Implications of Blockchain Technology for

Transaction Costs Economics in the Automotive

Industry
The Use Cases of the Market for Lemons and Ride Sharing

Seminar Paper in:

Media and Technology Management Seminar II - Information Technology
and the Organization of Economic Activity

Steve Wildman
Professor & J.H. Quello Chair of Telecommunication Studies Emeritus
Michigan State University
Affiliated Faculty, Silicon Flatirons Center & Visiting Scholar, Interdisciplinary
Telecommunications Program
University of Colorado, Boulder

University of Cologne

July 07, 2017

Alexander Vladimir Merdian-Tarko David Simmendinger

Student ID: 7325771 Student ID: 7321230
E-Mail: amerdian@smail.uni-koeln.de E-Mail: dsimmend@smail.uni-koeln.de

Lukas Steib Niklas Kern

Student ID: 7319940 Student ID: 7323475
E-Mail: lsteib@smail.uni-koeln.de E-Mail: nkern3@smail.uni-koeln.de
Contents

1. Introduction.. 1

2. Theoretical Foundation and Literature Review 2

2.1 Classic Theory on Transaction Cost Economics. 2

2.2 Literature on Blockchain Technology..... 4

3. Blockchain Technology 6

3.1 What is a Blockchain?. 6

3.2 Design Space....... 7

3.3 General Features.......... 8

3.4 Structural Advantages and the Corresponding Potentials... 9

3.5 General Issues......12

4. Implications of Blockchain Technology for the Market for Lemons.. 13

4.1 The Classic Market for Lemons....13

4.2 Application of Blockchain in the Market for Lemons... 14

4.3 Blockchains Impact on the Future Used Cars Market..... 19

4.4 Limitations and Open Questions.... 21

5. Implications of Blockchain Technology for Ride Sharing.................... 22

5.1 Todays Intermediary-centric Ride Sharing Environment........ 23

5.2 Hypothetical Blockchain-centric Ride Sharing Environment... 25

5.3 Limitations and Open Questions... 26

6. Conclusion. 29

References.. 31
1. Introduction

In recent months, cryptocurrencies have experienced an extreme hype resulting in an

all-time high on the stock market in June 2017. Bitcoins countervalue, for example,

temporarily rose to almost USD 3.000 per Bitcoin (NYSE 2017). Even though Bitcoin is by

far not the only cryptocurrency, it is the one that is most reported on and therefore the most

prominent in society. A common flaw arising from media articles is that Bitcoin is mixed-up

with Blockchain as a technology because these articles often do not unambiguously point out

the differences. In fact, Blockchain is the underlying technology of cryptocurrencies like

Bitcoin. Although it is essential to know its features in order to understand potential business

implications, Blockchain technology is still rather unknown in general and there is not much

literature dealing with concrete use cases.

The common literature available to a larger extent, mostly comments on the

implications of Blockchain technology on the finance and banking industry. However, there

are other fields in which Blockchain technology could be applied, such as health care,

insurance, supply chain management and plenty of others (CB Insights 2017).

Another potential field of adaptation of Blockchain technology is the automotive

industry, in which during the last months, more and more use cases popped up. Whereas

Daimler applies the technology within their finance department (Daimler AG 2017), Toyota

began to establish Blockchain technology in autonomous driving (Shieber 2017). Certainly,

this is not the only change occurring in the automotive industry (e.g. autonomous driving). On

the one hand, mobility concepts like car and ride sharing came up in recent years, on the other

hand, market size of used cars increased significantly (Porter and Sattler 1999) as the

possession of a car is still a status symbol. These two counteracting phenomena make the

market for cars highly multidimensional (Janasz and Scheidewind 2017).

This paper is meant to shed light on a new field by analyzing the impact of

Blockchain technology on the two trends in the market for cars. To do so, both dimensions

1
will be exemplified by the real-world use cases Market for Lemons and Ride Sharing,

respectively. Since both the use cases have transactions at their cores, transaction cost theory

will serve as an underlying theoretical concept as well as the initial point for the analysis.

Be aware that due to the non-existence of literature about the application of

Blockchain on these concrete markets and the novelty of the technology itself , this paper is

largely based on argument-backed speculation and additional assumptions are made where

needed.

The present work is structured as follows: Section 2 lays the theoretical foundation of

the work and presents a brief review of literature on economics of Blockchain. Then, section

3 explains Blockchain technology and its characteristics in more detail, which is essential to

understand the application and the following use cases. In Section 4 the first use case related

to the market for used cars is illustrated while section 5 introduces a second use case which

focuses on ride sharing. Section 6 finally draws a conclusion by presenting potential criticism

and taking an outlook.

2. Theoretical Foundations and Literature Review

In order to have coherent base about fundamental concepts before analyzing the

above mentioned use cases, this chapter is meant to briefly outline the classical theory on

Transaction Cost Economics and shed light on the current state of research on Blockchain.

2.1 Classic Theory on Transaction Cost Economics

In general, neo-institutionalism (also referred to as transaction cost economics)

investigates why institutions exist in our real-world economy, although they are superfluous

according to neoclassical theory of frictionless markets. Therefore, the neoclassical theory

supposes that all transactions can be made in absence of any costs, i.e. every participant of a

2
transaction is perfectly informed, so that both actors can agree upon a complete contract.

Hence, there is no need for an intermediary in the market (Krkel 2010).

In comparison, neo-institutionalism is based on the real-world assumption that

transactions caused costs, so called transaction costs. These transaction costs can be divided

according to their direction into internal (within a company or group) and external (in the

market) transaction costs, as well as by their temporal relation into ex-ante and ex-post

transaction costs. Amongst others, Picot (1993) exemplifies information costs, contracting

costs, negotiation costs and monitoring costs as transaction costs.

In neo-institutionalism, there are two famous approaches which explain the existence

of firms by using the theory of transaction costs. In the paper The Nature of the Firm

(1937), Ronald Coase provides a first approach, whereas the second approach published by

Williamson (1989) is more specific.

