You’ve probably heard the story of the market for “lemons” – not the fruit, I’m talking about low-quality consumer durables. In his seminal paper, economist George Akerlof showed that information asymmetry as to which second-hand cars are good and which are “lemons” (with sellers knowing more than the buyers) ended up lowering the price and driving out the good cars, because owners of these would not sell at an unfairly low price. This, in theory, should push the price down even further and eventually kill the market.
The thesis has received a lot of pushback over the years, especially from people who correctly point out that the market for second-hand cars is far from dead, but it does raise an important thought experiment: What does the person I’m buying from know that I don’t know?
Noelle Acheson is the former head of research at CoinDesk and Genesis Trading. This article is excerpted from her Crypto Is Macro Now newsletter, which focuses on the overlap between the shifting crypto and macro landscapes. These opinions are hers, and nothing she writes should be taken as investment advice.
Akerlof’s co-Nobel Prize winner Michael Spence extended this to the job market, introducing the theory of signaling and the over-reliance on credentials. Many have looked at how this impacts the stock and bond markets, and information asymmetry is one of the main preoccupations of the Securities and Exchange Commission. Asset issuers almost always know more than their target market and, when trading, sellers have different motivations (and presumably different sets of information) than buyers.
Not so with bitcoin and similar crypto assets.
With bitcoin, there is no management meeting behind closed doors to make decisions that will affect future revenue. With bitcoin, nothing gets altered without everyone knowing about it right away, and no code changes get through unless there is widespread consensus.
In this sense, bitcoin is a commodity. Wheat is wheat, gold is gold: We all know what they are and accept that their properties will not change anytime soon. With bitcoin, as with wheat and gold, you know exactly what you are getting.
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This matters for regulation. The SEC is right in thinking that some crypto assets should be treated like securities (such as tokens linked to projects heavily dependent on a small leadership team that hopes to extract profit from its efforts). But bitcoin has no leadership team – some may argue that the core developers are leaders, but they serve the community and do not maintain the network. What’s more, rules around financial disclosures are designed to level investors’ access to relevant information. It’s hard to imagine a more open book than decentralized blockchain networks.
Information symmetry also matters a lot for market structure. Take lending, for example. In traditional finance, borrowers have a more detailed idea of what they plan to do with the solicited funds, and this may be different than what they tell the lender, who compensates for this lack of transparency by requiring a ton of paperwork and/or applying math to credit profiles. Even when collateral is required, there is uncertainty: is that house, yacht or painting really worth its stated valuation? The compensation for this risk shows up in the interest rate to be applied.
With crypto lending, beyond counterparty risk (painfully relevant these days), there is no information asymmetry. Open-source code can be confirmed, rightful ownership of digital bearer assets is relatively simple to ascertain and their market value is easy to determine 24 hours a day, seven days a week, every day of the year.
Crypto collateral can be more volatile than the more traditional kind (although these days not necessarily). But this can be compensated for by high loan-to-value ratios. And the relative ease with which this collateral can be transferred, even programmatically via smart contract escrow should certain conditions be triggered, removes another layer of uncertainty as well as hassle.
This is a huge point. Lending based on high-quality crypto collateral has the potential to be safer, more efficient and more open than that based on traditional assets, largely because of information symmetry. What went wrong last year was lapses in risk and collateral management, often due to a lack of experience and/or oversight. We can hope that lessons have been learned and standards raised. Regulation can play a part as well, by requiring crypto lenders to publish loan-to-value and collateral handling policies.
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Stepping back, we can start to glimpse how market infrastructure could evolve were it able to focus more on liquidity and service, and less on compliance requirements designed to compensate for unequal information access. As well as enabling regulators to dedicate more freed-up resources to go after intentional crime, assets with embedded full disclosure could end up lowering transaction costs and enhancing capital efficiency for savers and builders.
I am by no means suggesting that networks such as Bitcoin are the solution to all the information asymmetry problems out there. I do believe, however, that the transparency, decentralization and open-source nature of some distributed systems can change how certain market-based activities are carried out, by removing layers and adding new types of simplicity.
These new systems could also end up influencing economic theory by showing that not all markets need to involve intangible expectations, and that the pricing in of these expectations does not always need to rely on thick veils of trust. At a time when the “market economy” is increasingly becoming the “information economy,” transparency and verifiability are taking on ever more important roles in defining the habits of transaction.
Obviously, these are sweeping statements, and the crypto market does have its share of lemons. Some projects are run by small teams who can change token characteristics, some blockchains are not decentralized, some assets are not reliably backed and some tokens are based on untested incentives. But established networks such as Bitcoin do offer an alternative way of thinking about the “credible disclosure” problem, with limited technology and human risk.
So, to give Bitcoin its place in the market slang fruit basket, I thought about the opposite of a lemon. Many economists use “peach,” but they bruise easily, wrinkle quickly and I don’t much like them. I’m going to go with “grapes.” They are sweet while lemons are sour, open to the air while lemons are wrapped in protection, and firmly anchored to the vine while lemons are pretty easy to pluck.
I don’t really see this catching on since the concept of “lemons” never made it over into the digital age anyway. In an age that generates and collects more information than we know what to do with, ironically markets today are hindered by information asymmetry as much as ever as much as ever. For the first time, we now have a technology that reliably embeds simple asset information in the asset itself. The subset of assets for which this simplicity is sufficient is small for now – but its impact is already being felt in market services being built today. And its evolution could end up shaping the structure and expectations of the market services of tomorrow.