Where Traditional Public Financing Fails, Blockchain Steps in

Both private and government funding have weaknesses. Crypto networks offer a third way to coordinate big collective projects.

AccessTimeIconJul 29, 2022 at 6:30 p.m. UTC
Updated May 11, 2023 at 6:12 p.m. UTC
AccessTimeIconJul 29, 2022 at 6:30 p.m. UTCUpdated May 11, 2023 at 6:12 p.m. UTCLayer 2
AccessTimeIconJul 29, 2022 at 6:30 p.m. UTCUpdated May 11, 2023 at 6:12 p.m. UTCLayer 2

This week saw big moves from the U.S. Securities and Exchange Commission. First, the regulator declared several digital assets “securities” in the course of lobbing insider-trading allegations at an employee of crypto exchange Coinbase. The SEC then opened an investigation into Coinbase’s own alleged unauthorized sale of securities.

That’s huge grist for those trying to read the tea leaves of U.S. crypto regulation, but I want to take a big step back and think about the underlying issue of how societies fund large collective projects. Securities are a well understood way of doing that, and the SEC regulates that system in large part to keep money flowing to genuine, socially useful investments.

But one of the major promises of cryptocurrency networks is an entirely new approach to pooling and deploying capital, one that complicates the traditional split between public and private funding. It’s a major reason crypto has captured the global imagination and a key topic for those who would like to see regulators strike a balance between protecting the public and fostering innovation.

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Bitcoin as nongovernmental public infrastructure

I’ve recently had an important reminder of why Bitcoin and other truly decentralized money systems have value in the real world. It came via “The Unbanking of America,” a 2017 book by Lisa Servon that tells an incredible story of the failures of private banking to serve even the most basic financial needs of Americans, and by extension, the world.

Those failures center on banks’ increasing consolidation, rising use of punitive fees and declining levels of service for average retail depositors. To pick just one particularly egregious example, Servon describes some banks’ use of “debit resequencing” software to actively increase the number of overdraft fees customers pay by processing withdrawals out of chronological order. Servon further describes how slow bank clearing times for checks have pushed even successful small businesses toward alternate services like check cashing storefronts.

The good news is that the percentage of Americans who are “unbanked” has decreased significantly over the past decade, and is now at 5.4% according to the Federal Deposit Insurance Corp., the lowest level since data collection began in 2009. But that may be more a result of economic growth than better bank services. As Servon details, a lot of people choose to not use banks because their policies are particularly punitive to low-income customers. So if the looming recession comes to pass, we may see traditional banking decline again.

The rise of anti-customer practices in conventional banking is substantially driven by its for-profit bias in the U.S. Activists have for years been campaigning for major reforms, such as an equivalent to the public or semipublic postal banking systems in Japan and Germany. Perhaps understandably, U.S. hostility to growing the public sector is a roadblock for that campaign.

Which brings us to Bitcoin. Bitcoin offers the core services of a bank, particularly saving and money transmission. It has plenty of downsides, such as its volatility and the various costs imposed by proof-of-work mining. But it offers, in whatever tentative and imperfect form, a true “third way” – neither government-run postal banking on the one hand nor rapaciously profit-hungry private services on the other.

Decentralizing public infrastructure funding

That third way would never have been possible without the approach to viral expansion baked into Bitcoin’s underlying security model and software implementation. Bitcoin incentivized early adopters and investment in at least two ways: Early miners got proportionately greater rewards thanks to the token-emission curve, and early holders of BTC tokens have benefitted from asset appreciation driven by growing adoption.

This is often thought of as a mere parallel to the Silicon Valley venture capital model that made early investors in Facebook and Amazon rich. But in reality, it’s something far more novel. Early Bitcoin supporters fed resources into a “bitcoin ecosystem” that ultimately funded everything from software development to hardware infrastructure and basic computer science research.

But the resulting network and ecosystem are not owned by a private corporation or by a centralized government. And while it’s not free to use, it is accessible to anyone with a smartphone and internet access, making it a more genuine “public good” than a lot of directly government-funded infrastructure or services. (U.S. National Parks, for instance, are very much not free.) Perhaps the most notable champion of the idea that blockchains can fund public goods is Kevin Owocki of Gitcoin, whose ideas I’m drawing on substantially here.

Bitcoin as a public good is also a striking contrast with the services offered by companies like Twitter or Google, which strategically describe themselves as “platforms” to help convey a sense of openness and neutrality. In reality, as we’ve discovered over the past decade, even the best-intended Web 2.0 “platform” is really a centralized corporate entity subject to political pressure – and that goes double for financial middlemen.

In a perfect world, keeping public financial infrastructure out of the hands of the government wouldn’t be particularly desirable. In principle (if you can hold your laughter for a moment), the government is an extension of citizens’ collective power and serves the interest of those citizens. But that is no longer how many Americans regard their own government, and for good reason.

In fact, an excellent case study in the ways the government has failed to serve the public interest is the internet itself, a story retold in Ben Tarnoff’s new book, “Internet for the People.” For three decades from the 1960s to the 1990s, research and development of the internet was almost entirely funded by taxpayer money, particularly through military and academic research channels.

But as the former ARPANET (Advanced Research Projects Network) became more commercially appealing in the early 1990s, the benefits of all that public investment were essentially handed out to telecom companies in exchange for campaign contributions to privatization-happy politicians. Tarnoff highlights that another future was possible:

During the privatization debate, Democrat Daniel Inouye, then a U.S. senator from Hawaii, proposed reserving 20% of internet backbone bandwidth as a strictly public facility. The provision never got traction in the context of the long Reagan Revolution and rising anti-government sentiment.

