Essays on Incentive Designs to Improve Market Performance

Abstract

This dissertation is composed of three chapters. Each essay describes and models the structure of a market; identifies an inefficiency in outcomes and proposes an incentive scheme to reduce the inefficiency.

First Chapter: Coordination Problems, Leverage Constraints and Smart Contract Solutions for the Repo Market, co-authored with Robert M. Townsend. We identify two inefficiencies in the US treasury repo market and propose solutions. In the first part we develop an empirically founded model of the repo market which displays multiple equilibria. In the second part we explain how the interaction of two distinct financial regulations has caused the unintended consequence of limiting the capacity of broker-dealers to intermediate repo transactions. In the third part we propose smart contract designs that address each inefficiency. The first contract structures the timing of contract commitments to induce a welfare maximizing equilibrium. The second contract replaces a chain of repo contracts with a single contract that reduces the impact of repo on broker-dealer balance sheets, which increases the volume of repo a broker-dealer can intermediate before hitting a regulatory bound. The replacement contract preserves the allocation of risk and payoffs. Our contracts can be implemented when money and treasuries are appended to programmable electronic ledgers.

Second Chapter: Conservation Priorities and Environmental Offsets: Markets for Florida Wetlands, co-authored with Will Rafey. We estimate a model for an existing decentralized market in Florida wetlands in which land developers purchase offsets from producers, who enhance wetlands. Offset values are aggregated over environmental attributes at fixed exchange ratios to preserve regional “no net loss”. Producers incur a sunk cost and are awarded offsets over time. We find substantial private gains from trade. We estimate a local flood externality generated by wetlands, which is not covered by current regulations, and which is exacerbated by a spatial separation of the urban locations of impact from the rural locations of offset production. We propose a localized Pigouvian tax on offset transactions which would have prevented $800 million of new flood damage over a 20-year span while preserving more than two-thirds of the private gains from trade.

Third Chapter: ADESS: A Proof-of-Work Blockchain Protocol Modification to Deter Double-Spend Attacks, co-authored with Isaac Ardis. A principal vulnerability of a proof-of-work ("PoW") blockchain is that an attacker can re-write the history of transactions by forking a previously published block and building a new chain segment containing a different sequence of transactions. If the attacker’s chain has the most cumulative mining puzzle difficulty, nodes will recognize it as canonical. We propose a modification to PoW protocols, called ADESS, that contains two novel features which increase the cost of launching a double-spend attack. The first innovation enables a node to identify the attacker chain by comparing the temporal sequence of blocks on competing chains. The second innovation is to penalize the attacker by requiring it to apply exponentially increasing hashrate in order to make its chain canonical. For any value of transaction, there is a penalty setting in ADESS that renders a double-spend attack unprofitable. We provide code to implement ADESS on the Ethereum Classic blockchain.