Dave Farber
2018-06-22 11:32:25 UTC
http://knowledge.wharton.upenn.edu/article/blockchain-isnt-revolution/?utm_source=kw_newsletter&utm_medium=email&utm_campaign=2018-06-21
Why Blockchain Isnât a Revolution
Jun 20, 2018
The terms Bitcoin and blockchain are sometimes used interchangeably, but thereâs 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 itâs hard to avoid pronouncements about how cryptocurrencies and blockchain technology could change everything (or at least, create massive wealth). Yet thereâs an equally loud chorus labeling them a massive scam, useless, and dangerous. And a surprisingly large audience still doesnât understand whatâs going on. One big reason for the confusion is that weâre 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 donât help much by sniping constantly about which is the ârealâ 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 âfinancializedâ 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 (âTrust-Minimizingâ)
Cryptocurrency is what youâve 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 thereâs 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 valuableâ â moneyâ â âcould be trusted without trusting anyone in particular to verify transactions.
The idea, if brought to full fruition (and thatâs a huge âifâ), 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.
âBitcoin showed that something valuableâ â moneyâ â âcould be trusted without trusting anyone in particular to verify transactions.â
Thereâs a cost. (Thereâs 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 donât know yet. Yes, the bitcoin in circulation is notionally worth north of $100 billion, but thatâs 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.
Thereâs also a catch. (Thereâs always a catch.) What works for small groups, bounded applications, and idiosyncratic users doesnât necessarily survive the climb to the mainstream. If it does, it often becomes something completely different. Until Facebook came along, it wasnât clear anyone could make real money on social networking, which was just a frivolous exercise for kids anyway. The fact Facebook did come along doesnât prove it was inevitable.
Some of those betting on the cryptocurrency revolution may be proven right. Itâs an exciting bet, with all kinds of potential upside, but still a gamble. Thereâs a reason true revolutions donât happen often. And when they do, there tends to be heavy collateral damage.
Blockchain (âTrackingâ)
The blockchain* phenomenon grows from the same root as cryptocurrenciesâ â âthe Bitcoin white paper of 2008 and its antecedentsâ â 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 isnât 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 âlogistics,â 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 doctorâs office, your medical records donât 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 didnât trust one another, costs could fall and performance could improve drastically. That is the essence of the blockchain vision.
âTrusting your own records on a blockchain is tantamount to trusting everyone elseâs records, because those records are one and the same.â
Trusting your own records on a blockchain is tantamount to trusting everyone elseâs 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 âpermissioned,â with essential functions limited to identified participants.
As with cryptocurrencies, there are aspects of this story that are still speculative. Because the blockchain thesis doesnât assume any radical changes in markets or business models, though, itâs a question of degree only. Cryptocurrency advocates carp that you donât need a blockchain for any of these arrangements. Well, you donât need a blockchain to create digital money either. Itâs only when you want to add the condition that banks canât intermediate, governments canât 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 donât solve these problems because the people and companies involved donât agree in practice, not because of some failing in theory.
Cryptoassets (âTradingâ)
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 âengage in socially optimal capital formation.â) 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 âalmost an obscenityâ (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, Ethereumâs 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 isnât necessarily a bad thing; itâs 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.
âCryptoassets divorce the exchange function of cryptocurrency tokens from their utility functions.â
If cryptoasset markets develop, there are all sorts of interesting possibilities for âtokenizingâ 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.
Donât Cross the Streams
The stories arenât mutually exclusive, per se. The success or failure of any one vision doesnât 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 itâs 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 ârealâ phenomenon can be an entertaining parlor game, but itâs 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, theyâre crossing the streams. The fact that thereâs massive fraud and theft in the ICO world doesnât tell you much about government initiatives around distributed ledgers. Whether or not thereâs 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 weâll be able to assess developments accurately.
*I use the term âblockchainâ for this category, because it emphasizes the value of the ledger over the currency or decentralization. Speaking precisely, though, most cryptocurrencies and cryptoassets use blockchains as well. And not every âblockchainâ system employs the data structure of a hash-linked chain of blocks.
This article first appeared in Medium.
