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In Consensus Algorithms We Trust

Theodor Beutel discusses the potential of blockchain.

Beyond Bitcoin
First on the agenda is payment. Initially proposed in 2008, Bitcoin is both the oldest and the highest capitalised (more than 100 billion USD as of November 2017) blockchain. Through the decentralised nature of blockchain technology, Bitcoin was the first to establish a trusted payment system without trustworthy intermediaries such as banks, central banks, and governments. To many, these attributes seem appealing, hence Bitcoin’s high valuation. It is, however, easy to overlook that blockchain, as a concept, has much more to offer beyond Bitcoin.

Analogy with the Internet
From the 1970s onwards, we notice a similar pattern with the emergence of the Internet. Back then, the world wide web was yet to be invented; however, email services were gaining traction. As the first mainstream internet application, email paved the way for the internet as we know it today with endless opportunities for innovation and instant, cheap, and global communication. Building on the foundations of the Internet, entrepreneurs all over the globe set up encyclopaedias, marketplaces, news sites, social media, etc. which previously could not be realised. Due to its fundamental importance for innovation and its wide-reaching effect on the global economy, the internet is considered a general purpose technology.

Blockchain as a General Purpose Technology
Could it be that Bitcoin is to blockchain, what email was to the Internet? Can we expect blockchain technology to mature and eventually become the foundation of a whole new field of innovation, just like the internet? It may not be too far-fetched to assume that Bitcoin merely represents a single, early-stage application of blockchain out of a plethora of further applications as a potential general purpose technology.

The potential of smart contracts
The evolution of blockchain technology is underway and progressing at a high pace. In 2014, it became apparent that there may be more to blockchain than securing payment transactions when Vitalik Buterin proposed the Ethereum blockchain. As opposed to Bitcoin, Ethereum is an example of a new kind of blockchain which combines the idea of smart contracts with distributed consensus algorithms. Smart contracts are essentially software code representing contractual terms and instructing computers to automatically process certain steps of a digitized contract. Smart contracts distinguish themselves from non-blockchain based software through their distributed architecture, meaning that there is no single entity which validates transactions and keeps information. Instead, a blockchain-based smart contract is virtually immutable and tamper proof, as it is validated from a distributed, decentralised network.

Platforms for Smart Contracts
Blockchains capable of smart contracts evoked a paradigm shift. Blockchains such as Ethereum, EOS, and NEO are not only able to secure transactions but automate them, which extends their scope significantly.  These blockchains typically act as a foundation for software developers to build applications which inherit the trusted, decentralised principles of blockchains. Therefore, blockchains such as Ethereum should not only be seen as yet another cryptocurrency, but rather as a fundamentally new way of programming which happens to rely on the same principles as cryptocurrencies. It is argued that the primary purpose of Ether (ETH; the cryptocurrency connected to Ethereum) is less a payment method, but rather a tool to power the processes behind Ethereum’s smart contracts

Capabilities of DApps
Why are smart contracts considered such a powerful mechanism and in what ways would they impact present structures? Several smart contracts taken together allow the creation of decentralised software applications, so-called DApps. In appearance to a user, these DApps may essentially look like any software application they are familiar with today; with the exception that DApps are not owned or supervised by intermediaries and skip the man-in-the-middle.

Economic benefits of decentralisation
For all of human history, intermediaries were to play an important role on markets in meeting supply and demand and keeping a share of a transaction to themselves as a reward. With recent funding rounds valuing ride-sharing platform Uber at $68 billion and room-sharing platform AirBnB at $29 billion, it can be assumed that this reward is not insignificant. Consulting our Econ 101 textbook, we learn that monopolies are more efficient with increasing economies of scale, but do not allocate resources efficiently when maximising for profit. Similarly, digital platform businesses tend to be ‘winner takes all’-markets, allowing platform owners to engage in monopolistic behaviour which is not necessarily good for consumers.

DApps’ potential for innovation
With DApps, however, a platform is effectively owned and maintained by each user to the extent they engage with the platform. Thus, a user is also a shareholder, which can be referred to as platform ‘cooperativism’. A platform’s decentralised counterpart therefore combines efficiency gains from economies of scale with efficient pricing due to its distributed power balance. This is inherent to decentralised applications, as crypto-economic principles incentivise everyone accordingly. Whether it be marketplaces (eBay, Amazon), media providers (Spotify, Netflix), social media (Facebook, Twitter), or the sharing economy (Uber, Airbnb); DApps could effectively replace these centralised platforms with peer-to-peer platforms. Following the sharp rise of platform businesses in recent years, we soon may face just yet another case of Schumpeterian creative destruction.

Barriers, Standards and (lack of) Regulation
As promising as these developments may seem, it is clear that the technology is still in its infancy. We see Bitcoin and many other cryptocurrencies being highly volatile in their valuation due to its absence of intrinsic value, its mathematically ensured scarcity, and plenty of speculation. Adoption wise, it has yet to ‘cross the chasm’ between early adopters and early majority of users and still a long way to go until mass adoption. While end-users tend to find the technology lacking in everyday-life use cases, are organisations and institutions deterred by insufficient scalability of blockchains and unpredictable volatility of cryptocurrencies. For instance, it takes up to 20 minutes (and used to be more than an hour in the early days) for a Bitcoin transaction to be validated which seems unthinkable compared to the few seconds it takes an average Aldi employee to scan all your grocery items.

Furthermore, from a regulatory perspective, cryptocurrencies and blockchain applications are still highly unregulated in most regions of the world. While some countries (including Bolivia, Ecuador, Kyrgyzstan, Bangladesh, and Nepal) declared Bitcoin illegal, most regulatory bodies choose to remain observing the technology for now. Concerning investments relating to decentralised applications (so-called initial coin offerings, short ICOs), the U.S. Securities and Exchange Commission (SEC) recently declared certain kinds of ICOs as securities – and therefore to come under its regulation. Even more, China and South Korea banned ICOs entirely with other nations considering similar measures.

At the same time, the blockchain industry begins to sort itself out. Major organisations from tech, finance, and other sectors join blockchain startups to form consortia (such as EEA, R3, and Hyperledger), which currently compete for dominance in the field. In other cases, the industry has reached a consensus (such as with the ERC20 standard for Ethereum smart contracts). However, efforts for standardisation and struggles for power will surely continue to be present for quite a while.

Despite present barriers and scepticisms, it seems hard to believe that blockchain technology will not fundamentally affect businesses and societies in the long term. Concerning its impact, it remains to be seen if blockchain will be considered as significant as the internet However, establishing trust in such an unprecedented scale and scope appears to be too much of a winning strategy that will convince people, organisations and governments – and at times may even render the latter two redundant.

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