Sound digital goods

Just as bitcoin is a promise for sound money 1, non-fungible tokens (NFTs) are a promise for sound digital goods 2. Both promises represent multi-trillion dollar opportunities and, if realized, will have widespread multi-order consequences.

To understand the argument for sound money, read these two threads summarizing The Bitcoin Standard and speculating on the positive impact of sound money adoption. In short: bitcoin is the soundest money because of its decentralization and mathematical protection against inflation. Adoption of sound money has wide implications, potentially profoundly positive 3.

A population naturally prefers sounder money as evidenced by Gresham’s Law.

Any circulating currency consisting of both “good” and “bad” money (both forms required to be accepted at equal value under legal tender law) quickly becomes dominated by the “bad” money. This is because people spending money will hand over the “bad” coins rather than the “good” ones, keeping the “good” ones for themselves.

People naturally spend the less sound money and hoard the sound money, effectively driving sound money out of circulation.

A monetary system without sound money disproportionately benefits those in power and hurts the average person. Those in power are able to print money at will, devaluing the holdings of everybody else. Adding to the negative consequences for average people, inflation disproportionally hurts later holders of the currency because inflation asymmetrically impacts different types of goods goods (the Cantillon effect).

On the other hand, a system with sound money “makes service valuable to others the only avenue open for prosperity to anyone, thus concentrating society’s efforts on production, cooperation, capital accumulation, and trade 4.”

What does this have to do with digital goods?

Source

First, we need to set the context that goods–collectible goods in particular–are the precursors to money 5. Humans evolved to seek collectibles with very specific characteristics because they helped them solve problems of cooperation. Collecting has continued throughout human history and is found in all of us–every age, gender, ethnicity, etc. As a result, trillions of dollars are stored in physical collectibles 6.

What makes a collectible desirable? Menger found that a commodity was more valuable (became a collectible) if it had at least the following desirable qualities 5:

1. More secure from accidental loss and theft. For most of history this meant carryable on the person and easy to hide.
2. Harder to forge its value. An important subset of these are products that are unforge-ably costly, and therefore considered valuable, for reasons explained below.
3. This value was more accurately approximated by simple observations or measurements. These observations would have had more reliable integrity yet have been less expensive.

Based on these three qualities, pre-crypto digital goods are deeply unsound compared with physical collectibles that you can hold, authenticate, and sell 7.

In most cases, digital goods are issued into a walled garden by the creator of the garden. The obvious example is video games, where users can buy and earn items. This market for digital goods is already huge ($80B last year) 8and driving the rapid revenue growth of games and mobile apps.

Despite their soaring popularity, digital goods today are highly problematic as collectibles. The root cause: lack of decentralization.

The “owner” of a pre-crypto digital good faces massive liquidity and trust risks. Pre-crypto digital goods are issued by central authorities that manage custody of the digital goods (risk to 1), can inflate the supply at will (risk to 2), and often limit the trade-ability of the items (risk to 3). A sound digital collectible should be worth at least an order of magnitude more.

Applying Gresham’s law, we should expect people to have a high preference for the more sound version of digital collectibles. Users will be quick to rid themselves of non-crypto collectibles and will hoard crypto collectibles–storing trillions of dollars. The opportunity for sound collectibles is at least as big as the opportunity for “digital gold”

In sum, blockchain offers sound money and sound digital goods. Both opportunities are on the order of trillions of dollars and if realized will have widespread consequences. Today’s money and collectibles are both problematic, but the path to mass-market adoption is still unclear with substantial execution risk. While users should prefer sound digital goods like they prefer sound money, incumbents are unlikely to support adoption and crypto-native social worlds are unproven and require considerable time and effort. Despite these challenges, the gravitational pull is towards sound digital goods, a win for users.

Originally published at www.tonysheng.com on April 17, 2018.