Coase (1937) explains the existence of firms in a very intuitive way. He states that it

is reasonable to avoid the market mechanism and make use of a firm solution when the

internal transaction costs are lower than the external transaction costs.

By assuming the three fundamental elements, bounded rationality, opportunism and

asset specificity, Williamson (1989) provides a more detailed examination. In Williamsons

line of argumentation, organizations exist because of incomplete contracts. Bounded

rationality, his first fundamental assumption, implies that the humans cognitive capacity is

limited and that information is limited. Hence, actors are not able to observe all possible

future states of the world and therefore are not able to form complete contracts which results

in transaction costs. Williamson (1989) defines opportunism as being an underlying

assumption of the risk associated with bounded rationality, e.g. risk associated with

untrustworthy transaction partners. Especially, when asset-specific investments are required

and contracts are not complete, opportunistic behavior of one of the agents implies substantial

risk which could lead to hold-up problems. Hereby it does not matter if the opportunistic

3
behavior is actually performed or not fully observable. In order to overcome such problems

and to avoid transaction costs, vertical integration can be the key measure.

Related to Williamsons (1989) assumption of bounded rationality, Akerlof (1970)

conveys the theory of information asymmetry in the paper entitled The Market for

Lemons. In general, there are two types of information asymmetry: Hidden action and

hidden information. Hidden action denotes that at least one transaction participant has other

opportunities which cannot be foreseen by the other participant. In the context of Williamson,

this corresponds the opportunism determinant. Hidden information refers to information

owned by at least one transaction partner which the other partner cannot access. In line with

Williamsons (1989) argumentation, hidden information relates to bounded rationality.

Problems resulting from these factors are moral hazard and adverse selection,

respectively. Akerlof (1970), especially, discovers the existence of adverse selection in the

market for used cars, because high-quality vehicles get squeezed out of the market due to

information asymmetries. Hence the market for used cars remains unsolved and inefficient.

2.2 Literature on Blockchain Technology

The literature on Blockchain technology and its applications has grown strongly

especially in the past few years (Schlatt et al. 2016). It is worth mentioning that a majority of

the existing Blockchain literature focuses mainly on areas like finance, banking and

cryptocurrencies (e.g. Bitcoin) as applications of Blockchain technology (Lee 2016; Peters

and Panayi 2015). Potential applications of Blockchain may, however, go well beyond

banking and finance as will be shown later. Another major share of publications examines

technical (Becker et al. 2013; Croman et al. 2016) or legal aspects (Fairfield 2015; Kiviat

2015; Wright and De Filippi 2016). Schlatt et al. (2016) give a comprehensive and detailed

overview of and insight into the current status of Blockchain in terms of technological

development, current and potential applications as well as benefits and hurdles that still need

4
to be taken for the technology to fully succeed. Since Blockchain comprises a rather novel

technology, it is not surprising that the scientific communitys definitions, arguments and

viewpoints may not always align and may even diverge in some specific aspects as will be

shown in the following.

While literature on Blockchain is abundant in general, a mere fraction of this

literature examines the economics of Blockchain in particular. Evans (2014), for instance,

examines economic aspects of decentralized public ledgers platforms and cryptocurrencies.

He points to the fact that simply comparing transactions executed on Blockchain to

transactions executed on another platform ignores an important fact (Evans 2014). There may

be inefficiencies depending on the incentive and governance systems incorporated in

Blockchain systems that potentially reduce the overall efficiency of a system running on

Blockchain, ultimately making it inferior to other, perhaps already existing systems (Evans

2014). Further costs related to Blockchain that are potentially ignored in comparisons like

above may be costs associated with regulation and complementary service providers (e.g.

vaults, wallets etc.), according to Evans (2014).

Davidson, De Filippi, Potts (2016) describe Blockchains as a new but potentially

revolutionary technology (p.18) that consists of a decentralized public ledger which is made

secure through encryption. They, in fact, propose two ways to think about economics of

Blockchain: (i) Blockchain simply as a new general purpose technology and (ii) Blockchain

as a new institutional technology that competes with firms, markets and economies in being

the institutional alternative for the coordination of economic actions of groups of people

(Davidson, De Filippi, Potts 2016). The question whether Blockchain as an institutional

alternative is more efficient than other alternatives depends on different behavioral, cultural,

technological and environmental conditions (Davidson, De Filippi, Potts 2016).

Catalini and Gans (2016) explore Blockchain and cryptocurrencies from an economic

perspective and explicitly determine two costs that may be reduced through the adaption of

5
Blockchain technology. Efficient verification and auditing of transaction attributes is crucial

for the thriving of markets and the emergence of new ones (Catalini and Gans 2016).

Blockchain enables the cheap recording of such attributes in and their linking to a

decentralized public ledger, thereby driving down the costs of verification (Catalini and Gans

2016). Going one step further, combining Blockchain with a cryptocurrency may eliminate

the need for trusted intermediaries (moving them more towards a role where they engage in

market design), eventually lowering the cost of networking (Catalini and Gans 2016).

The main target of this brief literature review is to show how approaches chosen by

researchers differ exploring the economics of Blockchain and that there is no broad consensus

on the economic implications and foundations of this novel technology, yet. The present work

strives to complement previous work on the economics of Blockchain focusing on the area of

Transaction Costs Economics.

3. Blockchain Technology

Blockchain is sometimes confused with Bitcoin. But it is in fact the technology on

which Bitcoin and many other applications run and by no means limited to the application in

the area of cryptocurrencies. The following sheds more light onto what Blockchain

technology is, how it works, what its benefits and drawbacks are and what potentials

Blockchain contains.

3.1 What is a Blockchain?

Since Blockchain is still quite at the beginning of its development, no uniform

definitions have been agreed upon yet (Mattila 2016; Swan 2015). Schlatt et al. (2016) define

Blockchain as a distributed data structure that saves transactions transparently,

chronologically and irreversibly in a network. Walport (2015) defines Blockchain similarly as

a kind of database that consists of information entries grouped in blocks of data that are

6
encrypted and stored in chronological order. In other words, Blockchain is a decentralized

(i.e. it is not controlled by some central authority) database that records transactions

transparently, chronologically and irreversibly.

