The General Theory of Decentralized Applications, Dapps

The Emerging Wave of Decentralized Applications

Authors: David Johnston, Sam Onat Yilmaz, Jeremy Kandah, Nikos
Bentenitis, Farzad Hashemi, Ron Gross, Shawn Wilkinson and Steven Mason

See also the previous version of this document [on Google Drive](https://docs.google.com/document/d/1Qh0KIQpy3Ob070BKHNA82fYGL0atlGSfmKCKJpS-QH8/edit?usp=sharing).

The emergence of Dapps

A new model for building successful and massively scalable applications
is emerging. Bitcoin led the way with its open-source, peer-to-peer
nature, cryptographically-stored records (block chain), and limited
number of tokens that power the use of its features. Several
[applications](https://en.bitcoin.it/wiki/List_of_Decentralized_Autonomous_Corporations)
are adopting the Bitcoin model in order to succeed.
[BitShares](https://docs.google.com/document/d/1RLcjSXWuU9vBJzzqLEXVACSCdn8zXKTTJRN_LfoCjNY/edit),
[Mastercoin](http://www.mastercoin.org/) and Open Garden are just a few
of those “decentralized applications” that use a variety of methods to
operate. Some use their own block chain (BitShares), some use existing
block chains and issue their own tokens (Master Protocol and
Mastercoin), and others operate at two layers above an existing block
chain and issue their own tokens (OpenGarden).

This paper describes why decentralized applications have the potential
to be immensely successful, how the different types of decentralized
applications can be classified, and introduces terminology that aims to
be accurate and helpful to the community. Finally, this paper postulates
that these decentralized applications will some day surpass the world’s
largest software corporations in utility, user-base, and network
valuation due to their superior incentivization structure, flexibility,
transparency, resiliency, and distributed nature.

Definition Of A Dapp

For an application to be considered a Dapp, it must meet the following
criteria:

1. The application must be completely [open-source](https://en.wikipedia.org/wiki/Open_source), it must operate autonomously, with no entity controlling the majority of its tokens, and its data and records of operation must be cryptographically stored in a public, decentralized [block chain](https://en.bitcoin.it/wiki/Block_chain).

2. The application must generate tokens according to a standard algorithm or set of criteria and possibly distribute some or all of its tokens at the beginning of its operation. These tokens must be necessary for the use of the application and any contribution from users should be rewarded by payment in the application’s tokens.

3. The application may adapt its protocol in response to proposed improvements and market feedback but all changes must be decided by majority consensus of its users.

Bitcoin As A Dapp

Satoshi Nakamoto, the creator of Bitcoin described his invention as “A
Peer-to-Peer Electronic Cash
System[[2]](https://dl.dropboxusercontent.com#ftnt2)”. Bitcoin has been
shown to effectively solve the problems that arise from a trust-less and
scalable electronic cash system by using a peer-to-peer, distributed
ledger, the Bitcoin block chain. In addition to being a peer-to-peer
electronic cash system however, Bitcoin is also an application that
users can interact with through computer software). But most importantly
for the purposes of this paper, based on the criteria outlined above,
Bitcoin is a decentralized application. Here is why:

1. All Bitcoin software applications are open-source, no entity (government, company, or organization) controls Bitcoin and all records related to the use of Bitcoin are open and public.

2. Bitcoin generates its tokens, the bitcoins, with a predetermined algorithm that cannot be changed, and those tokens are necessary for Bitcoin to function. Bitcoin miners are rewarded with bitcoins for their contributions in securing the Bitcoin network.

3. All changes to Bitcoin must be approved by a majority consensus of its users through the proof-of-work mechanism.

Nomenclature & Its Importance

Decentralized applications were initially described as Decentralized
Autonomous Corporations, DAC, in an article written by Daniel Larimer,
of Invictus Innovations. This papers avoids the term corporation for two
reasons.

First, because it carries with it unnecessary preconceptions. For
instance, a corporation is established in a jurisdiction, it has shares,
a CEO, employees, etc. Dapps, like Bitcoin, have none of these
characteristics. In addition, the narrative is very important for the
way Dapps are perceived by various nations and jurisdictions. The same
way that governments struggle to learn and regulate Bitcoin because the
concept of currency is associated with it, governments might be
compelled to regulate an open-source computer program that is a
decentralized application.

