The Cost of Trust
The goal of every life is to survive and thrive, consciously or unconsciously. Cooperation is one of many ways which can make thriving easier. Cooperation works because “the whole is greater than the sum of the parts”. However at the very core, cooperation requires cooperating entities to agree on certain things. Agreement is the underpinning of cooperation. This agreement is created based on beliefs of individual entities at the time the entities start cooperating, and there can be things in the agreement that are amendable and things that are not.
Beliefs are the basis of an entity’s actions. As time progresses, the beliefs of entities can change which leads to amendment in the agreement. But there can be certain things in the agreement that are written in stone [ due to unchanged beliefs ] and so they cannot be amended. Now what if we have an entity whose belief has changed and wants to amend the agreement, but the other participating entities disagree? In some cases this breaks the agreement and therefore the cooperation. But in some cases it does not! How?
Well, before the breakup, the entity whose belief has changed assesses whether the breaking of cooperation makes its thriving better or worse? If it makes it worse, the entity will not break the cooperation, instead it will still perform actions consistent with its beliefs but inconsistent with the agreement. This creates a discrepancy between the actions and the agreement. But it is very much needed because the cooperation is beneficial to the entity.
This discrepancy between actions and the unamendable parts of the agreement by entities whose beliefs have changed is called lying.
Lying [ the ability to create this discrepancy ] is the most powerful tool at an entity’s disposal in the wake of unamendable parts of an agreement but which is still benefited by the cooperation. Lying is simply the discrepancy between actions and the agreement, and it is the very basis of a cooperation in the real world. Why? Because in the real world, a lot of beneficial cooperations will have unamendable parts in an agreement that have become unrealistic or impractical or undoable [ as time progresses ] for one or more entities but they cannot break the cooperation because that might impede its goal of thriving.
Whether it is a marriage, a relationship, family or cooperation between companies or governments, most cooperations have entities that will lie [ entities deviating from the agreement ].
Basically, lying is the byproduct of an unamendable agreement [ caused by unchanged beliefs ] and the inherent positive value of that cooperation.
How does lying affect the cooperation? Firstly, to have an effect on the cooperation, the other participating entities must know that there exists such a discrepancy. If they do not, there is no effect. But in the cases where the participating entities do know, lying can have no effect, a positive effect or a negative effect. The negative effect is called damage to the cooperation. So there exists all kinds of cooperations, some where the lies have no effect or some where they have a positive effect. However there are a lot of cooperations where the lies have a damaging effect.
Entities realized early on that cooperations have value and they can help thriving better. This coupled with the unamendable parts of an agreement caused by rigid beliefs creates potential entities that can lie [ create a discrepancy ].
There is overwhelming data that shows that a lot of cooperations where entities create this discrepancy end up failing and damaging the participating entities. So with this new realization, entities need a way to mitigate the damage in the wake of lies. How do we achieve that? Entities come up with a method, where in they periodically spend resources to make sure that all participating entities adhere to the agreement [ why periodically and not just once? because as we have established beliefs can change overtime, so this is a recurring cost ]. This verification is the extra cost the entities bear to reduce the damage that can potentially be caused in presence of lying entities.
This cost is called the cost of trust. It is the resources spent by participating entities to ensure that every entity adheres to the agreement, so basically it is just a verification cost. Verification does not prevent the damage, but it can certainly reduce the damage. Due to periodic verification, the discrepancy can be caught before it becomes too big. Most real world cooperations, especially in the world of finance, end up being the victims of a zero sum game if they do not invest resources to establish periodic trust.
Let us recap,
- Cooperation makes thriving easier. Entities enter into cooperation by agreeing on certain aspects drawn from their beliefs at the time of drafting the agreement.
- As time progresses, some beliefs might change and therefore the agreements need amendment. However there will always be cases where agreements which cannot be amended [ due to rigid beliefs of other participating entities ], in such cases cooperations can break as continuing the cooperation can make thriving harder.
