The Blockchain Protocol: Peer-to-Peer Financial Management Towards Equality

April 27, 2016

While the public may be unaware of the fragility of the of the internet — the reality of that statement must be realized. The physical infrastructure and backbone of the internet is a scattering of varying pieces of hardware — a jerry-rigged contraption. Internet “[i]nfrastructures encompass hardware and software, spectacular installations and imperceptible processes “ (Parks, 5). The blockchain falls under imperceptible process. This is not a new physical infrastructure so much as it is an innovative use of the existing hodge-podge of nodes.

As a look into the future of the internet, these ideas stems from my previous thesis which argued that implementation of a widespread communicative protocol such as TCP/IP provided a foundation for diverse development from the edges. Distributed development is critical to fighting inequality.

As a strong believer in free markets I am an advocate of free trade. In the way that science and technology can be affected by inequalities in society, so too can the exchange of value — financial privilege self-propagates. The widely circulated Bitcoin PDF explains how to dis-intermediate the financial system; this paper attempts to explain why.

Investigation into disintermediation within the context of network philosophy will show why disintermediation that occurred during the dot-com boom did not affect all actors equally. An anthropological perspective on the network of food production and consumption will be used to investigate the implications of centralized banks on society.

Why finance? Currency is everything — it is an exchange of value that allows trade. One can think of it as an unbiased medium that allows exchange of energy between users. A trade must be equal value for equal value for neither party to come out as a superior.

Disintermediation & Network Philosophy

We want to think about what disintermediation meant during the dot-com boom; more importantly we must think about what it did not mean. In this transition

period, less reliance was placed on distributors of physical goods because the vendors did not need to rely on intermediaries to distribute their product and take a cut. Vendors could maximize their returns by interacting directly with their consumers through a website — a store on the internet. This can benefit both parties if the savings are passed on to the consumer. Vendors can continue to undercut each other and consumer savings on transactions rise. Here the vendor’s returns are maintained while the consumer realizes an even lower loss on their value store. There are an equal volume of payments still occurring from the consumer base whether or not the payments are being made in person or online. In person a consumer may be able to choose to pay with physical money or with a credit/debit card. Online consumers are relegated to credit/debit cards and bank transfers. Disintermediation of product distribution meant a rising volume of transactions at financial intermediaries. While the product can now be shipped directly from the vendor to the consumer, the payment must always pass through a financial institution.

As intermediaries to every transaction, banks continue to prosper. Not only do these actors maintain their value store, their value stores continue to grow as long as trade occurs through their channels. These institutions take on responsibility for their involvement in transactions and therefore take a fee. These types of processes allow the institutions to continue to grow, profiting on the volume and value of transactions. Individuals who have access to bank accounts and credit can use this capital to continue to grow their own worth. The future of the internet is a continued journey of decentralization towards equality. The rise of peer-to-peer networking to allow transactions without institutions demonstrates how all nodes can act as consumers and vendors while the network as a whole provides the services of the financial intermediary.

A network of interaction that relies on certain nodes for distribution is always at the mercy of those central nodes. This is bad from an access perspective that is based on vulnerability. Central nodes are responsible for external nodes and therefore find themselves gaining power over time.

Paul Baran’s network visualizations will help us better unpack the idea of decentralized vs. distributed interactions.

The current financial exchange pattern is a decentralized system. Money flows from an edge node (a consumer) to another edge node (a vendor) that both rely on a central node (a trusted financial institution) to carry out the transaction

Jared Diamond, in his essay “The Worst Mistake in the History of the Human Race”, bemoans the inequality that was created by systemization and centralization of food production and distribution. The rise of agriculture makes food more accessible for the public and the systemization allows ease of mass production for the farmer but the result is a public that relies on easy access to food and a farmer class that must focus on high carbohydrate foods in order to feed the growing and increasingly expectant public.

We have now a distinction of creators and consumers of energy. Every transaction is an exchange of energy. One can imagine that in a hunter gather society the individuals must live in a sustainable manner. When a gatherer climbs a tree to get a fruit he is expending energy to acquire some in a different form. Sugar is a source of energy. When a farmer plows a field, she is expending energy to grow some in another form — probably an energy dense carbohydrate like potatoes. When a consumer buys that potato he is using currency to pay the farmer for the energy she expended. Through systemization the farmer will recognize a higher yield margin than the gatherer. There exists a class of society that relies on this distribution node.