To clarify what a Blockchain is and to shed light onto how the technology actually

functions, let us consider the example of a cryptocurrency transfer for illustration purposes.

Note that transactions do not necessarily have to be those of cryptocurrencies, but may be

contracts, records or other information as well. Also note that the following example is

simplified and based on the explanation of Schlatt et al. (2016). For a more detailed and

technical explanation see Schlatt et al. (2016) and their respective references.

In a first step, an individual initiates a transaction (e.g. a transaction of Bitcoin or

another cryptocurrency) using a so called wallet which is a third-party software to store,

receive and send cryptocurrencies. The requested transaction is broadcasted to a peer-to-peer

(P2P) network of computers called nodes. The network of nodes uses specific algorithms to

validate the transaction and the initiators status. When the verification of the transaction is

successful other nodes, that are specialized computers called miners, combine it with other

verified transactions that then form a block of data. The miners process the newly formed

block of data and reach a consensus on what the new Blockchain should look like. The new

block of data is added to the existing chain of data blocks in a way that is permanent and

unalterable. This final step completes the process and individuals see in their respective

wallets whether the transaction has been successful or not. The miners are rewarded (e.g. with

freshly minted Bitcoin) for providing the computational power to keep the Blockchain valid

and running (Schlatt et al. 2016).

3.2 Design Space

The Blockchain described in section 3.1 resembles the Bitcoin-Blockchain - it is

public, open and decentralized. More precisely, it is 100% decentral. It is possible, though, to

7
decrease the degree of decentralization and increase the degree of centralization in the design

process of a Blockchain (Schlatt et al. 2016). This might be useful for a simple reason: the

100% decentral Blockchain may not be optimal for implementation in a specific area or even

causing problems linked to its specific design. For a Blockchain to work in a specific area it

has to be adapted to the specific circumstances given in that specific area. If not properly

adapted, the implementation of Blockchain might easily fail (Schlatt et al. 2016).

A Blockchain can be generally designed along two dimensions: (i) the dimension of

permission and (ii) the dimension of purpose. Concerning the dimension of permission, a

Blockchain can be either public with no restrictions on permission or private entailing

restrictions on permission. When a Blockchain application is meant to be public it makes

sense to keep restrictions on permission low. When a Blockchain is meant to be used between

two or more companies or institutions it makes sense to make is private. Concerning the

dimension of purpose, a Blockchain can be either transaction-oriented or logic-oriented. A

Blockchain that is transaction-oriented might be mainly used for the exchange of a

cryptocurrency for example while a Blockchain that is logic-oriented might be used for the

implementation and execution of smart contracts and the like. A smart contract, in essence, is

a snippet of computer code that is self-executed when some specific conditions are fulfilled.

Bitcoin and other cryptocurrencies use public and transaction-oriented Blockchains.

The Ethereum Blockchain is also public but logic-oriented since it focusses on smart contracts

for a large part. Transaction-oriented and logic-oriented private Blockchains are usually

implemented between two or more companies or other institutions to exchange value.

3.3 General Features

Referring back to the presented Blockchain design space for the purpose of our paper

we want to focus on a permission-free and transaction-oriented specification similar to the

technology underlying the Bitcoin environment. According to Schlatt et al. (2016) those types

8
of Blockchains can be characterized by three major features that are important to derive the

potential that is inherent in this new type of technology. Yet implied in Blockchains

functionality those features are (i) decentralization, (ii) distributed consensus mechanism and

(iii) cryptographic principles.

In contrast to the majority of existing ledgers that are managed by central institutions,

Blockchain constitutes a public ledger that is distributed among a network of different

independent computers or nodes. Those nodes are able to synchronize and communicate with

each other. To emphasize the aspect of complete decentralization it is important to mention

that every node stores a complete copy of the system.

Management and maintenance of the Blockchain is facilitated by a distributed

consensus system (Bogart and Rice 2015), forming the second key feature. A consensus

among the participating nodes in the system is used to agree upon and verify the actual

systems state and enables the coordination throughout the whole network (Bogart and Rice

2015).

According to Badev and Chen (2014), Blockchains are based on two cryptographic

principles introduced as the third general Blockchain features. Those two principles are public

key cryptography and hashing. Simplifying the technical details, the former can be described

as an algorithmic generation of two corresponding keys (public and private key) that together

represent a unique digital signature playing an important role to forward transactions on the

Blockchain (Bhme et al. 2015). The later is used in the creation process of new blocks

primarily to prevent fraudulent action since manipulation of data input would cause a hash

value to change drastically (Condos et al. 2016).

3.4 Structural Advantages and the Corresponding Potentials

Given the Blockchain functionality and its key features described in the previous

chapters the subsequent passage aims to derive possible advantages and potentials of this new

9
technology that could have massive impact on economic processes that we face today. The

following list has no right of completeness and other yet unobserved potentials might arise in

the future, but it should provide an impression of what could become possible through the

implementation of Blockchain technology.

In accordance with the design of a decentralized system the whole Blockchain is

reproduced among all individual nodes participating in the network. This in fact prevents the

existence of a single point of failure meaning that overall performance of the whole system is

not dependent on single nodes. Therefore, while the potential threat of downtime and data

loss is diminished, the Blockchain seems to increase system durability and availability

(Walport 2015).

Furthermore Blockchain comprises a complete and immutable history of activity

within the network. Once a record of a transactions is validated onto the distributed

Blockchain it is practically immutable leading to a high degree of confidence for processes

and applications running on this kind of infrastructure. This goes in line with the

argumentation of Bogart and Rice (2015) claiming that a complete and unaltered history of

activity protects from fraudulent usage and increases the security level of the whole system.

Despite those advantageous aspects derived from the fact of decentralization, one of

the core potentials created by the Blockchain is the facilitation of peer-to-peer exchange

(Burelli et al. 2015; Don Tapscott and Alex Tapscott 2016). The Blockchain technology

enables direct exchange between nodes without the need of intermediaries that act as trusted

third party authorities. By canceling out middlemen, that usually cause friction coming in

form of costs, delays and additional risks, Blockchain could increase efficiency in all types of

value exchange between peers (Schlatt et al. 2016). As a side effect of disintermediation users

are increasingly in the focus and in control of all the information and transactions within the

system (Bogart and Rice 2015).