- However there will be similar situations [ unamendable agreements ] where breaking cooperations makes thriving harder. So entities create a discrepancy between their actions and the unamendable agreement.
- Now some discrepancies can have a negative impact on cooperations and they get damaged which in turn makes thriving harder.
- Since the ‘4.’ is a reality, entities want to invest resources in making sure that the damage can be reduced by introducing what we call the “cost of trust” where they periodically spend resources to ensure that participants adhere to the agreement or can catch the damage early on.
TLDR: Lying [ the ability to create discrepancy between actions and agreement ] is a fundamental property of any cooperation and therefore all participating entities must bear a cost of trust to reduce the potential damage that certain lies can do.
Davidson, Sinclair and Novak, Mikayla and Potts, Jason, The Cost of Trust: A Pilot Study (July 24, 2018). Available at SSRN: https://ssrn.com/abstract=3218761 or http://dx.doi.org/10.2139/ssrn.3218761The Cost of Trust is the most important parameter of the Cooperation. Why? Because, we cannot stop beliefs from changing, we cannot get consensus to amend the agreement, and some participating entities that see value in the cooperation will create discrepancies. The Cost of Trust is a powerful parameter to keep the discrepancies in the know, so we can study whether the discrepancies are detrimental to the overall cooperation or not, and if they are we can take preventive or corrective actions. The “Cost” in the “Cost of Trust” = the total amount of resources participating entities spend periodically to ensure smooth functioning of the cooperation.
The paper above states – “Occupations which are represented in high cost-of-trust activities include managers, lawyers and judges, tax professionals, accountants and auditors. Overall, it is estimated that the cost of trust accounts for 35 per cent of U.S. employment in 2010.”
Blockchain
The main potential use case of Blockchain today is to reduce the “Cost of Trust” in Financial systems.
Why might *emphasized* blockchain be a catalyst *emphasized again* for change in the world of finance [ We do NOT know how the technology will impact other domains ] ?
Cryptography – Addresses the problem of communication in the presence of adversaries.
M-Pesa is an interesting idea where they use unused mobile minutes as a form of currency.
So the question is, how do you move value or money on the internet without a trusted central intermediary so that it is fully peer-to-peer? Ans: Satoshi Nakamoto’s paper.
“I’ve been working on a new electronic cash system that is fully peer-to-peer, with no trusted third party.”
In a sense, Satoshi’s contribution was not entirely new – the ‘distributed consensus’ problem Satoshi was proposing to solve is well-known. This is the question of how multiple, independently run computers can reliably agree on a set of common data in the presence of faults, i.e. where there is a risk that one or more computers are intentionally or unintentionally programmed to introduce false information.
https://voxeu.org/article/blockchain-catalyst-change
Question: Is Blockchain a new internet layer?
So what is blockchain? Basically, it is time-stamped append-only logs.
What is blockchain technology? It verifiably moves data across a decentralized network. The economics of blockchain technology are centered around the economics of verification and the economics of networking. Blockchain adds cost to verification through the consensus protocol [ but it might be lesser than the cost of verification in a centralized third party like banks as it exists now ]
Finance is fundamentally about moving money and risk through a network. The network being the 7 billion people.
Which is the longest running blockchain? https://toshitimes.com/the-longest-running-blockchain-has-existed-on-nyt-pages-since-1995/
A Payment system is just a method to amend and record changes in Ledgers for money. A DBMS is just a method to amend and record changes in DB’s for data. So a Payment system is like a DBMS for money. So a Payment system is just used to Amend ledgers of two parties, the lender and the receiver.
The Gold standard came in the middle, where the Fiat currency could be exchanged for Gold. Now the Fiat Currencies do NOT work with the Gold Standard since there isnt enough gold to back the Fiat currencies.
The central banker, what they are trying to do is ensure the stability of this thing called money and prevent it from getting debased. The reason Fiat current for a particular country is called Legal Tender is because people MUST accept it as a medium of exchange for goods or debt.
Computer Science 101 