Keio University Distinguished Professor
Tokyo Japan Cell +81 ââ70 4490 7275â¬â¬
-------------------------------------------
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Why Blockchain Isnât a Revolution
Jun 20, 2018
The terms Bitcoin and blockchain are sometimes used interchangeably, but thereâs 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 itâs hard to avoid pronouncements about how cryptocurrencies and blockchain technology could change everything (or at least, create massive wealth). Yet thereâs an equally loud chorus labeling them a massive scam, useless, and dangerous. And a surprisingly large audience still doesnât understand whatâs going on. One big reason for the confusion is that weâre 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 donât help much by sniping constantly about which is the ârealâ 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 âfinancializedâ 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 (âTrust-Minimizingâ)
Cryptocurrency is what youâve 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 thereâs 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 valuableâ â moneyâ â âcould be trusted without trusting anyone in particular to verify transactions.
The idea, if brought to full fruition (and thatâs a huge âifâ), 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.
âBitcoin showed that something valuableâ â moneyâ â âcould be trusted without trusting anyone in particular to verify transactions.â
Thereâs a cost. (Thereâs 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 donât know yet. Yes, the bitcoin in circulation is notionally worth north of $100 billion, but thatâs 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.
Thereâs also a catch. (Thereâs always a catch.) What works for small groups, bounded applications, and idiosyncratic users doesnât necessarily survive the climb to the mainstream. If it does, it often becomes something completely different. Until Facebook came along, it wasnât clear anyone could make real money on social networking, which was just a frivolous exercise for kids anyway. The fact Facebook did come along doesnât prove it was inevitable.
Some of those betting on the cryptocurrency revolution may be proven right. Itâs an exciting bet, with all kinds of potential upside, but still a gamble. Thereâs a reason true revolutions donât happen often. And when they do, there tends to be heavy collateral damage.
Blockchain (âTrackingâ)
The blockchain* phenomenon grows from the same root as cryptocurrenciesâ â âthe Bitcoin white paper of 2008 and its antecedentsâ â 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 isnât 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 âlogistics,â 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 doctorâs office, your medical records donât 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 didnât trust one another, costs could fall and performance could improve drastically. That is the essence of the blockchain vision.
âTrusting your own records on a blockchain is tantamount to trusting everyone elseâs records, because those records are one and the same.â
Trusting your own records on a blockchain is tantamount to trusting everyone elseâs 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 âpermissioned,â with essential functions limited to identified participants.
As with cryptocurrencies, there are aspects of this story that are still speculative. Because the blockchain thesis doesnât assume any radical changes in markets or business models, though, itâs a question of degree only. Cryptocurrency advocates carp that you donât need a blockchain for any of these arrangements. Well, you donât need a blockchain to create digital money either. Itâs only when you want to add the condition that banks canât intermediate, governments canât 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 donât solve these problems because the people and companies involved donât agree in practice, not because of some failing in theory.
Cryptoassets (âTradingâ)
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 âengage in socially optimal capital formation.â) 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 âalmost an obscenityâ (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, Ethereumâs 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 isnât necessarily a bad thing; itâs 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.
âCryptoassets divorce the exchange function of cryptocurrency tokens from their utility functions.â
If cryptoasset markets develop, there are all sorts of interesting possibilities for âtokenizingâ 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.
Donât Cross the Streams
The stories arenât mutually exclusive, per se. The success or failure of any one vision doesnât 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 itâs 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 ârealâ phenomenon can be an entertaining parlor game, but itâs 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, theyâre crossing the streams. The fact that thereâs massive fraud and theft in the ICO world doesnât tell you much about government initiatives around distributed ledgers. Whether or not thereâs 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 weâll be able to assess developments accurately.
*I use the term âblockchainâ for this category, because it emphasizes the value of the ledger over the currency or decentralization. Speaking precisely, though, most cryptocurrencies and cryptoassets use blockchains as well. And not every âblockchainâ system employs the data structure of a hash-linked chain of blocks.
This article first appeared in Medium.
Keio University Distinguished Professor
Tokyo Japan Cell +81 ââ70 4490 7275â¬â¬
-------------------------------------------
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