On top of that, the consensus mechanism to verify the actual system state solves the

10
double spending problem since every node checks individually the validity of new blocks and

the inherent transactions stored in those blocks (Tschorsch and Scheuermann 2015).

Public key cryptography and its resulting digital signature lead to authenticity of the

Blockchain activities since only the initiator of such an action knows the private key that is

connected to this action (Schlatt et al. 2016). At the same time this aspect underpins the

accountability of actions on the Blockchain since an activity that is marked with the unique

digital signature of one entity cannot be doubt (Walport 2015). The last advantage inferred

from the cryptographic principles is the inherent integrity. On the one hand nobody can alter

specifications of a particular action without the corresponding key (Bogart and Rice 2015).

On the other hand the hash function allows to reference each block to its precursor and

provides each block with a time stamp emphasizing the integrity of the whole Blockchain.

Taking into account all of those potentials one can argue that with an adequate

number of participants within a network Blockchain comprises a highly robust and secure

system.

Next to the potentials that can be derived directly from the general features of the

Blockchain, the whole infrastructure bears even further potentials. Since all of the

transactions are stored in the blocks and accessible by everyone Blockchain has a high level

of transparency (Xethalis et al. 2016).

Depending on the particular Blockchain version, transactions are programmable

enabling the creation of more complex and conditional actions and facilitating autonomous

functional chains with the help of so called smart contracts (Schlatt et al. 2016). Combining

this with the conception of Blockchain becoming the technological backbone in different

industries one could think of an ecosystem with highly autonomous processes across various

industry sectors.

The last advantageous aspect that has to be mentioned can be traced back to

Blockchain protocol being an open source protocol. This implies that the protocol executes as

11
the code dictates and every participant in the system can rely on the fact that her transactions

are going to be executed and forwarded as the protocol demands.

3.5 General Issues

Despite the various potentials that have been mentioned yet and the predominantly

positive evaluations of Blockchain technology there are also reasonable issues related to this

topic. This chapter aims to give a short overview of potential problems that could eventually

hinder Blockchain to become widely adopted.

An often criticized issue with reference to the consensus mechanism is its high energy

demand necessary for the proof of work. Huge server farms, where new blocks are mined,

entail high electricity costs especially for cooling mechanisms. This issue is closely linked to

the restriction in terms of Blockchains scalability that limits the overall usage of applications

(Peters et al. 2015). It is not only the increase in electricity that is needed in the mining

process against the background of a growing network but also the increase in storing power

that limit scalability. Although there are first solutions to those two issues like limiting

Blockchains scale for the particular use case or Kryders Law, claiming an exponential

increase in storing power, only future can tell if Blockchain development is able to overcome

those obstacles. Besides, the number of simultaneously processed and validated transactions

is limited (Schlatt et al. 2016). Since this can be traced back to the proof of work mechanism,

a new way of validating transactions onto the Blockchain could eventually diminish this

problem.

Even though private key cryptography enables the existence of a unique digital

signature for each participant, a loss or theft of this particular key would cause the inputs in

the respective accounts to become inaccessible for the original owner (Condos et al. 2016).

Referring back to the potential of a new Blockchain-based ecosystem that spans across

various industries, there could be a potential lack of interoperability with existing systems or

12
applications that even complicates this per se difficult project (Silverberg et al. 2015).

Furthermore the irreversibility of the transaction could cause severe problems

(Xethalis et al. 2016). If a failure occurs during the submission of a transaction process this

would constitute an irreversible unintended action caused by human error. This points to a

crucial issue related to Blockchain technology. Even though it offers wide possibilities for

automated processes governed by code, the human aspect cannot be fully bypassed.

Depending on the particular situation and human intentions this could give rise to serious

problems hindering the adoption of Blockchain technology.

4. Implications of Blockchain Technology for the Market for

Lemons

In the following chapter we want to apply the theory of neo-institutionalism and

Blockchain technology in a specific use case. Our goal is to examine how far Blockchain

could potentially alter economic principles and underlying processes we face in the market for

used cars. Since we are in the early adoption phase of this new technology and there is no

blueprint of its implementation, parts of our elaboration are highly speculative and based on

rational argumentation.

4.1 The Classic Market for Lemons

As briefly mentioned at the beginning of section two, Akerlof (1970) explains the

used car market in the paper entitled The Market for Lemons. In the used car market, the

seller of a car is generally better informed about the quality of the car compared to the

potential buyer. Hence, there is a disequilibrium of information which Akerlof (1970)

denominates asymmetric information.

13
 Obviously, the seller will solely be willing to sell the car if the price offered by the

buyer meets his expectations. As the buyer is not that aware of the cars condition, he cannot

gauge the exact quality. Therefore, he aligns his price offer with the average quality of all cars

available on the market. As a result, all sellers of above-average quality cars drop out of the

market as they cannot realize their expected price for a high-quality car. Akerlof (1970) calls

this phenomenon adverse selection. As a result, the average quality of used cars on the market

will decline. Anticipating this, the buyers realign their price offers with the new average

quality of cars offered which, in turn, will push more sellers out of the market. After several

iterations of this procedure, merely cars of low quality will remain in the market. As a result,

one can observe a welfare loss as the market is inefficient since only cars of low quality will

be traded.

4.2 Application of Blockchain in the Market for Lemons

Observing the nature of items which are used by an average person on a daily basis,

two natural categories of goods emerge. On the one hand, consumables goods have to be

replaced regularly as they use up with consumption. On the other hand, durable goods like

cars do not quickly wear out and yield utility over time. As these goods theoretically satisfy

the consumers need as well as a new product and can still be used for a longer period, they

compete with new, unsold goods. Therefore, for cases of durable goods, the second-hand

market can constitute a relevant extension of the product category.

