Blockchain Platform Design under Market Frictions: Decentralization, Service Provision, and Block Rewards
40 Pages Posted: 3 Nov 2021 Last revised: 6 Sep 2023
Date Written: September 4, 2023
Abstract
This paper studies the optimal design of a proof-of-stake blockchain platform with a native utility token (e.g., Ethereum). The platform offers one unit of divisible services (block space) in every round and commits to a platform design that consists of a number of nodes (degree of network decentralization), a sequence of block rewards, and a sequence of service quality levels (e.g., of the smart-contract language). The platform, validators, and users repeatedly trade tokens on a spot market. Users value network decentralization and service quality, and the platform allocates its services in a decentralized way. In the optimal design, network nodes make no profit, users receive positive rent, and the platform sets the number of network nodes and service quality levels inefficiently low. With market frictions, the inefficiency persists even with a large user base, as the platform cannot fully capture the rent it generates. This emphasizes the importance of well-functioning token markets. Moreover, the platform faces a tradeoff between ICO volume and later market capitalization. A social planner will prefer the decentralized platform over a platform with monopoly pricing power whenever the weight on consumer surplus is sufficiently high. The results continue to hold under free entry for nodes.
Keywords: blockchain, platform, ICO, proof-of-stake, decentralization, utility token, antitrust
JEL Classification: D40, D47, D59, G29, L40.
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