Second, because traditional corporations may engage in several
techniques to raise capital (like selling shares of its stock and pay
dividends or borrowing against its stock and pay interest) that a Dapp
does not need. The concept of a Dapp is so powerful and elegant, because
it does not include these traditional corporate techniques. The
ownership of the Dapp’s tokens is all that is required for the holder to
use the system. It’s that simple. The value of the tokens is determined
by how much people value the application. All the incentives, all the
monetization, all the qys to raise capital are built into this
beautifully simple structure. Dapps are not required to recreate the
functions that used to be necessary in centralized corporations in order
to balance the power of shareholders and offer returns for investors and
employees.

Classification of Dapps

There are several characteristics according to which decentralized
applications can be classified. For the purposes of this paper, we will
classify DApps based on whether they have their own block chain or they
use the block chain of another DApp. Based on this criterion, there are
three types of DApps.

**Type I** decentralized applications have their own block chain.
Bitcoin is the most famous example of a type I decentralized application
but Litecoin and other “alt-coins” are of the same type.

**Type II** decentralized applications use the block chain of a type I
decentralized application. Type II decentralized applications are
protocols and have tokens that are necessary for their function. The
Master Protocol is an example of a type II decentralized application.

**Type III** decentralized applications use the protocol of a type II
decentralized application. Type III decentralized applications are
protocols and have tokens that are necessary for their function. A
hypothetical Cloud Protocol that uses the Master Protocol to issue
‘cloudcoins’ that can be used to acquire cloud computing services would
be an example of a type III decentralized application.

A useful analogy for a type I DApp is a computer operating system (like
Windows, Mac OS X, Linux, Android, iOS) for a type II DApp a general
purpose software program (like a word processor, a spreadsheet software,
a file synchronization system such as Dropbox) and for type III DApp, a
specialized software solution (like a mail-merge tool that uses a word
processor, an expense report macro that uses a spreadsheet, or a
blogging platform that uses Dropbox.) Using this analogy, it may be
expected that due to network effects and the ecosystem surrounding each
decentralized application, there will be a few type I DApps, more type
II DApps and even more type III DApps.

At this point, it is important to mention that there are currently
several excellent open-source projects that leverage type I DApps.
Colored coins and CoinJoin, for example, are based on the Bitcoin block
chain and provide useful features to their users. These projects however
cannot be classified as type II DApps, according to our definition,
because they don’t issue and manage a token. (The development and
operation of these projects depends on donations instead.)

The Value of Dapps and Their Tokens

For a complete analysis about why tokens associated with DApps, and the networks powering the DApps are valuable, [see this paper](https://docs.google.com/document/d/1Qh0KIQpy3Ob070BKHNA82fYGL0atlGSfmKCKJpS-QH8/edit).

The operation of a DApp
———————————-

Mechanisms for Establishing Consensus

There are two common mechanism by which DApps can establish consensus:
the **proof-of-work**, POW, mechanism and the **proof of stake**, POS,
mechanism.

With the proof-of-work mechanism, decisions about changes in a DApp are
made based on the amount of work that each stakeholder contributes to
the operation of the DApp. Bitcoin uses that approach for its day-to-day
operation. The mechanism for establishing consensus through POW is
commonly called mining.

With the proof-of-stake mechanism, decisions about changes in the DApp
are made based on the percent ownership that various stakeholders have
over the application. For instance, the vote of a stakeholder who
controls 10% of the tokens issued by a DApp, carries a 10% weight. The
Master Protocol is based on the POS mechanism.

The two mechanisms can be used in parallel, as is the case with
[Peercoin](http://peercoin.net/). Such a combination allows a DApp to
operate with less energy consumption than proof-of-work alone, and
allows it to be more resistant to [51%
attacks](https://en.bitcoin.it/wiki/Weaknesses).

### Mechanisms for distributing tokens

There are three common mechanisms by which DApps can distribute their
tokens: mining, fund-raising and development.