The automotive industry is one of the most prominent examples. Due to increases in

car longevity (Hamilton and Macauley 1998), fleet sales and leasing, the market for used cars

has been growing significantly (Porter and Sattler 1999). Looking at its market size, in 2010

there were three times more used vehicles sold in the U.S. than new cars (Bureau of

Transportation Statistics 2017). Furthermore, the successful introduction of new, very flexible

mobility concepts like car and ride sharing makes the market for cars highly multidimensional

14
(Janasz and Schneidewind 2017). In consideration of the expectation that people will more

and more lose the need of possessing a car themselves and prefer flexible services like Uber

or Car2Go, the retail market for cars needs to improve in order to secure profits and stay

competitive. As the market for used cars constitutes the flexibility mechanism in the market,

an improvement in efficiency and price security increases the overall utility of possessing a

car and could therefore enhance the retail market for automobiles.

Obviously, since the time when Akerlof (1970) identified the lemons problem in the

market for used cars, technology has dramatically improved as can be seen in Figure 1. In

recent years, computers have become ubiquitous and also found their way into modern cars.

In order to allow for transportation optimization and improving security, modern cars are

capable of using communication standards like Bluetooth, Wi or 3G/4G networks. This

enables a vehicle-to-vehicle and vehicle-to-infrastructure communication (Dimitrakopoulos

et. Al 2012; Gerla et. al 2014). Even autonomous driving is making progress as projects like

Waymo by Google (Google 2017) or Daimlers Mercedes-Benz F 015 Luxury in Motion

(Daimler 2017) show. These fully connected cars could soon be widely distributed (Fagnant

and Kockelman 2015).

Figure 1: Phases of evolution of the connected car

Source: Ninan et. al (2015).

15
 To assess the potential implications of adopting Blockchain technology onto the

market for used cars, the conception of a scenario is essential which identifies the

technological requirements on top of the current technical equipment as well as the resulting

functional factors: The main questions which need to be answered is what could an

implementation of a working Blockchain-based mechanism look like and through which

factors does it affect the problem of asymmetrical information as stated by Akerlof?

As illustrated by Bond (1982), the quality of the services a durable good provides can

deteriorate with age and the level of required maintenance or the probability of failure may

increase and therefore lower its market value. This use case thus aims to transfer and provide

all the relevant information which could influence the value of cars into a Blockchain

ecosystem.

As mentioned earlier, the key advantages of Blockchain as a public ledger technology

lie in its transparency and security (see section 3.4). For the transparency attribute to hold, all

the information must be accessible by every market participant. Respectively, the security

attribute is ensured on the one hand by its decentralized organization and the irreversibility of

information. On the other hand, it also must be guaranteed that the provided information is

correct.

To best cover all the mentioned aspects, the ideal complete documentation of the

following aspects, which determine or occur during the lifecycle of a car, is necessary:

1. The origin of the of the car before acquisition

2. History and details of accidents

3. All incidents of maintenance like repairs and other services

4. Data about the usage intensity (e.g. odometer, frequency, average speed)

16
 5. Changes in ownership

Figure 2: Lifecycle of a car within a Blockchain ecosystem

Source: Own figure based on Wirelesscar (2017)

As visualized in Figure 2, this covers most relevant events which can occur during the

lifecycle of a car within a Blockchain ecosystem and have an effect on the product value. In

order to be able to cover the mentioned aspects, additional technological add-ons are required

for the car itself as well as for the environment in which our Blockchain car is embedded.

In detail, a connected car must be able to perform the following actions and processes:

1. The car must be connected to the Blockchain. This can be realized by the existing

Internet 3G/4G and Wi-Fi modules.

2. The car has to collect all the relevant data (as mentioned above) and upload it on

the Blockchain without any further human contribution needed. The origin of each car

needs to be included to avoid trade of stolen cars.

3. Gathered data needs to be accessible to every market participant. This is given by

the nature of Blockchain as a public ledger technology.

4. All parts of the vehicle must be connected, and distinct verification of each part

17
 must be given in order to be able to make each part unique and allow for recognizing

differences. Furthermore, if the car loses connection to one part, it needs to be able to

record it.

5. Repairs must be correctly documented by the executing entity. This can be

incentivised by making the car itself recognize incurring defects and recording and

recognition of which parts are renewed. Through this mechanism, it could be avoided

that parts get renewed which do not have to be, inferior quality parts are used and

logically that the service provider cannot charge for measures which have not been

conducted. However, an uncertainty factor remains as a repair service provider has an

information advantage as they have far more expertise regarding cars and still might

behave opportunistic.

The underlying technical assumptions for the implementation of a working

Blockchain ecosystem may seem very unrealistic today. However, van der Meulen and Rivera

(2015) from Gartner, Inc. predict, that by the year 2020, more than 250 million units of so

called connected cars will be sold globally, which heavily rely on being connected via a

wireless Internet access. Recent developments regarding the collection of data in the

automotive industry also significantly increase the probability of the illustrated scenario to

become reality. For example, Tesla today already collects data of their vehicles odometer,

accidents, service- and repair history, average speed driven, location, battery usage, charging

times, starting and stopping of the engine, braking and acceleration and even on radio and

horn use (Tesla 2017). The difference however is, that this information is not available for

public and centrally stored. Hence, the key attributes of Blockchain application in forms of

transparency and security cannot be reached. Moreover, as Ninan et. al (2015) expect the

technological impacts on the industry to be of transformational and not incremental nature,

further significant technological improvements with increasing connectivity of cars could be a

18
plausible trend.

4.3 Blockchains Impact on the Future Used Cars Market

Clearly, the scenario constructed above does not resemble the current state of the

used car market. Nevertheless, if future cars had all the features mentioned, one could

imagine the impact on the Market for Lemons described by Akerlof (1970). The line of

argumentation is based on the central assumption of asymmetric information which describes

the information inequalities between the potential buyer and the seller of a used car. Indeed,

Blockchain technology in the above specified setting has the power to lessen or even to

eliminate information asymmetries in the market for used goods. Assuming all contract

relevant information being stored in the Blockchain, the attributes of Blockchain support

(more) complete contracts since information gets (more) symmetric.

