This working paper – available here – discusses whether traditional competition policy instruments such as antitrust and regulation are adequate to address competition concerns in the cryptocurrency field. In short, the author finds that traditional competition policy instruments are inadequate.

The paper is structured as follows:

  • Section 2 describes the topic. It begins with a short description of how means of payment (i.e. money and the like) are created. It then explains how the current monetary and financial system creates risks of excessive production of money, leading to inflation and/or asset-bubbles, which can lead to a decline of trust in a system that is reliant on it to function. Various bank regulations and public policies – such as capital regulation and deposit insurance – and rescue policies – such as lender of last resort – have been introduced to increase trust in the system.

The paper then moves to a description of cryptocurrencies, which have a fundamentally different nature from that of the contemporary bank-based monetary system. A cryptocurrency is a digital register that uses cryptography, distributed ledgers, and mechanism design to control changes in the registry. The entries of the register are used as tokens that serve as a medium of exchange. Unlike current means of payment, most cryptocurrencies are not backed by any real assets or guarantees, and hence have no intrinsic value: their value is totally dependent on trust in their future value.

The author then discusses the grounds for regulating cryptocurrencies, building on regulatory analysis – which requires that a market failure be identified before regulation is considered, and that an assessment of whether this failure can be properly addressed by regulation or other public policies be then pursued. For example, a market failure associated with most money-related services is that these services can be used to support crimes. Hence, regulations such as know your customer obligations and anti-money laundering requirements are justified. Secondly, asymmetric information allows persons with more information to take advantage of persons with less information. This justifies market integrity regulations such as the prohibition of market abuse, and rules ensuring investor and consumer protection. Third, financial services are also associated with certain failures that may lead to financial instability and costly disturbances in the real economy (i.e. systemic risk). While it is generally assumed that cryptocurrencies have not reached a significance necessary for them to impose a risk to the financial system, this might be an issue in the future.

In what concerns us here, the most relevant market failure is related to lack of competition and resulting market power. At this point, the discussion moves to the characteristics of cryptocurrencies that may be relevant from a competition law and policy standpoint. The discussion gets a bit technical at points, but I’ll focus on the conclusions here. First, cryptocurrencies utilize blockchain technology and cryptography to create trust. Cryptography and distributed ledger technology are combined into blockchain technology and utilised to minimize the risk of abuse and fraud, such as double-spending. Second, there are a number of cryptocurrencies. Besides competing with one another, cryptocurrencies can as be seen as alternatives to money and other payment services.  This is examined in detail in the next section.

  • Section 3 discusses strategic competition and market power in cryptocurrency markets.

The section begins by developing an analytical framework for analysing competition in the cryptocurrency markets. It outlines a number of characteristics that distinguish the supply of currencies from mainstream industrial organization models, such as specific advantages (seigniorage, charging of fees) and costs (issuance, trust-creation) that money issuers face. In addition to the specific characteristics of currency competition when compared to normal competition in providing goods and services, competition between cryptocurrencies has additional characteristics that are relevant to understand competition in these markets. Such characteristics are mainly related to cryptocurrency design and production (protocols, mining, etc.). The author notes that there is not much literature studying these particular aspects of a cryptocurrency from a strategic competition point of view.

The paper then uses the previous sections to gain insight into the potential for market power in cryptocurrency markets. The assessment is split into two parts.

First, it looks at the potential for agents to obtain market power within the operation of a given cryptocurrency that has gained adoption, such as Bitcoin. If a cryptocurrency has already gained qualified adoption, users of this currency are potential targets for exploitation. The users of a currency may be exploited by agents within the currency and agents related to the currency’s interaction with the outside world: (i) the most obvious way users can be exploited within a currency is from the transaction fees set by the block validators (i.e. those people who validate transactions in the context of a block chain). The incentives for this will depend greatly on the protocols for validating transactions. Likewise, core team developers may also abuse their control over the currency; (ii) persons external to the currency who hold market power in services vertically or complementarily related to a cryptocurrency’s operations may also exploit the users of the currency. For example, mining hardware has become heavily specialised, which means it may be monopolised via structural entry barriers and intellectual property rights. At the same time, a large mining facility is not very mobile and may be subject to exploitation by the local energy or internet provider.

The second part of the assessment looks into whether a specific currency can have market power. To figure out if a cryptocurrency has market power, one must start with the cryptocurrency in question and ask if it provides services unique and valuable enough for someone in control of it to exercise market power. At present, this looks unlikely, as cryptocurrencies compete not only among themselves but also with traditional means of payment. However, cryptocurrencies are subject to both network effects and platform effects, which may create the conditions for market power to arise.

  • Section 4 looks at whether competition policy, regulation or even direct government participation in cryptocurrency markets is appropriate. The section begins with an overview of competition law, and of how it may apply to cryptocurrencies, going over a number of different possibilities. It then moves to why competition law may not be the best instrument to promote competition in the cryptocurrency field. First, given the decentralised nature of ledgers and blockchains, antitrust may find it hard to identify the entities to which liability might attach. This is compounded by cryptographic mechanisms and obstacles to access that may make it difficult to determine who controls the nodes or other relevant components within the blockchain. Furthermore, the supply of a currency, and in particular of a cryptocurrency, may interfere with several public policies. The application of competition law may interfere with such policies as well.

As such, the author argues that recourse to policy instruments other than competition law may be preferable. These can take the form of ex ante regulation regarding transaction fees, or requiring non-discriminatory access to ancillary services such as exchanges and wallets. Regulations could also be used to limit network and platform effects, such as the use of central counter-parties to create a safer environment for over the counter (OTC) trading or requiring merchants who accept certain currencies to also accept cryptocurrencies. One particularly important alternative in this regard is for governments to issue their own cryptocurrencies. Several central banks are exploring the issuance of electronic base money to the public and have started research on the topic, including on the ideal attributes of a government issued cryptocurrency, its technical implementation, and potential economic consequences.

  • Section 5 concludes the paper. In short, it argues that the production of cryptocurrencies has some characteristics that render much of the standard workhorse for competition policy, industrial organization and its associated of-the-shelf models a poor fit for cryptocurrency markets

Comment:

While there have been papers about the role that blockchain technology can play in competition enforcement, this is the first paper I am aware of that deals with the enforcement of competition law in blockchain enabled markets – particularly as regards cryptocurrencies. The competition analysis is not particularly developed, but considering how speculative the paper is that is not at all surprising. Also not surprising is the fact that this work was produced by someone attached to a central bank, which are clearly taking the lead on how to regulate blockchain markets.

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