With the mining mechanism, tokens are distributed to those who
contribute most work to the operation of a DApp. Taking Bitcoin as an
example, bitcoins are distributed through a predetermined algorithm to
the miners that verify transactions and maintain the Bitcoin block
chain.

With the fund-raising mechanism, tokens are distributed to those who
fund the initial development of the DApp. Taking the Master Protocol as
an example, Mastercoins were initially distributed to those who sent
bitcoins to a given address at the rate of 100 Mastercoins per bitcoin
sent. The bitcoins collected were then used to fund the development of
applications that promoted the development of the Master Protocol.

With the development mechanism, tokens are generated using a predefined
mechanism and are only available for the development of the DA. For
example, in addition to its fund-raising mechanism, the Master Protocol
used the collaboration mechanism to fund its future development. An
additional 10% of the Mastercoins generated through fund-raising was set
aside for development of the Master Protocol. Those Mastercoins become
available through a pre-determined schedule and are distributed via a
community-driven bounty system where decisions are made based on the
proof-of-stake mechanism.

To summarize: Tokens of a DApp that establishes consensus through
proof-of-work are distributed by mining, by people buying directly from
miners and by trading for goods and services; that is the case with
Bitcoin. Tokens of a DApp that establishes consensus through
proof-of-stake are distributed based on the contribution of stakeholders
during a fundraiser, by people collaborating on the development of the
DApp and by trading for goods and services; that is the case with the
Master Protocol.

Formation & Development Of A Dapp

Development of decentralized applications takes place in three steps.

**Step 1: A whitepaper is published describing the DApp and its
features**

As in the case of Bitcoin, the most common way by which a DApp takes
form is by the public release of a whitepaper that describes the
protocol, its features, and its implementation. After the public
release, feedback from the community is necessary for the further
development of the DA.

**Step 2: Initial tokens are distributed**

If the DApp is using the mining mechanism to distribute its tokens, a
reference software program is released so that it can be used for
mining. In the case of Bitcoin, a reference software program was
released and the initial transaction block was created.

If the DApp is using the fund-raising mechanism, a wallet software
becomes available to the stakeholders of the DApp, so that they can
exchange the tokens of the DA. In the case of Mastercoin, an Exodus
fund-raising address and a wallet script were publicly released.

If the DApp is using the development mechanism, a bounty system is put
in place that allows the suggestion of tasks to be performed, the
tracking of the people who are working on those tasks and the criteria
by which bounties can be awarded.

**Step 3: The ownership stake of the DApp is spread**

As tokens from mining, fund-raising and collaboration are distributed to
a greater number of participants, the ownership of the DApp becomes less
and less centralized and participants that held a majority stake at
earlier have less and less control. As the DApp matures, participants
with more diverse skills are incentivized to make valuable
contributions, and the ownership of the DApp is distributed further.
Through market forces the tokens of a DApp are transferred to those who
value it the most. Those individuals then can contribute to the
development of the DApp in the areas that they have an expertise.

The case of Bitcoin illustrates the point. By some estimates, Satoshi
Nakamoto mined many of the first 1,000,000 bitcoins. As developers
contributed code to Bitcoin and miners contributed computational power
to the Bitcoin network, the market began to value bitcoins more highly.
As the system matured even more, people with diverse skills started
valuing Bitcoin and contributing to its development. Now that more than
12 million bitcoins are in circulation and Satoshi Nakamoto’s high
original ownership stake has been diluted.

Legal model for the operation of DApps
———————————————————

Operating under open-source licenses allows DApps to be open for
innovation without restrictions of copyright or patent. In addition, by
being completely open-source, decentralized applications can operate
under the legal model of open-source software. Bitcoin, for example,
uses the MIT open-source software license. The Master Protocol
similarly, requires all code that is based on it to be open-source and
available to the community.

Issuance and Holding of Tokens

From a technical perspective, those issuing tokens as part of a
crowd-sale are selling access to software for the users of that
software. The private keys associated with the tokens that the users
purchase are literally the passwords that the users need to access a
DApp’s software. From a tax perspective, those holding tokens are
holding digital property. If the tokens have no market value outside of
their use in the DApp, it is hard to determine their actual value.

