From: Wei Dai <weidai@eskimo.com>
Date: Mon, 16 Oct 95 01:18:51 PDT
To: Cypherpunks <cypherpunks@toad.com>
Subject: transaction costs in anonymous markets
Message-ID: <Pine.SUN.3.91.951016011355.2241A-100000@eskimo.com>
MIME-Version: 1.0
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Some people have predicted (advocated?) frictionless capitalism, which 
will be brought about by the use of digital technology to reduce transaction 
costs.  However, in anonymous markets these costs may be quite high.  
Two main components of transaction cost in an anonymous market will be 
the cost to maintain anonymity and the cost to evaluate reputations.

Maintaining anonymity requires that communications be done through 
special untraceable protocols.  The current state-of-art (i.e. 
RemailerNet) adds several hours of transmition time to each message to 
achieve effective untraceability.  Contract negotiation, for example, 
becomes very difficult under these circumstances.  Untraceable 
communications also use up more computing and communications resources.  
Although remailers don't yet charge any money to pass along messages, 
this is sure to change in the future.  Unless the structure of the 
Internet is completely redesigned, untraceable messages will always cost 
more than traceable ones, although I hope this cost difference can be 
reduced through technical advances.

The second big part of transaction cost in an anonymous market is 
reputation evaluation.  Of course, normal, everyday transactions require 
reputations to be evaluated.  However, more effort and cost will be 
expanded on these evaluations in an anonymous market because the effects 
of misevaluations will be much more damaging.  Reputations must be 
constantly reevaluated, as pseodonyms are easily transfered.  Since no 
good theories of reputation currently exist, these evaluations are 
difficult to automate.  Perhaps theoretical advances can make these 
evaluations easier and/or more accurate.  However there does not appear 
to be any major research effort in this area.

If these costs remain high, but anonymous markets develop regardless, it 
will be interesting to see how these costs affect the structure of the 
markets.  Will special protocols for contract negotiations develop to 
minimize the number of round-trip messages?  Will each market be 
dominated by a few big entities because people can't keep track of 
reputations of many smaller players?  But then how will these big 
entities be organized?

Wei Dai