Why Blockchain Isn’t a Revolution
The terms
Bitcoin and blockchain are sometimes used interchangeably, but there’s actually
some misunderstanding about the innovation. In this opinion piece, Kevin Werbach, Wharton professor of legal studies and business ethics, explains
the differences among the three groups that comprise this technology:
cryptocurrency, blockchain and cryptoassets.
These days it’s hard to avoid pronouncements
about how cryptocurrencies and blockchain technology could change
everything (or at least, create massive
wealth). Yet there’s an equally loud chorus
labeling them a massive
scam, useless, and dangerous. And a surprisingly large audience still doesn’t
understand what’s going on. One big reason for the confusion is that we’re not
all talking about the same things.
The three communities share a basic set of
design principles and technological foundations, but the people, goals, and
prospects are almost completely distinct. Those involved don’t help much by
sniping constantly about which is the “real” movement. So, let me try to
clarify things.
There is cryptocurrency: the
idea that networks can securely transfer value without central points of
control. There is blockchain: the idea that networks can
collectively reach consensus about information across trust boundaries. And
there are cryptoassets: the idea that virtual currencies can be
“financialized” into tradable assets. The first truly is a revolutionary
concept, but the jury is still out on whether the revolution will succeed. The
second and third are game-changing innovations on the path to significant
adoption, which are nonetheless essentially evolutionary.
Cryptocurrency
(‘Trust-Minimizing’)
Cryptocurrency is what you’ve probably heard
the most about, starting with Bitcoin. The easiest way to understand it is not
to puzzle over the details of mining or digital cash. Instead, focus on the
decentralization of trust, as I do in my forthcoming
book.
Many activities require trust. Without trust,
a $20 bill is just a green piece of paper, a vote in an election is a pointless
ritual, and someone offering me a ride in their car is a potentially dangerous
stranger. Traditionally, trust meant depending on partners, institutions, or
intermediaries. Those centralized trust
architectures are powerful; among other things, they
brought us modern industrial civilization. But there’s a downside to trust.
Trust implies vulnerability. The people, governments, and companies we trust
may turn out to be untrustworthy, for any number of reasons. Bitcoin showed
that something valuable
— money
— could
be trusted without trusting anyone in particular to verify transactions.
The idea, if brought to full fruition (and
that’s a huge “if”), could transform society. We could have transparent
companies that truly reflect
the will of their stakeholders,
governments that truly
reflect the will of their citizens, an
internet freed
from the corrupting value-extraction of
powerful gatekeepers, the end
of fake news, and massive
automation of daily life for the betterment of
humanity. Or at least, we could have solutions that markedly improve on the
status quo. Decentralization is valuable in all sorts of ways.
There’s a cost. (There’s always a cost.) For
Bitcoin, the costs involve a very slow network with limited functionality that
wastes massive amounts of electricity and enriches a side community of miners.
Maybe those are worth it. Maybe technological advances, through the parade of
new blockchains and blockchain enhancements, will drive down the costs. We
don’t know yet. Yes, the bitcoin in circulation is notionally worth north of
$100 billion, but that’s cryptoasset thinking. Is anyone using bitcoin yet
to do something, other than to get rich, to make a point, or
to avoid law enforcement? And it gets steadily worse as one progresses down the
list of nearly 2,000 (or perhaps many more) extant cryptocurrencies.\
There’s also a catch. (There’s always a
catch.) What works for small groups, bounded applications, and idiosyncratic
users doesn’t necessarily survive the climb to the mainstream. If it does, it
often becomes something completely different. Until Facebook came along, it
wasn’t clear anyone could make real money on social networking, which was just
a frivolous exercise for kids anyway. The fact Facebook did come along doesn’t
prove it was inevitable.
Some of those betting on the cryptocurrency
revolution may be proven right. It’s an exciting bet, with all kinds of
potential upside, but still a gamble. There’s a reason true revolutions don’t
happen often. And when they do, there tends to be heavy collateral damage.
The blockchain* phenomenon grows from the
same root as cryptocurrencies — the Bitcoin
white paper of 2008 and its antecedents — but seeks
something very different. Rather than trying to do without trust, blockchain
starts from the premise that our trust is
too limited. We only really trust ourselves, or our own
organization. Yet no person, or company, is an island. Even the government of
an island isn’t an island, for that matter, when it has to trade and interact
across the water.
The world is filled with processes,
especially among larger companies and governments, where things must be tracked
from one trusted zone to another. Firms spend $10 trillion per year globally on
“logistics,” which is short for putting stuff on transportation systems
controlled by someone else. Manufacturers, distributors, and retailers keep
their own trusted (yet independent) records of the same items as they flow
through supply chains. When you walk into a new hospital or doctor’s office,
your medical records don’t necessarily walk in with you. They are even less likely
to walk out together with the new ones you generate. All of these breakdowns in
information flow feed the fearsome dragon known as transaction costs. According
to the dominant school of economics today, the effort to slay that dragon is
the essential
driving force in the economy.
A significant chunk of the transaction costs
between firms (and sometimes within them) flow from the limited elasticity of
trust. If every party to a transaction trusted the information involved, even
though they didn’t trust one another, costs could fall and performance could
improve drastically. That is the essence of the blockchain vision.