But in a bit of fractal irony, this kind of handover itself feeds into rising skepticism of conventional government structures for funding public goods. At least right now (arguably because of legalized graft through lobbying and campaign finance), the U.S. government has been significantly subverted toward channeling public money and its products into private pockets.

In the case of the internet, that ongoing process has included the removal of “common carrier” obligations from high-speed internet providers by the Bush and Trump administrations. Broadly, these obligations are meant to ensure certain public benefits in exchange for the handover of natural monopolies or publicly subsidized infrastructure to private for-profit operators. Over the course of the 20th century, common-carrier provisions ensured that, for instance, telephone service reached rural Americans.

Their elimination when it comes to broadband internet amounted to a massive corporate giveaway. It has led more or less directly to Americans paying more than citizens of nearly any other developed country for high-speed internet access, while getting worse service. Most damningly, it has led to the underprovision of high-speed internet to low-income and rural Americans – in much the same way that private banking has failed to serve low-income customers.

The bottom-up alternative

I won’t make the simplistic argument that decentralized funding along the lines of Bitcoin offers a “better” way to build public financial or technical infrastructure. It’s certainly not efficient enough to compete with the resource aggregation powers of a properly functioning government – in part because of its vulnerability to scams and fraud (more on that in a moment).

But Bitcoin’s model of bottom-up growth does seem rational in a context where a properly functioning government is nowhere to be found. In today’s America, and in many other nations, it seems any system created by public funds would be perpetually at risk of simply being handed over to the most persistent and deep-pocketed oligarchs, or having its rules subverted by rent seekers with unique access to legislators. This is more or less what happened with banks and financiers during the 2008 financial crisis – they lobbied to have the rules changed for their own benefit, and they won.

Bitcoin and similar systems may, in other words, offer a path to build public goods that aren’t vulnerable to government or regulatory “capture.”

But the technological underpinnings of these systems also come with serious limitations. These structures can’t properly incentivize certain kinds of needed activities, and they introduce new kinds of risks. In particular, the premise of decentralized funding of public goods has proven to be extremely useful for scammers. Promising a replay of Bitcoin-like growth is extremely effective bait for projects that, too often, wind up building nothing at all.

But how to identify those cons early enough to protect less-savvy backers, while also enabling the good parts of decentralized funding, is a Gordian knot that we’ll have to untie another day.

Decentralized research and its limitations

Another apparent limit to decentralized funding of public goods, at least so far, is the case of basic research. This is clear in the development of the computer science behind blockchains, which itself emerged substantially from traditional publicly funded universities. As just one example, David Chaum, the godfather of digital cash, was largely trained and supported through the heavily publicly subsidized University of California system.

But as the crypto story progressed, it became more complicated. A lot of the most important application-focused research on digital cash starting in the 1990s was channeled through less formal networks that brought together academics, entrepreneurs and assorted rogues.

Above all, the cypherpunk mailing list was a crucial node of the community starting in the mid-1990s. Featuring a sui generis mix of technical brilliance and bizarro radicalism, it played a seemingly major role in pushing Satoshi along the path to creating Bitcoin – and it seems unlikely that anything similar could have existed in a purely corporate OR purely governmental context.

Since the debut of Bitcoin, crypto systems have further complicated the relationship between public and private projects. Particularly since around 2018, venture capitalists have begun devoting money to companies that build on Bitcoin or Ethereum. But because of the nature of blockchain networks, the benefits of such investments haven’t accrued entirely to the companies being funded. Crypto as a whole has begun to generate significant “public funding,” of a sort, for an entire ecosystem of developers, researchers, even philosophers and journalists (ahem).

This is more tilted toward real-world applications than basic research, but there is still a lot of crypto-derived funding for work that’s a long way from being business ready. One example is zero-knowledge proofs (ZKPs), which could profoundly revolutionize online privacy and data, but only once a lot of new tools are built to take advantage of it.

Crypto is where a lot of ideating on ZKPs is taking place, particularly at the level of application development. And rather than accumulating under one or a few corporate banners, that open-source knowledge will feed into a broader ecosystem, benefiting everyone.

Though again, let’s not give crypto itself too much credit: The work behind zero-knowledge proofs stretches back to 1985 work by academics, and was supported in part by government funds.

Redefining public investment

All of this contemplation about funding innovation and public infrastructure doesn’t easily yield up bullet-pointed takeaways. My main injunction here is to recognize that “the way we’ve always done things” doesn’t have to be the way things continue to be done, particularly when it comes to collective coordination around projects with potentially big collective benefits. Modern financial capital and modern government-funded investment both have their own biases and vulnerabilities, and it’s not crazy to consider that an entirely different structure could have entirely new strengths.

Specifically, the aggregation of economic power has fundamentally relied on intermediaries for the bulk of the modern era. Even nominally “public” projects funded through governments are at continual risk of takeover and subversion by those intermediaries. However imperfect and tentative in its current form, blockchain networks and cryptocurrencies’ biggest implication may be cutting out the middleman, not just from banking, but from a lot of other roles, too.

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David Z. Morris is CoinDesk's Chief Insights Columnist. He holds Bitcoin, Ethereum, and small amounts of other crypto assets.