Bitcoin, Ethereum, Tokens and ICOs — disrupting the internet
If ever there was one constant theme in the history of information technology, it is the battle between open networks and closed networks. This theme as played out in every wave of information technology.
Telephone: Independents versus AT&T
Radio: Hobbyists versus NBC
Television: Independent cable channels versus the networks
For about 2 decades, internet seemed to have avoided this fate, thanks in large part due to its internet’s “neutral” design (more on this when we talk about net neutrality another day). But, with the rise of iOS, Android on our smartphones and the dominance of Google search and Facebook, the internet is no longer open and decentralized.
In the race to find the next foundational technology after the AI wave, all the incumbents are very keen to get us ready for augmented reality and virtual reality wave. That makes sense and they will likely succeed in the short term. Their financial might gives them tremendous leverage in ensuring we make a seamless transition to mixed reality on their platforms and devices.
However, a potential ground breaking technology is conspicuous by its absence in the likes o conferences like F8 and WWDC — the Blockchain. It is worth understanding why.
Let’s take a moment to revisit the innovation behind the blockchain.
A blockchain is simply a decentralized network with information. The innovation here is in the word “decentralized” — the blockhain has made it possible for us to have a centralized database of information that is not owned by any organization.
Instead, blockchains are really sitting on the computers of many, many computers on the internet (whose owners are called “miners”).
This is a ground breaking innovation as this was never possible till the blockchain came about. This is thanks to a now iconic paper by a still mysterious Satoshi Nakamoto. This innovation is significant because owning the data in that centralized database is what has given the likes of Facebook its awe inspiring power.
But, before we get to why today’s giants don’t talk about the blockchain, let’s first understand the news around Bitcoin, Ethereum and “Initial Coin Offerings.”
Bitcoin, very simply, allows you store value on the Bitcoin blockchain. Bitcoin allows us to store information on how much value each account on the Bitcoin blockchain has and keep it synced across the Blockchain. Bitcoin’s value has surged in the past few months. Some of the surge was explained by Japan’s decision to treat Bitcoin like any other currency. Some of it might be explained by a rush to find a new store of value given the high global uncertainty of late.
But, the surge is definitely unusual and unnatural.
This has caused all sorts of issues around Bitcoin’s blockchain as the network hasn’t yet proved itself capable of handling this scale. For example, a transaction right now takes hours to get confirmed.
So, these scalabilities issues have been at the heart of arguments around Bitcoin in recent years. The programmers who maintain the network can’t agree on the best way to solve them and there is a sizeable section calling for a “fork” or the creation of a new blockchain that is designed for scalability.
That context about issues around Bitcoin sets the scene for Ethereum. While still in his teens, a Russian programmer called Vitalik Buterin was an early Bitcoin adopter, developer and writer. Having experienced the issues around the Bitcoin blockchain first hand, he decided to build a new blockchain called Ethereum with Ether, its own cryptocurrency.
So, what is Ethereum? Ethereum enables you to store value (à la Bitcoin) but also add “smart contracts.” Smart contracts enable us to add conditions around sending value, for example. Or, put differently, it is programmable digital money.
This isn’t the easiest concept to grok. So, here’s a table that will help (HT Linda Xie, Coinbase).
So, how would you use Ethereum?
Here’s an example from Linda’s post — imagine you are buying a home from another person. Traditionally, there are multiple third parties involved in the exchange including lawyers and escrow agents which makes the process unnecessarily slow and expensive. With Ethereum, a piece of code could automatically transfer the home ownership to the buyer and the funds to the seller after a deal is agreed upon without needing a third party to execute on their behalf.
Most major technology companies today play the middle-firm in these transactions. Think AirBnB, Uber, eBay, Facebook, Twitter, et al. We’ve always had middle-firms. The internet, however, made it possible to cut intermediaries and go via just one central firm. For example -
But, decentralization potentially means removing any middle-firms and enabling service providers and users to transact with each other with no intermediaries.
Ethereum has numerous use cases — here is an interesting list based on current experiments from Deloitte university press.
This is a long list and I’m definitely still just beginning to grasp smart contract applications.
Okay, I kind of get this. But, what is all this noise about tokens and initial coin offerings?
Each blockchain is a network. We’ve so far talked about two networks — the Bitcoin blockchain and the Ethereum blockchain. As you can tell, both these networks exist to do different things. The Bitcoin blockchain is a store of value while Ethereum is all about smart contracts (that can also double as a store of value).
But, there will be other legitimate reasons to create blockchain based networks. In the past, however, building a network based business has proven really hard. Would you bet on taking on Amazon, Facebook and Google — giants by every way you want to measure success?
This problem is called the “bootstrap” problem — networks only become useful after using a critical mass of users. And, it gets harder and harder to reach the critical mass once you have massive incumbent networks.
Tokens and ICOs change this game.
An ICO is a sale of crypto tokens.
Imagine you want to start a new coin — ABCoin. You believe ABCoin is going to be great and worth $100M someday. You can now decide to do an “initial coin offering” or ICO to sell 10% of these coins. The buyers of the new offering pay up Bitcoins to get these tokens worth $10M in the hope of future return (much like the stock market). These tokens can be traded but don’t confer ownership rights.
