Most people have heard of the “lemons market” – but not the fruit. I am referring to low-quality consumer durables. His seminal paperGeorge Akerlof, an economist, showed that there was information asymmetry about which second-hand cars were good and which were “lemons”. Sellers knew more than buyers and this led to lowering the prices and driving out good cars. This is because the owners of the cars would not be willing to sell them at an unjustly low price. In theory, this should drive the market down and push the price even lower.
This thesis has been criticized a lot over the years, particularly by people who rightly point out that there is still a market for second-hand vehicles. However, it raises an important question: What do the people I am buying from know that I don’t?
Noelle Acheson was the former head for research at CoinDesk, Genesis Trading. This article was taken from her Crypto Is Macro Now Newsletter, which focuses on the intersection of the changing crypto and macro landscapes. These are her opinions and should not be considered investment advice.
Michael Spence, Akerlof’s cowinner of the Nobel Prize for Economics, extended this concept to the job market by introducing the theory and over-reliance upon credentials. Many people have examined how this affects the bond and stock markets. The Securities and Exchange Commission is concerned with information asymmetry. Asset issuers know almost always more than their target markets and sellers are motivated (and likely have different sets of information) when trading.
Bitcoin and other crypto assets are different.
Bitcoin is open to all. There are no closed-door meetings for management to make decisions about future revenue. Bitcoin is open source. This means that everyone can see what’s happening and there is consensus on code changes.
Bitcoin is therefore a commodity. Wheat is wheat, and gold is gold: All of us know their properties and we accept that they will not change in the near future. You know exactly what bitcoin is like wheat and gold.
Read more: Noelle Acheson – Shifting Crypto’s Center of Gravity
This is important for regulation. SEC has a right to consider crypto assets securities. This includes tokens that are linked to projects that heavily depend on a small leadership group that hopes to make a profit. Bitcoin does not have a leadership team. Some may argue that core developers are leaders but they serve the community and don’t maintain the network. Furthermore, financial disclosure rules are intended to make investors have equal access to the relevant information. Decentralized blockchain networks are the most open system possible.
Market structure also depends on information symmetry. Let’s take lending as an example. Traditional finance allows borrowers to have a better idea of their plans for the funds. This may differ from what they tell lenders. Lenders compensate for this lack of transparency by asking for a lot of paperwork and/or applying maths to credit profiles. There is uncertainty even when collateral is required. Is the house, yacht, or painting truly worth the stated value? This risk is compensated by the interest rate that will be charged.
Crypto lending is free from counterparty risk, which can be very painful these days. There is also no information asymmetry. Open-source code is possible to confirm rightful ownership of digital bearer asset. Their market value can also be easily determined 24 hours a days, seven days a săptămână.
Although crypto collateral is less volatile than traditional collateral, it can still be a risky investment. However, high loan-to value ratios can compensate for this. This is offset by the ease of transferring collateral, even programmatically, via smart contract escrow if certain conditions are met.
This is an important point. Because of information symmetry, lending based on high-quality cryptocurrency collateral can be safer, more efficient, and more transparent than traditional assets. Last year’s failures were due to poor risk management and collateral management. This was often due to lack of oversight and/or experience. We can only hope that we have learned lessons and that standards are being raised. Regulators can also play a role by requiring crypto lenders publish loan-to value and collateral handling policies.
Read more: Noelle Acheson – Code vs. Code vs.
Looking back, it is possible to see how the market infrastructure might evolve if it could be able to concentrate more on liquidity and service and less on compliance requirements that compensate for inequal information access. Assets with embedded full disclosure can help regulators free up resources to pursue intentional crime. They could also lower transaction costs and increase capital efficiency for savers as well as builders and savers.
While I do not believe that Bitcoin is the answer to all information asymmetry issues, networks like Bitcoin could be. However, I believe transparency, decentralization, and open-source nature in some distributed systems can make certain market-based activities more transparent and simple.
These systems may also influence economic theory, showing that not all markets have to include intangible expectations and that pricing in these expectations doesn’t always need to rely upon thick veils. Transparency and verifiability play an increasingly important role in defining transaction habits, at a time when “market economy” is becoming “information economy”.
These are broad statements and the crypto market has its fair share of lemons. Some projects are managed by small teams that can modify token characteristics. Others blockchains cannot be decentralized and assets are not always reliably backed. Other tokens are based upon untested incentives. However, established networks like Bitcoin offer a way to think about the “credible disclosure problem” with minimal technology and human risk.
To give Bitcoin its place as a market slang fruit, I considered the opposite of a lemon. Although many economists prefer “peach”, they are fragile and wrinkle easily. I don’t like them. I will go with grapes. They are sweeter than lemons, they are open to the air, while lemons have protection and are securely anchored to the vine. Lemons are easy to pick.
This is unlikely to catch on, since “lemons” has never been incorporated into the digital age. Ironically, markets are being hindered by information imbalance in an age where we have more information than we can use. We now have technology that embeds basic asset information within the asset for the first time. This technology is only applicable to a small subset of assets, but it is already having an impact on market services that are being built today. Its evolution could shape the structure and expectations for market services of the future.