Lecture 3: Distributed Ledger as a Solution to an Information Problem

Distributed ledgers solve the information problems inherent in fragmented or decentralized markets by providing a shared history of transactions. This centralized record allows market participants to coordinate actions effectively and achieve Pareto optimal outcomes, which are mathematically impossible to reach when traders only possess limited, local knowledge.

• Optimal economic outcomes — Markets function best when reaching Pareto efficiency, a state where no individual can gain without another losing, but fragmented systems struggle to reach this state without perfect information [03:52].
• Fragmentation friction — Breaking a market into isolated bilateral trading pairs creates information gaps that prevent traders from executing the most efficient exchanges [02:11].
• Ostroy-Starr theorem — Mathematical proof demonstrates that in a decentralized system where traders only know their own history, reaching a competitive equilibrium is often impossible without access to the wider system's data [33:13].
• Money as information — Introducing a common commodity or currency acts as a bridge, allowing participants to satisfy trade requirements without needing to know every other trader's past transaction history [37:14].
• Intermediary risks — Relying on a central broker-dealer or bank to facilitate trades solves the coordination problem but introduces vulnerabilities related to market power and monopoly behavior [49:30].
• Ledger utility — Distributed technology functions by providing a shared record of all trades, effectively fulfilling the centralized information requirement needed to achieve efficient global outcomes [1:04:56].

How does the Ostroy-Starr theorem define the limitations of decentralized trading? What roles do intermediaries perform in reducing liquidity requirements during trade settlement?