Consider transparency as one key attribute of Blockchain technology. Transparency

implies that every user of the Blockchain has access to all the information it contains. In the

previous defined use case example, both the seller and the buyer of the used car have the

same information about usage, service history, accidents and lots of other data as these data

get automatically stored in the Blockchain by the car. Looking at the service history case, the

Blockchain enables the buyer to investigate whether service has been made within the

proposed intervals or whether there have been some profound other issues. Nevertheless, it

will remain complicated to check the quality of the service which will be discussed in a more

detailed way in section 4.4. Furthermore, the fear that a potential buyer can access all the

information about the car leads to the fact that the seller is no more able to hide information

from the buyer. This may distract the seller from not sticking to the proposed service

intervals. Additionally, the seller gets incentivized to moderately use his car, e.g. drive some

miles to get the engine warm before testing the quick acceleration of the car when the engine

is still cold. Another application worth mentioning is whether the car had an accident or not.

19
This is of importance since accidents cut prices of cars. As all these information is

transparently stored in the Blockchain, the seller cannot hide these information anymore,

implying information to get more symmetric.

Security is the second key attribute of Blockchain technology. Since information is

irreversible and stored decentral, nobody can manipulate the data once it has been entered in

the Blockchain. This attribute ensures the correctness of the information accessed by seller

and buyer as it will be transferred into the Blockchain automatically by the car and cannot be

changed by any other individual. In the context of our example, looking at the odometer

explains the advantages. In the past, a lot of odometers got manipulated by the owner so that

they displayed a much lower figure than the car actually drove. As buyers oftentimes favor

cars with only few driven miles but may suspect the seller to have manipulated the odometer,

they will lessen their price offer although the true expected value is higher. On the one hand,

Blockchain helps to overcome this problem since the owner is not involved in the reporting of

these data anymore. On the other hand, Blockchain technology prevents the seller from

changing the data of the odometer in a second step. It can prevent the seller from doing so, as

every user of the Blockchain stores all the information on its own device. If the seller changes

the data in his block, all other user will remark the error. So, security helps to guarantee that

the provided information is correct.

Combining these attributes of Blockchain technology shows that both participants of

the transaction are equipped with the same, correct data. Thanks to Blockchain technology,

information gets more symmetric. Since all transaction-relevant data can be accessed by both

seller and buyer, the asymmetric information assumption made by Akerlof (1970) can be

(partly) solved.

From the buyers perspective, this implies that he is able to better assess the quality of

the car. Hence, he will no longer align his price offer with the average expected quality of

cars on the market. Instead, the buyer can reconcile his price offer with the expected quality

20
of exactly the car he wants to buy. Compared to the initial Akerlof model, this expected

quality is closer to the true quality. Therefore, the sellers of high-quality cars may face a

fairer price which meets the quality of their car. As they will accept the price, they will no

longer get pushed out of the market. Adverse selection is no problem of the used car market

anymore. So, the market gets more efficient and welfare losses decrease overall.

4.4 Limitations and Open Questions

As pointed out, several technical assumptions and features are necessary for the

conclusion in chapter 4.3 to hold. As some of them seem very likely to be fulfilled in the near

future, the realization of others remains unclear.

Regarding the technical feasibility, the main limitation is the requirement of all parts

of the car to be connected to the Blockchain. This is not given today as it is not practicable to

implement a corresponding short distance computer module into every single part of a vehicle

and probably even in the future might be too costly.

The most critical obstacle of the application of Blockchain is based on the current

insufficient capability of securing that information is fully correct. The reason is the

remaining human factor (see section 3.5) which cannot be avoided completely. Manual input

of mechanics or ex-ante price agreements between individuals comprise potential for

manipulation of data before its storage and falsely influence the expected value of a car.

Moreover, the quality of used parts and the overall quality of repair services can hardly be

measured as we pointed out that complete identification of all the parts is not feasible. To

weaken or solve the potential of opportunistic behavior, a third party (e.g. an independent

non-governmental organization) could be established to observe and check the quality and

correctness of services. Nevertheless, the transmission of data requires a specific software to

work. As this will likely be supplied by the manufacturer, the correctness of data depends on

the producer. Manufacturers could have an incentive to modify the underlying software as

21
this would artificially increase the perceived product value with higher computed resale value.

If the potential efficiency increase is high enough, resources for the implementation

of a working Blockchain could be given. The relevance of an application of Blockchain

technology in this field is limited to future, yet unsold cars as cars today do not meet the

technical requirements. The logic follow up question is whether people will still possess a car

on their own in the future as sharing concepts become more and more popular?

Even if this is the case, scholars do not agree on the overall importance of

information asymmetry. Hendel and Lizzery (1997) as well as Tabarrok and Cowen (2015)

convey that the market for used cars does not shut down and volumes of trade for high and

low quality used cars can be quite substantial even in the presence of significant information

asymmetries. Additionally, Thierer et. al (2015) point out that the introduction of the Internet

and curation systems like reputation ratings already solve information asymmetry in large

parts. In contrast, Ghose (2009) provides evidence for the continuing existence of information

asymmetry and the related problem of adverse selection for the online used goods market,

despite the presence of reputational feedback and information on product condition.

Leaving the importance of asymmetrical information aside, the implementation of a

Blockchain also contains certain risks for consumers. As constant connection and tracking

becomes a standard feature, the amount of person-specific, sensitive information will sharply

increase. This offers vast potential risk for privacy violations and due to the high dependency

of cars on connectivity, they could also become more vulnerable to cyber attacks.

5. Implications of Blockchain Technology for Ride Sharing

In our second use case we want to apply Blockchain technology in the context of ride

sharing as one concrete subarea of the broad sharing economy sphere. For this purpose we

first need to give a short overview on the ride sharing industry we face today. Although there

are several platform providers engaging in fierce competition we decided to focus on Uber as

22
the leading player in this field attracting lots of users in various cities around the globe. Since

Uber right now does not build its service on Blockchain technology, in a second step we are

going to construct a hypothetical scenario where ride sharing is enabled purely via Blockchain

technology before analyzing and evaluating this particular use case.