Trusting your own records on a blockchain is
tantamount to trusting everyone else’s records, because those records are one
and the same. The duplication of settlement, the further duplication of
reconciliation, the further duplication of auditing, and perhaps the further
duplication of regulatory reporting, can all fold into the original
transaction. The most prominent companies in the world are participating in all
manner of blockchain trials and consortia because they see the huge potential.
Decentralization here is one design goal among several, not a foundational
requirement as with cryptocurrencies. So these systems typically are
“permissioned,” with essential functions limited to identified participants.
As with cryptocurrencies, there are aspects
of this story that are still speculative. Because the blockchain thesis doesn’t
assume any radical changes in markets or business models, though, it’s a
question of degree only. Cryptocurrency advocates carp that you don’t need a
blockchain for any of these arrangements. Well, you don’t need a blockchain to
create digital money either. It’s only when you want to add the condition that
banks can’t intermediate, governments can’t block transactions, and no one can
influence the money supply that Bitcoin has a purpose. The blockchain thesis
similarly targets a particular class of scenarios. Traditional database
solutions don’t solve these problems because the people and companies involved
don’t agree in practice, not because of some failing in theory.
Cryptoassets (‘Trading’)
Cryptoassets take cryptocurrency tokens, turn
them into instruments of trading, and spin ever more complex financial
instruments out of the threads they produce. The potential scale is immense,
with trillion-dollar markets not that unusual in modern finance. Where this
effort diverges from the first is that it views cryptocurrencies not as a way
to facilitate activities without centralized trust, but as a new investment
asset class. Because they are natively digital, cryptoassets can in theory be
traded more efficiently than existing instruments. They are inherently flexible
and global. Virtually all of the major Wall Street players are eager to get in
on the action, as are the institutional investors that supply them with
capital. Regulatory concerns that kept them out are gradually being addressed.
Once the fundamental value of a digital token
on a decentralized network is established, why not just use it to make money?
(Sorry, to “engage in socially optimal capital formation.”) Cryptoassets depend
on the fact of cryptocurrencies, because there needs to be
something valuable to trade. Securities must be secure. But cryptoassets ignore
or reject the idea of cryptocurrencies, that trust is “almost
an obscenity” (to quote the man who did the original security audit on
Bitcoin). To the cryptoasset trader, both trust and the absence of trust are
nothing but means to an end, known as liquidity.
Permissioned blockchains will also support
tokenized assets, by the way, including eventually sovereign currencies. The
difference is that the goal will be effective tracking more than profitable
trading.
Another way to think of this is that
cryptoassets divorce the exchange function of cryptocurrency tokens from their
utility functions. If you want to use bitcoin to pay merchants, Ethereum’s
ether to purchase computing cycles for distributed applications, Filecoin to
purchase cloud file storage, or Augur Rep to verify the results of prediction
markets, you put a value on those tokens based on what you get out of the
application. In theory, more demand for use in the application means less
available supply, which pushes up the price. In practice, none of the
applications are significant yet, so the value of the tokens is highly
speculative. Speculation isn’t necessarily a bad thing; it’s the appetite for
risk that drives financial markets. Sometimes, though, that speculation drives
markets over a cliff. The key question for cryptoassets is whether and how
speculative instincts will be modulated.
If cryptoasset markets develop, there are all
sorts of interesting possibilities for “tokenizing” physical things like
commodities and real estate, digital things like intellectual property, and
other kinds of rights, using the financial engineering and analytics tools Wall
Street has developed over the years. The necessary foundations are already
being built.
Don’t Cross the Streams
The stories aren’t mutually exclusive, per
se. The success or failure of any one vision doesn’t necessarily imply much
about the others. Cryptocurrencies have the most disruptive potential, because
they promise to decentralize power. That also creates the biggest barriers to
success. Both blockchain systems and cryptoassets scale back that
decentralization for other benefits. They differ in the uses they target, so
it’s not a competition to determine the right answer. Crossovers can generate
significant opportunities, but they need to be evaluated in their own lane.
Initial coin offerings (ICOs), for example, fuse cryptocurrencies and
cryptoassets. Should they be assessed as a new form of crowdfunding or a way to
kickstart decentralized economies? What counts as success or failure looks
different depending on the answer.
Deciding which is the “real” phenomenon can
be an entertaining parlor game, but it’s ultimately not enlightening. Any
judgments about success or failure of blockchain-related technologies need to
be couched in terms of the relevant sub-category. When observers point to
enterprise adoption and high prices on cryptoasset exchanges as evidence for
the viability of cryptocurrencies, they’re crossing the streams. The fact that
there’s massive fraud and theft in the ICO world doesn’t tell you much
about government
initiatives around distributed ledgers. Whether or
not there’s a good business putting
banks on blockchains(or something blockchain-like) says little
about the prospects for decentralized
automated organizations.
The sooner we stop treating this as a unitary
phenomenon, the more we’ll be able to assess developments accurately.
http://knowledge.wharton.upenn.edu/article/blockchain-isnt-revolution/?utm_source=kw_newsletter&utm_medium=email&utm_campaign=2018-06-21
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