Because very few jurisdictions have publicly given guidance on how
tokens issued by DApps will be treated from a regulatory and tax
perspective, legal expert in the particular jurisdictions should be
consulted.

Non-profit organization

There are no legal entities required for a DApp to operate because it is
not a company. Owners of tokens do not need to be represented by a
corporation and contributor do not need any specific legal entity
either. However, sometimes tokens are issued by a non-profit
organization that will never receive financial benefits from the DApp.
Such an organization will have the following responsibilities:

1. Issuance of initial tokens
2. Holding of developer tokens
3. Management of bounty payments
4. Determining the DApp direction

Ideally, the non-profit organization will make decisions in a
decentralized manner, using a “proof of stake” voting mechanism for any
decision.

Best practices for creating a Dapp and Frequently Asked Questions
————————————————————

What qualifies a software application as a DApp?

1. The application must be completely open-source, it must operate autonomously, with no entity controlling the majority of its tokens, and its data and records of operation must be cryptographically stored in a public, decentralized block chain.

2. The application must generate tokens according to a standard algorithm or set of criteria and possibly distribute some or all of its tokens at the beginning of its operation. These tokens must be necessary for the use of the application and any contribution from users should be rewarded by payment in the application’s tokens.

3. The application may adapt its protocol in response to proposed improvements and market feedback but all changes must be decided by majority consensus of its users.

What is a token?

The purpose of a token is to allow access to a computer application. For
example, an individual must own a number of bitcoins in order to be able
to perform any transaction on the Bitcoin network. Tokens in DApps do
not represent any underlying asset, they do not give rights to a
dividend, and no equity is represented through them. Although the value
of a DApp token may increase or decrease over time, tokens are not
equity securities.

How do tokens get distributed?

There are several ways by which the tokens of a DApp may be distributed:

1. Crowd-sale tokens: An initial one-time sale of tokens is a common way to initially fund a DApp. The funds raised from such a crowd-sale should be controlled by an entity that is independent of the founders, commonly a Foundation.

2. Developer tokens: A portion of the tokens can be set aside for developers working on the project. As the market sets a valuation for the project, the developer tokens will gain value, attracting additional contributors to the project.

3. Premined tokens: It is best if no tokens are premined because most communities and investors are negatively predisposed to it. A premine may be successful only if a meaningful reason is provided by the founders.

4. Minable tokens: Distribution of tokens by mining incentivizes the community to contribute resources to the DApp. In Bitcoin for example, there is a block reward every ten minutes, that incentivizes miners to provide hashing power to Bitcoin. Similarly, DApps need to determine how to incentivize the network to contribute the required resource as this is the most important decision about the token distribution.

How do I start developing a Dapp?

To develop a DApp it is advised to follow these steps:

1. Create a whitepaper that has at least the following sections: — Intentions and goals of the DApp — Plans for token distribution — Mechanism for establishing consensus — Structure of the non-profit that oversees the DApp — Management of developer bounties — Technical description of the DApp

2. Gain community engagement by releasing the plan and by revising it based on feedback.
3. Set a date when the community can contribute to the crowd-sale.
4. Sell the initial tokens based on your whitepaper and establish a non-profit to oversee the development of the DApp.
5. Begin executing your idea while the non-profit plans future development.

Why is a DApp a profitable model for developers, users and contributors?

The model allows contributors to get involved with the project as
purchasers of tokens, as project contributors or as providers of
resources to the network. All of these contributors benefit from the
exchange of the tokens and from the possible appreciation of their
value.

What is a user-behavior reward?

A user-behavior reward is given to contributors that provide utility to
the network. The whitepaper should outline what constitutes utility for
the DApp. (For example, hashing power is utility on the Bitcoin network
and it is rewarded.) Utility should be measurable, like in the case of a
data storage DApp, amount of storage is measurable.

