November 21, 2019
What would happen if we were to view a much wider variety of public goods as being susceptible to market-based price discovery, for instance, in the way that commodities such as gold or petroleum are traded in both spot and futures markets?
Andreas Freund (The Blockchain Swiss Army Knife, ConsenSys) and Lewis Cohen (Co-Founder, DLx Law) reimagine the equitable allocation of public goods through tokenization. This white paper introduces a novel, fair method of tokenizing impure public goods that carry some level of scarcity.
Naturally occurring public goods (e.g., water, forests, beaches) are often thought of as “free” public utilities—something with a virtually unlimited supply that can be consumed without any direct economic cost.
We are all considered the “owners” of these public goods. In most cases, we do not expect to be “charged” for their consumption. Because we tend to think of these public goods as abundant, we fail to think about their truly limited supply or the need to provide equitable access and fair allocation.
Although there is a general acknowledgment of an economic cost to many human-made public goods such as highways, airports, and libraries, there is little thought given to the effectiveness of cost-recovery schemes.
Pure vs. Impure Public Goods
- In economics, a public good is a good that is both non-excludable and non-rivalrous. Economists further segment public goods into “pure” and “impure.”
- A “pure” public good is one where an individual’s consumption of the good does not in any way impact others’ opportunity to consume the same good and where, as a practical matter, individuals cannot deny each other the opportunity to consume the good.
- An example of a “pure” public good is street lighting: one individual’s enjoyment of the lighted street does not in any way detract from that same enjoyment of others. Likewise, it is not possible to light a street for some individuals while excluding others.
- What interests us here are “impure” public goods—those where at least to some extent the consumption by one individual negatively impacts the ability of others to do so (i.e., there is some level of scarcity).
Challenges with the current impure public goods fee structure
- Due to many factors, it is difficult to construct a market for many impure public goods.
- There are economic costs involved, and limitations in access (not everyone can visit a park, bask on a beach, or simultaneously enter a congested downtown area).
- Additionally, many practical frictions limit how available resources are allocated and how costs can be recovered.
- As a result, the true economic value of impure public goods and their optimal usage can be difficult to determine.
- Fees for accessing and maintaining public goods be it tolls or admittance fees, tend to be structured as flat amounts that do not reflect the complex dynamics of both supply and demand.
- Until recently, we lacked the technological means to let markets address the cost allocation problems of public goods at scale.
A market-based pricing architecture for impure public goods
- We will use the example of congestion pricing in an urban city to illustrate market-driven prices for impure goods.
- Congestion pricing is an instructive example of an “impure” public good. There are a finite number of vehicles that can safely occupy a geographic area at a single point in time (scarcity), and, with some effort, access to that area can be limited, or at least observed (excludability).
Token model, distribution and usage
Potential models for market-based congestion pricing are straightforward to construct:
- Every resident of a city is issued a finite number of digital access receipts for the congested area free of charge. In this exercise, we’ll say one access receipt per day for a year for simplicity. Let’s call these receipts “tokens” – this term will be familiar given how mass transit systems have used physical tokens in the past.
- Those tokens are valid for an agreed period (say, one year), and new tokens are issued periodically to eligible citizens.
- Every driver of a vehicle needs to pay (i.e., transfer to the municipality), say one token, upon entering the congestion zone of the city during certain hours of the day. The access right of the token expires once the driver and vehicle leave the congestion zone.
- Tokens are destroyed once used.
- Drivers of vehicles can buy one or more tokens in an open marketplace.
- Token prices are set in the marketplace based on supply and demand (perhaps at least initially with government-set minimum and maximum prices).
- Algorithmic tools could be developed to allow travelers needing access but without tokens to simplify purchases by pre-setting parameters to various preferences (e.g., minimize cost, plan-ahead as far as possible, prioritize travel flexibility, etc.).
- The token can only be used to access the city’s congestion zone and nothing else.
- The city may reserve the right to issue additional tokens as a “safety valve” if the demand for tokens is significantly outstripping token supply at any one point. Minting supplemental tokens avoids the potential for excessive “surge pricing”—similar to what ride-sharing providers use to incentivize drivers to come online to increase the supply of drivers when the demand for rides significantly outstrips supply. We recognize that a completely unchecked market can create undesirable short-term pricing distortions. These distortions would need to be managed either centrally through a third party such as a municipal agency subject to appropriate oversight and transparency, or programmatically through rules embedded in the exchange protocol. This is an important point with far-reaching consequences, and we will discuss it in more detail when we explore the economic and social implications of our model.
Since impure public goods by definition have some level of scarcity, they could become expensive to access. If a marketplace for that access is established, some market participants can be expected to attempt to game the system to gain an “unfair” advantage, as is seen in almost all open marketplaces. We will discuss examples of potentially malicious behavior of participants and how to mitigate it once we have discussed the functioning of the marketplace itself.
Marketplace Description and Dynamics
A marketplace for these tokens to be exchanged is simple to imagine:
- All persons interested in accessing the congestion zone would first need to register their identity. Registering identity could be a simple process handled through a mobile app (for those from outside the region who may be entering for the first time). Anyone would be able to register with the marketplace. There will, however, be a certain level of automated “know your customer” (KYC) checks such as validation of a credit card (to buy tokens) or verification of a participant’s local utility account (for token issuance).
- Every registered participant could buy or sell tokens in an easy-to-use online marketplace.
- Bids and asks for tokens would be registered with the marketplace and matched based on the rules set by buyers and sellers in the bid/asks. Properly constructed, these transactions could, in theory, take place on a peer-to-peer basis without a need for third-party intermediaries.
- Each trade could be subject to a small fixed trading fee deducted programmatically that would go to the municipality to support the maintenance of the system.
- A variety of other rules could be implemented, such as a rule requiring that no registered participant can hold more than two to three times the number of tokens regularly issued to an individual at any point in time. A role of this type would avoid token concentrations in the hands of a few individuals.
- Trades between buyers and sellers could be settled with a 100% cash-collateralized stable settlement coin (the “coin”) pegged to, e.g., the USD (or the EURO, if in the Eurozone, etc.) to avoid complicated bank transfers between individuals.
The coin would work as follows:
- A buyer pays $100 with their credit card to obtain 100 coins plus a transaction fee, which are issued once the credit card payment is received. The first currency paid could be held with a bank or other regulated entity. The 100 coins could then be used to purchase more tokens.
- Coins could be converted to a relevant fiat currency such as USD, at which point a conversion fee would be due. Alternatively, registered participants may use the coins to pay for other city-owned services or charges. Examples of such services and charges are parking fines, municipal business license fees, utility bills, or public transportation tickets.
- Participants can “gift” tokens and coins to other registered participants. Only the standard trading fee would apply to gifted transactions.
- Marketplace fees etc. must be paid in the coin.
The expectation is that with enough participation and liquidity in the market, a highly dynamic price picture will evolve. When demand is high, prices will rise, and when demand is low, they will sink. Participants may devise a plan to save their tokens through rideshares and sell them in the market for a profit to pay, for example, for a vacation or other discretionary items.
Token Marketplace Mechanics