5.1 Todays Intermediary-centric Ride Sharing Environment

In todays economic landscape we see a paradigm shift away from centralized

organizations offering a particular service or product to a passive group of customers towards

decentralized organisations that aggregate supply provided by a particular group of people

and match it with an active group of customers (De Filippi 2017). In line with that, one can

observe a shift from the desire of ownership to access, fueling the so called sharing economy

(Rifkin 2014).

To approach the ride sharing market and understand the role of Uber it seems feasible

to name general basic platform business principles and apply them to the special case of Uber.

According to Choudary et al. (2016) every interaction on a platform between a producer and a

consumer entails three different types of exchange. These are an exchange of information, an

exchange of services or goods and an exchange of currency. In the special case of Uber

information is provided in form of driver availability and location in response of a ride

seeking passenger request. While the actual exchange of service is the transportation itself,

the payment from passenger to driver is facilitated through the platform. The core interaction

on a platform can be decomposed into the three key components participants, value unit and

the filter (Choudary et al. 2016). Applying this to Uber the core interaction enabled via the

platform is obviously a car ride. While the participants are drivers and passengers, a list of

available cars displayed to passengers constitutes the respective value unit. With the help of a

filter, that is an algorithm developed by Uber, selected customers are matched with drivers

depending on availability, location and occupancy. This matching process is enhanced by

23
additional services like a curation mechanism that allows to see and give ratings of drivers

and passengers, thereby establishing a certain proportion of trust among platform users. On

top of that Uber, as the intermediating instance, is able to balance supply and demand by

adjusting prices in real time to accommodate shortfalls in the supply of drivers or surges in

demand. Given these platform interactions and services Uber is able to monetize its business

by charging a certain percentage of the fare that is paid for each ride. To put it in very simple

words Uber provides kind of a listing service enhanced with a combination of a real-time

connection, a curation mechanism, and a transaction facilitating tool.

The existence of Uber can be also justified from an economic perspective when

re-considering the theoretical foundation of the present work in section 2.1. Williamson

(1989) found that bounded rationality, opportunism and asset specificity were the reason why

contracts are incomplete. Intermediaries therefore exist to facilitate transactions between

market participants. Uber is precisely such an intermediary that facilitates transactions

between drivers and riders that otherwise would be subject to Williamsons three factors.

Without Uber transactions between drivers and riders probably would not take place at all.

After having outlined Ubers business practice and economic rationale one could

argue that most part of the value that is created on the platform stems from the crowd itself.

To be more precise, a high proportion of what makes Uber attractive to passengers is

delivered by the drivers who are not employed nor hired by Uber but voluntarily register on

the platform and offer their driving service. Nevertheless huge profits resulting from this

value exchange between drivers and passengers are captured by Uber as the intermediary and

platform provider (De Filippi 2017). Aligning this with the term of the sharing economy

introduced at the beginning of this chapter it seems legitimate to ask the question, whether the

sharing economy really is about sharing between peers or if it is not rather an industry

controlled by large intermediaries? Are intermediaries like Uber really needed to actually

enable peers to exchange value like a car ride? To analyze whether Blockchain technology

24
could possibly change the status quo in the ride sharing environment the following chapter

aims to outline a hypothetical situation where our use case is truly based on a peer-to-peer

value exchange without an intermediary like Uber.

5.2 Hypothetical Blockchain-centric Ride Sharing Environment

Since the technology is still in its infancy it is not possible to specify all of the details

and to describe all of the corresponding processes for the Blockchain-centric ride sharing

scenario. Though it should be possible to get a first impression of what such a scenario could

look like.

The most important aspect is the fact that Uber as an intermediary becomes

superfluous and is replaced by a pure peer-to-peer exchange of value. Ride sharing 2.0 would

not need a middleman anymore that facilitates transactions between passengers and drivers,

but relies solely on Blockchain technology that is owned by nobody and constitutes a truly

decentralized, autonomous community. In general, everyone would be able to participate and

access the Blockchain that is based on open protocol and does not rely on a centralized server.

Today the crowd forms the source of information, money and value in a market that is

governed by the platform provider Uber. In the new scenario this crowd would become the

market itself. The crowd continues to be participants on the one hand but also performs the

clearing of transactions and the management of the market at the same time. Having outlined

the general principle of the new ride sharing environment it remains to be explained how

important steps like identification, the aggregation of supply and demand as well as the

payment could be designed in this scenario.

An identification mechanism has to ensure a secure ride sharing process since driver

and passenger will have to record proof of identity, age and the ability to pay for a ride or

drive the car, respectively. This would result in a digital signature containing all of the

25
relevant information for every market participant that is stored on the Blockchain and linked

to the respective individuals via public key cryptography.

Based on the principles of a decentralized autonomous community most processes

would be governed by code and for example matches a potential passenger with the closest

driver. The execution of the right code snippets would be conditional on specific triggering

events like the passengers request for a ride facilitated through the Blockchain.

With respect to the payment mechanism two approaches are reasonable. Assuming

that even in the future payments via the Blockchain and the respective requirements will not

have found broad adoption, a token-based payment mechanism could be used. For each ride a

driver would be rewarded with tokens that in a second step could be exchanged for money or

used as payment for the next ride as a passenger. A passenger would have to buy tokens first

in order to request a ride, respectively. By following this approach the token would be a

placeholder for the direct exchange of money. Given the assumption, though, that all of the

market participants are going to have an e-wallet, where they store currency, one could also

imagine the whole payment process to be facilitated by smart contracts directly via the

Blockchain. If a ride has been provided this would cause a smart contract to be executed

transferring a specific amount of currency from the passengers wallet to the drivers

Blockchain account.

The described disintermediation would enable the real sharing economy and

passengers as well as drivers would be better off from a monetary perspective since

transaction fees, that have to be paid to an intermediary like Uber, disappear.

5.3 Limitations and Open Questions

The scenario pictured above, where there is no intermediary coordinating transactions

between drivers and riders, seems quite unlikely for a number of reasons. A general concern

26
is that enough peers would need to switch to the new Blockchain-centric ride share solution -

if no critical mass is reached, the solution is not likely to last long.