The Current State of Type II and III Dapps
————————————————————

One mechanism by which type II DApps can leverage the block chain of
type I DApps is by embedding additional data to the transactions taking
place in the type I DA. The Master Protocol, for example, embeds
additional data on the transactions of the Bitcoin network. Although
currently (February 2014) Mastercoin embeds its additional data in an
ad-hoc way into the Bitcoin block chain, the release of the 0.9 version
of the Bitcoin reference client will provide a standard method for that
embedding. By using the methodology of “provably prune-able outputs,”
type II decentralized applications that are based on Bitcoin will be
able to embed data in a systematic way and Bitcoin miners will have the
option to prune those data.

Given this development, several type III DApps are in various stages of
development. They include:

- MaidSafe provides a “proof of resource” mechanism and decentralized data structure for storing files privately or publicly in the cloud.
- StorJ provides a front-end, Dropbox-like cloud storage of files utilizing MaidSafe and other systems in the back-end.
- Ethereum provides consensus-based scripting and computing resources.
- OpenGarden provides mesh network-based Internet services.
- Scalion provides an incentivized version of the Tor Network with nodes serving as Tor relays and exits.
- Shared Miles provides a proof of transportation mechanism that allows for an open source transportation standard.
- BlockAuth provides a multi signature OAuth-style system for sharing private data with third parties.
- API Protocol provides an open source standard for hosting, normalizing, and sharing API data.

Conclusion
—————

Dapps have the potential to become self-sustaining because they empower
their stakeholders to invest in the development of the Dapp. Because of
that, it is conceivable that Dapps for payments, data storage, bandwidth
and cloud computing may one day surpass the valuation of multinational
corporations like Visa, Dropbox, Comcast, and Amazon that are are
currently active in the space.

* * * * *

Appendix
————

### Resources for an economic model of DApps

- [A comparison between Metcalfe’s, Zipf’s and Bitcoin’s law](https://i.imgur.com/AWEfTjZ.jpg).

“In fact there is a strong correlation (R2 = 0.82) between number of users and price. All these things are not understood by too many people, unfortunately. Also the price doesn’t grow linearly with the number of users but instead with the power of 1.45 of the number of users. That is nice because for the price to increase 1000 times you need only 140 times the number of users of today. We have about 2 million BTC users.” <https://i.imgur.com/CiOxeBY.jpg>. Credit for images and quote [gsantostasi](http://www.reddit.com/r/Bitcoin/comments/21pujs/bitcoin_compared_with_metcalfes_and_zipfs_law/).

- [Correlation between the value of a DApp and Metcalfe’s Law](http://imgur.com/RDPz54G). Credit for image [Peter R](https://bitcointalk.org/index.php?topic=400235.msg5882283#msg5882283).

A proposed metaphor for Dapps

It would be beneficial to have a well-grounded and easily accessible
metaphor for Dapps. Such a metaphor would ideally have the virtue of
simplexity, so that it could be used for human-computer interfaces.

Such a metaphor could be a
[zygote](http://en.wikipedia.org/wiki/Zygote). A zygote is the point
where one biological cell generation ends and the next one begins. A
zygote acclimates, and it responds to the outside world without changing
its genes, it cannot be regulated, it is stuck with its own genes and
its recursive. The zygote is autonomous because it is stuck with its own
genes, it is an application because it is a cell, it is distributed, and
it is authorized to act as a single entity from other other cells; it
shares, in other words many of the characteristics of a decentralized
application.

Terms that could created out of the term zygote include *zyprotocol*,
the zygotic protocol, *zapp*, the zygotic application, *zen*, the
zygotic entity, and *zybit*, the zygotic bit.

Johnston’s Law

“Everything that can be decentralized, will be decentralized”.

David A. Johnston

Based on the economic and efficiency advantages of decentralized
applications its clear that existing centralized services will be
displaced over time by decentralized alternatives. This shift is likely
to come most quickly for services in which the network effect advantages
of Metcalfe’s Law are most critical to the success of the service
provider.

http://www.johnstonslaw.org/

More Links

1. [Facebook Group] https://www.facebook.com/groups/appcoins
2. TBD — other social channels / skype group (need an admin for the skype group to get contact requests)

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