially contains a huge agency risk like USDT, that is, money security exchange can change, revoke or even change the value reflected in the token. What can we do? Only believe in the safety of money.

    Case 4: DAI

    In addition, there is a special kind of asset, such as the stable currency DAI of MakerDAO. In essence, it is a stable option. DAI generated by eth mortgage is an option based on eth. It has a strict pricing formula, which is in line with the design that we have no agency risk but only algorithm risk. But there is also a problem with DAI. The price variable that determines its risk value is input by human. There is no good verification mechanism for this price, but it is input irregularly through several internal nodes. The basis for our position closing is the input price of these so-called nodes. Obviously, this risk is not algorithmic, but we need to believe that these nodes do not do evil or make mistakes, although However, maker has a rollback mechanism, but it also introduces the trust risk of rollback: who will determine the need for rollback? Why trust them?

    the degree of decentralization

    Based on the above analysis, we can summarize:

    That is, in the blockchain world, a complete value interaction process, as long as there is a link with agent risk, it is actually different from BTC, that is, we still introduce human risk, not code risk.

    Therefore, in the blockchain world, the quality of decentralization and the agency risk are two sides of a coin, and they are different expressions. The former is a perceptual description, and the latter is a rational definition. It is completely appropriate for us to measure the degree of decentralization with the agency risk.

    Not only can we judge the degree of decentralization of a system, but also we can find out which areas of agent risk can be solved by blockchain, so that we can really enter the application era of blockchain.

    Trust algorithm

    In a world full of agency risks, we have established a set of incentive system based on laws, systems, etc. to maintain the effectiveness of principal-agent structure, so that the world can operate normally. But the cost is also huge. Imagine all kinds of corporate scandals and regulatory corruption, which is the inevitable risk of the past model. No matter how well our incentive mechanism is designed, this fundamental risk cannot be eliminated. It can be said that the evolution of human society is the story of constantly changing models to deal with agency risk.

    However, this change brought about by blockchain technology is the most thorough solution to the agent risk. No longer need to trust any third party, no matter authority, hero or sage, but only need to trust the code! Trust algorithm!

    This is a dazzling moment in the financial history, which is worth our in-depth and comprehensive exploration. However, most people did not return to their minds, thinking it was just a small attempt, and soon compromised in the traditional model, which makes people sigh.