Williamsons (1989) bounded rationality, opportunism and asset-specificity appear

again problematic since the intermediary disappears and a Blockchain per se does not have

the characteristics of an intermediary. While asset specificity is not such a severe issue here,

bounded rationality and opportunism are because without an intermediary there is nobody

who aggregates supply and demand and nobody who monitors the behavior of opportunistic

individuals. Then, Picots (1993) four types of transaction costs introduced in section 2.1 pose

a further problem. It is quite clear that Uber is currently taking care of these costs. It is not so

clear whether they are taken care of in the purely Blockchain-centric solution, though.

Uber gathers information from and distributes it among drivers and riders, Uber

provides an enforcement mechanism in case of a dispute, Uber matches supply and demand

so there is no need for negotiations and Uber monitors what is going on between its drivers

and riders and provides a curation mechanism. All these services both create value and reduce

individual transaction costs for Ubers customers. Particularly the provision of information

and the distribution of it among drivers and riders paired with the aggregation of supply and

demand are one of Ubers greatest strengths. All of these aspects appear to be more

problematic in a purely Blockchain-centric ride share scenario where transactions are directly

exchanged among peers. So in essence, peers would have to take care of all aspects that Uber

is currently taking care of themselves. To be fair, intermediaries like Uber take their

sometimes quite large shares and make huge profits. Those, of course, could be saved in

monetary terms if there were no intermediaries. But then there are other, partly non-monetary

costs that occur when intermediaries are absent. Whether the savings exceed the newly

inferred costs or not or whether the two quantities are equal in the end is difficult to say.

There are many more open questions: How exactly is information shared among

drivers offering a ride and individuals seeking a ride? How are the interactions between

27
drivers and riders monitored and how are they curated to ensure quality? What kind of

enforcement mechanism is applied in case of disputes? What is the driver selection process

like and how is it guaranteed that a driver is qualified and reliable? Uber controls for the

human factor as an error source, but who will do this when there is no intermediary but only

peers exchanging value? Are peers really willing to trust in a Blockchain, a novel technology,

instead of a centralized institution (e.g. Uber) like they are used to?

From a user experience perspective a purely Blockchain-centric ride share solution

without an intermediary also seems quite unrealistic. What makes Uber so successful is, to a

certain extent, that it is easy and convenient to set up and to use. Easiness and convenience of

usage are for many customers significant factors that decide whether they continue to use a

service or churn. A ride share solution that builds purely on Blockchain as a peer-to-peer

exchange might be confronted with enormous technical challenges since Blockchain is a quite

complex technology. A high level of technological complexity often entails a rather

complicated user interface which makes the use less easy and convenient. That said, it seems

quite unlikely that a purely Blockchain-centric ride share solution could deliver the same user

experience like Uber simply because it is way more complex in technological terms compared

to an intermediary like Uber.

Another arguable aspect is the question where the actual value is captured and

aggregated if everything is purely decentralized and based on peer-to-peer exchange without

intermediaries. Taking the early phase of the Internet as a reference point where it constituted

a platform for people to create and share content in a decentralized way it was possible to

observe the surge of huge corporations like Google or Amazon that started to capture value by

creating capabilities in search and discovery, logistics and trust. Translating this to the context

of a Blockchain-centric scenario it seems reasonable to assume that even in those

decentralized networks there will be some kind of layer that will aggregate value through

those aforementioned capabilities. The concrete design of such layers remains to be difficult

28
to describe at the current status of technological development but there may exist

intermediaries similar to Uber operating in the Blockchain environment.

6. Conclusion

The target of the present work is to show how Blockchain technology may potentially

impact transaction costs in different areas of the automotive industry that are important in

terms of scale and orientation towards the future. For this purpose two use cases have been

developed, analyzed and evaluated.

Analyzing our first use case, one clearly recognizes the potential of Blockchain

technology. In fact, Blockchain could change the market for used goods. Especially, the

attributes transparency and security alter the underlying assumption of asymmetric

information. As information gets (more) symmetric and can be accessed by the buyer and the

seller of a used car, high quality cars will no longer be pushed out of the market. Hence, the

market will be more efficient. Nevertheless, remaining technological feasibility and the

existence of a human factor limit the enforceability of the concept.

The second use case on ride sharing showed that todays economic environment in

the peer-to-peer sphere is dominated by large intermediaries like Uber that capture a huge

proportion of the generated value by providing an interface to facilitate transactions between

passengers and drivers. Although a pure Blockchain-centric scenario would result in

disintermediation enabling a pure form of sharing with benefits for the participants, there are

still lots of open questions and limitations especially with regard to the aggregation of supply

and demand as well as the human factor within this hypothetical scenario. As a consequence

it seems to be reasonable to expect a development where even in a pure blockchain-centric

peer-to-peer market intermediaries will appear facilitating transactions between peers and

providing certain capabilities in the fields of search, discovery and trust.

The present work merely scratches the surface of a very specific application area of

29
Blockchain technology and operates hypothetically due to a very narrow scientific

foundation. This is due to the fact that Blockchain is a quite novel technology and still in its

infancy. There are numerous open questions to be answered and topics to be discussed along

with more technological development before Blockchain can become a technology generally

and widely applied. There is not much doubt that, once market-ready, Blockchain may disrupt

a lot of businesses, industries and potentially even societies. Given its enormous potential, the

scientific community should engage in further research on Blockchain in general and specific

aspects that affect society in particular. Future research should especially focus on setting a

uniform baseline for the dealing with Blockchain and its economic implications. Research

should also further examine potential applications of Blockchain in areas that are core to

society and also potentially to be disrupted by technological innovation. With the further

development of connected and autonomously driving cars, a closer examination of

Blockchain integrations in this specific area might be highly relevant and interesting. Only

through the thorough study and understanding of Blockchain and the resolving of open issues

and questions surrounding it, it will be possible to leverage the benefits of the technology to

generate an outcome that is optimal.

30
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