You now use $10M to fund the project and make ABCoins great again — while still maintaining ownership. But, now, you have $90M left. What do you do? As Chris Dixon masterfully summarizes — A well-designed token network carefully manages the distribution of tokens across all five groups of network participants (users, core developers, third-party developers, investors, service providers) to maximize the growth of the network.
So, what you might do is design systems that do the following -
- Pay your core developers and employees
- Rewards miners with tokens for mining
- Reward third-party developers for awesome applications they build on your network
- Return some money to your investors
- Pay all service providers who help you maintain this network
Most of these payments will decrease over time. So, early adopters get disproportionate value for taking the risk. And, assuming you are successful, the value of your token keeps increasing.
So, crypto tokens are an elegant way to solve the bootstrap problem (again, HT: Chris Dixon)
In the early stage, they ensure early adopters can fund the growth of the network. And, over time, the power of network effects kicks in.
The Token Bubble?
All of this has led to what many think is the token bubble. But, before we look at that. Let’s consider the innovations tokens have made possible. In a fantastic post, Balaji Srinivasan and Naval Ravikant lay out a few of the breakthroughs -
- Tokens are an alternative to equity fund raising. As detailed above, ABCoin could just raise money with an ICO.
- They are a non-dilutive alternative — i.e. no ownership stake
- They can be bought by anyone (and aren’t limited to “accredited investors” / rich folk and have no borders)
- As a creator, they enable you to cash out immediately.
- They enable a business model that aligns incentives across various participants in a network. Currently, only the few individuals who created the network reap rewards.
- Future technology executives will be more like Bill Gates than John Sculley — as understanding this world requires both willingness and ability to dig into technical details
All that said, it is hard to avoid the feeling that we’re likely in a bubble.
Additionally, there’s reason to believe that the blockchain might just be the equivalent to “Linux” (which powers Android and, thus, most of the internet — but is non commercial) versus this being a replacement to the internet in itself. The argument here — why would you use a blockchain based file storage system when you are happy with Dropbox?
But, playing devil’s advocate to that, there’s plenty of reasons to be optimistic. Chat app Kik (a Whatsapp competitor) is launching its own crypto currency called “Kin” and will likely do an ICO. This is a significant move as Kik brings its own massive network to this versus starting from scratch. Kik has 300M registered users but has struggled fighting Whatsapp and Facebook. So, this move feels like a bet-the-business move and make sense.
So, where does all of this lead us?
There are 2 ways to interpret what is going on here -
- What we’re seeing right now is a bubble. And, we’ll see the bubble burst because people have incorrectly assumed that the blockchain is going to replace the internet instead of simply being the infrastructure that powers it (i.e. the linux analogy)
- What we’re seeing is likely a bubble but, if that is the case, this is just the beginning of highs and lows before we build a blockchain based internet that is designed around decentralization.
It’s funny how writing forces you to clarify your thinking. For years, I read about blockchains and believed in the linux analogy. But, writing about the blockchain and technology in general has led me to believe that we’re likely heading toward a blockchain based internet. I think we’re still a decade away from that happening. But, I feel it is on its way.
Option 1, i.e. blockchains powering the internet, is already happening. Governments around the world are experimenting with blockchain technology to maintain centralized registries. Sweden is testing a land registry, Dubai wants distributed ledgers to power the government by 2020 and Georgia has already moved its land registry to the blockchain. When you have governments among your early adopters, you know you are onto something.
There are still problems to be solved (primarily around scalability) before we can look at an internet built on the blockchain. I think it is helpful to think about how the internet grew (as in the graph below — H/T Ben Evans, a16z). It was a long while before we experienced “mainstream internet.”
Crypto currencies are likely in the pre-1995 phase. The reason they’re mainstream is because technology waves build on each other.
So, the best way to put this in perspective is to treat this as a period of experimentation. We are experimenting with decentralized systems in a world that has been built around centralized groups (nations, companies). There are going to be plenty of highs and lows in the coming years.
Or, as The Economist eloquently summarizes this view around what we’re seeing with ICOs —
The best comparison may be with the internet and the dotcom boom it created in the late 1990s. Like the internet, cryptocurrencies both embody innovation and give rise to more of it. They are experiments in themselves of how to maintain a public database (the “blockchain”) without anybody in particular, a bank, say, being in charge.
If there is such a thing as a healthy bubble, this is it. To be sure, regulators should watch out that cryptocurrencies do not become even more of a conduit for criminal activity, such as drug dealing. But they should think twice before coming down hard, particularly on ICOs. Being too spiky would not just prick a bubble, but also prevent a lot of the useful innovation that is likely to come about at the same time.
Links for additional reading
- Chris Dixon on Crypto Tokens (a must read) — Medium
- An introduction to Ethereum by Linda Xie — Coinbase
- What are ICOs — The Economist
- Balaji Srinivasan and Naval Ravikant on Tokens — Medium
- Bitcoin boom — is this like the Tulip bubble? — The Economist
- Governments backing the blockchain — The Economist
- Blockchains are the new Linux — Techcrunch
- Ethereum use cases — Deloitte university press
- Ethereum market map by Jordan Odinsky — Medium
- Ethereum in 25 minutes by Vitalik Buterin — YouTube
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