Both the consumer and the vendor are sacrificing quality for quantity. The vendor is doing so to maximize returns, the consumer is doing so to minimize loss. While these seem similar, they are philosophically distinct. The vendor’s maximization of return and consumer’s minimization of loss creates a dynamic where the vendor’s value store is constantly benefitting and the consumer’s value store is constantly deteriorating.

Not only does this situation encourage inequality to prosper, it creates vulnerabilities in the network at that node. Reliance on this margin puts the power and responsibility in the hands of the farmer. Diamond points to the Irish potato famine of the 1840s during which hundreds of thousands were affected by starvation.

A look at the health and societal effects of the rise agriculture shows a loss in resiliency and a rise of inequality after the demise of hunter gather societies. Hunter gather societies can be thought of as individual nodes that operate within the network of the planet while agricultural distribution systems use farms to draw from the network of the planet and disperse results to non-involved external nodes.

Farming trades quantity for quality as conditions dictate that societies must mass- produce food to sustain their growing size. This momentum creates a false belief that we must rely on mass farming — Diamond notes that in a study of modern hunter gather groups, individuals still receive the sufficient daily nutrition.

Currency acts an unbiased exchange of value — think about it as an exchange of energy. The current way that we exchange currency does not result in a fair trade of energy — system operators are benefitting from the continuation of the system.

Blockchain Protocol

In his 2009 paper, Satoshi Nakamoto suggests a new peer-to-peer banking system that utilizes CPU power to maintain integrity of the ledger rather than relying on a societal institution. Nakamoto’s system relies on distributed ledger called the blockchain — a string of blocks where each block represents a transaction. The chronological order of transactions is critical to address the double spending problem. The vendor who receives the first check should be the vendor that is allowed to cash the check. Nodes on this network are computers that act as witness to each transaction and record each block in their own copy of the ledger. A new node can be added to the network and will take on the longest existing ledger. This node now owns a full history of the blockchain and represents a valid ledger. Nodes can be taken off the network and added back. As long as the majority of nodes on the network hold a copy of the ledger, the integrity of the ledger can never be questioned.

The cons of trust based financial institutions include impossibility of non-reversible transactions, mediation between institutions, and minimum viable transaction size. Nakamoto cites these underlying issues as responsible for more friction between vendors and consumers due to the worry of double spending and the required acceptance of the possibility of fraud. Naturally physical currency avoids this issue due to the physical exchange of a value store vehicle but these transactions still cannot occur over a communications network without a trusted third party to handle the possibility of fraud on both sides. These institutions serve to protect their clients, but must charge fees for their verification and disputes with other trusted sources (Nakamoto, 1).

The Bitcoin paper describes the main issue that it attempts to address in order to overcome the need for a trusted third party is the double spending problem — a case where an individual writes a check to two vendors, the first vendor to cash it will be paid by the bank but the second vendor’s check will bounce.

In Bitcoin world, every transaction that is made is written to the blockchain that is hosted on a number of nodes and can be viewed publicly from any computer. The transaction is simply the increasing of one account numbers balance and the decreasing of another account number’s balance.

This addition and subtraction happens instantly and simultaneously in every copy of the distributed ledger. If another transaction is made, the account number can be queried — by anyone including the recipient. Open history of account transactions allows easy auditability. The double spending problem is now solved.

This does not require new physical infrastructure so much as a different way of using the infrastructure. Keeping all network nodes on the blockchain allows the network to serve as the trusted institution. Through everyone’s slight individual sacrifice of resources (so far as keeping an updated record of the ledger) — a trustless system can be created where no piece of currency can be spent twice.

The double spending problem is solved by a P2P network that works in unison to hash the transactions into a time stamped chain (Nakamoto, 1). This hashing process is a high-level computing process that ensures security. A human who completed the hashing process (known as the SHA-256 Algorithm) by hand required 16 hours to complete the transaction. I mention this to highlight the intensity of the computing required to verify a transaction within this network.

Nakamoto notes the longest existing “chain of hash-based proof-of-work” will serve as the basis for new nodes to begin working within the network. In this way we can think of the network as one big accounting system. Rather than using one computer to crunch numbers, we use their processing power in unison to co-author the shared ledger; one computer from many. The blockchain protocol frees external nodes from needing to rely on central nodes for financial management and transactions; reliance is now upon the network.

