I’ve been critical of people’s propensity to make bold, sweeping statements and predictions about technologies like blockchain. Then last month, after taking stock of the Miami BTC conference, I wrote an article titled “The Blockchain Movement Is Dead, Long Live the Blockchain Industry.” I guess the pull was irresistible.
But consider Exhibit One: the announcement this week that JP Morgan is launching a “JPM Coin” product to allow large corporate clients to settle payments instantly on a distributed ledger. This is entirely different from open, decentralized technologies like Bitcoin. But it seems like a ready-made use case for blockchain technology; right now, international wire transfers, for example, take days to settle, and JP Morgan already operates a staggering $6 trillion-per-day payments business.
From those who have been part of the blockchain movement, preaching the end of big banks like JP Morgan for years, such announcements can be frustrating and easy to criticize, especially given CEO Jamie Dimon’s notorious crypto criticism a year ago. But to understand why the technology may end up strengthening financial intermediaries that it could in theory topple, one needs to fully appreciate the economic concept of path dependence.
Looking in the Rear View Mirror
Economist Paul David first used the phrase in a 1985 paper discussing the QWERTY keyboard. Makers of mechanical typewriters first adopted the standard to slow people’s typing down and avoid breaking machines. But that decision long ago impacts the decision of whether to roll out a superior keyboard today. (It turns out that the story was largely fiction, but that is another matter.)
For our purposes, Wikipedia has a great definition: “The set of decisions one faces for any given circumstance is limited by the decisions one has made in the past or by the events that one has experienced, even though past circumstances may no longer be relevant.”
If you think “history matters” is yet another instance of economists finding profundity in obvious concepts we already know, you’re right. But the best economic ideas often sound disposable until we think of how many times people disregard them.
The equilibrium models that dominated the field in the ’80s and continue to do so today mostly disregard path dependence. The equations would get far too complicated. Only as evolutionary and complexity economics have gained steam have economists started to adopt computer simulations that can deal with such long chains of history.
Intermediaries Get Stronger
The claim that blockchain will topple Wall Street disregards path dependence. A decentralized, open financial system based on something like Bitcoin may be superior along many lines to today’s system, brokered by big financial intermediaries. In fact, many of us might choose it over the status quo if we were starting from a clean slate today. But we aren’t.
Big banks like JP Morgan have many, many very wealthy customers who trust the bank to safely execute frequent large transactions. Even if the circumstances of a bygone era have changed, that bygone era resulted in these relationships, which don’t evaporate overnight. Adopting blockchain technology makes sense as it allows the incumbent JP Morgan to appropriate some of the advantages of blockchain technology while continuing those relationships.
Path dependence in part explains why we can’t predict the future when it comes to new technologies. There are too many past decisions influencing today’s landscape to fully account for in some rigorous calculation. Financial intermediaries that might not stand a chance against blockchain technology were it allowed to develop in a vacuum instead might be strengthened by it.