Each device that is connected to the internet should be able to allocate space to this simple ledger of value distribution. Each device can act as a distributary node giving information about all the values of all accounts on the network. Using computer in a communistic way maximizes our ability as humans to act in a democratic way. On a level this seems obvious, use unbiased machines to manage unbiased exchange of value.

Rather than storing the ledger in a hidden place where only a select few can read it and validate it’s integrity, the ledger is open to the public and is held at each node. Any node that attempts fraud by suggesting an invalid exchange is then denied because the chronology of the blockchain is maintained.

Utilizing the combined computing power of all computers on the network, accounting can be performed at a high level and fraud can be ousted. In order to override the entire P2P network, there would need to be a majority of computers that were proposing the same fraudulent blockchain history while also authoring present blocks to outpace the network. The computational power required to do this is unrealistic.

This protocol creates a communicative foundation to support physical hardware development in any way. This network is further decentralized and provides a platform for more nodes to join easily and act as more than consumers.

Social Implications

I wish to assert that reliance on institutions to manage our individual value stores works negatively on society in two main ways. These views are supported by a variety of insights into trade and value exchange as well as philosophy about network utilization. Institutional banks both propagate inequality and create vulnerabilities in the exchange network.

Financial planning, while it might seem an obvious concept, is not diffused. Individuals are encouraged by society to rely on institutions to manage their financial wellbeing. In a world of energy exchange held up by unbiased currency, knowledge of how to manage said currency can empower individuals to take responsibility for their freedom to trade with anyone.

Free trade is not truly free if large institutions maintain a hold on the capital within the market. Trade is still locked into the channels that it flows through. Funds are held at a number of centralized location — the big, trusted banks. Funds are then taken from an account in one of these banks and transferred to an account at another one. The only thing that’s changing is the value stored on both account numbers, yet both end users must bear the cost of supporting the existence of the banks.

Some under banked populations in developing countries cannot even take advantage of the trade that flows through large institutions. Accounts at banks cost too much and relegate would-be global consumers to their local markets where their currency is liquid and will be accepted for goods. A single global cryptocurrency such a Bitcoin could alleviate these unequal accesses to external vendors. Rather than relying on a bank to perform the transfer of funds, the communication of information over the existing infrastructure would give everybody with an internet connection true access to the global economy. Trade between any consumer and any vendor no longer needs to be facilitated by a centralized financial institution. Consumers no longer need to bear the burden of supporting these institutions.

The future of the internet is peer to peer rather than relying on centralized, trusted distributors. The blockchain and the financial system is a good example of how this process will occur because financial transactions must be secure and the current process of their distribution creates inequality. Rather relying on a centralized mint or our current financial paradigm of a few “decentralized” big banks, the blockchain protocol uses a P2P network to process financial transactions between any two parties. Big banks act as a select class of distributary nodes who enjoy elite status due to the external nodes reliance on their existence. The rise of a P2P network will undermine currently centralized nodes who profit by taking advantage of external nodes. In the financial system this exists in the form of managing and transaction fees.

External nodes must rely on the elite class of nodes to handle mediation between transactions. External nodes bear the cost of these processes and personnel at the elite nodes benefit from the continued reliance on their services as overseers and auditors.

Implementation of the blockchain protocol and forcing users to sacrifice a portion of their computational power in order to ensure fair exchanges can occur will lead to freer trade and growth for the network as whole. Using computers in a communistic way maximizes our ability as humans to act in a democratic way.

Works Cited

Baran, Paul. (1964, August). On Distributed Communications.

Diamond, Jared. (1999, May 1). The Worst Mistake in the History of the Human Race. Discover: Science for the Curious.

Greenstein, Shane. (2015). How the Internet Became Commercial: Innovation, Privatization, and the Birth of a New Network. Princeton University Press.

Hargittai, E., & Hsieh, P. (2013). Digital Inequality. In W. H. Dutton (Author), Oxford Handbook of Internet Studies (pp. 129–150). Oxford University Press.

Nakamoto, Satoshi. (2009). Bitcoin: A Peer-to-Peer Electronic Cash System.

Parks, Lisa, & Starosielski, Nicole. (2015). Signal Traffic: Critical Studies of Media Infrastrucutre. Urbana, IL: University of Illinois Press.