The Blockchain Disruption, explained to a friend

The advent of blockchains is as revolutionary as the Internet itself — A first look at the economic consequences.

It’s January 3rd, 1995. Cookies have not been created yet. Websites are amnesic — they can’t recall who you are as you move from a webpage to another. Websites are dumb, too: Javascript is still in development at the University of Urbana-Champaign. And Websites are ugly, as, for many years to come, there are no CSSs. Many eureka moments are still to come, so much pain to relieve from users: waiting for pages to load, clicking refresh to try loading again, typing search that do not provide any useful result... Thank God for mIRC — though everyone is so weird!

Assume that you know what’s coming. You know that this Internet is the information highway of the future. Deep inside, you have a feeling that, in a decade or two, people will spend the majority of their day time using it — and that they will probably never disconnect again. Ever.

What would you do? Would you move to Silicon Valley? Would you put your money in Netscape? Would you dare? Or would you watch?

Today is January 3rd, 1995 again — for Blockchains. The word sounds gloomy and repulsive. “Are blocks obstacles? What is it with these chains? I don’t want to be chained!” Yet, what is coming at us will change everything that we do. It is fascinating and actually wonderful. Good things are hiding behind this bewildering new word.

Are you ready for the ride?

The Genius of Blockchains

Blockchains consist of permanent, distributed, digital ledgers, resistant to tampering and carried out collectively by thousands of servers. The network is open and participants do not need to know or trust each other to interact.

Blockchains significantly increase efficiency, cost-effectiveness, irreversibility, transparency, auditability and censorship resistance in transaction systems.

Blockchains enhanced system trust and security with several innovations:

• A Blockchain is a decentralized database — because blockchain’s data is copied across thousands of servers that coordinate the addition of data across the system, it is quasi impossible to tamper with the data, which makes it a source of truth.

Note: The electronic transactions can be automatically verified and recorded by the nodes (i.e. servers) of the network through cryptographic algorithms, without human intervention, central authority, point of control or third party (e.g. governments, banks, financial institutions or other organizations). Even if some nodes are unreliable, dishonest or malicious, the network is able to correctly verify the transactions and protect the ledger from tampering through a mathematical mechanism called proof-of-work, which makes human intervention or controlling authority unnecessary.

• A Blockchain’s code is open source — anyone can download the source code to verify that it does what it is meant to do, and suggest edits to the blockchain community for increased security or performance.
• Cryptography enables both privacy and verifiability — which is essential to count votes while keeping choices private, transferring money while keeping bank statements confidential, storing confidential information while enabling authorized persons to have partial access.

Note: This level of trust in verifiability, privacy and security did not exist before blockchains were invented, and computer science has a long history of trying to design systems with all of these attributes. The increase in server performance, the decrease in the cost of storing data, and the development of distributed databases by the open source community made it possible to design global systems that are coercion-resilient and performant. Cryptography was already well developed, so its implementation to these distributed databases created Blockchains.

In short, Blockchains are databases that make it possible to perform secure transactions on systems that everyone can trust.

Given the level of security they provide, Blockchains became over the last few years the best digital solution to transact not only assets (cryptocurrencies, digital assets, property rights), but also information (store and verify identity, build secure voting systems).

These abilities make Blockchains natural contenders to replace the majority of intermediation systems we use today. Furthermore, Blockchains become phenomenal competitors to all of today’s intermediation systems when we realize that, once built, blockchains do not require human intervention.

The economic efficiency of blockchains will disrupt major segments of today’s tertiary economy.

Disruption Theory

Clay Christensen’s Disruptive Innovation Theory is without a doubt the most important management framework since Porter’s Five Forces.

Christensen defines two types of disruptive innovations: Low-end disruption is based on gaining an enlarging market share through a lower cost base, whereas New-Market Disruption is based on creating a wholly new market.

Christensen’s theory is based on two types of Innovative Disruptions

The blockchain technology heralds significant disruption potential based on both types of disruptions, attacking at once several companies and industries we use and rely on every day.

Blockchain’s low-end disruption is about cost efficiency

The cost efficiency of Blockchain is obvious when we consider the fact that we don’t need anyone on a payroll to maintain a blockchain.

Blockchains already disrupt most foreign-transaction markets, starting with P2P remittance and going mainstream with wider adoption. Most cryptocurrencies are trying to disrupt the gigantic payment and transaction market, but let’s look beyond that for a moment.

When we look at the jobs that services companies perform in intermediation markets (insurance, banking, notaries, trading), most of these companies follow well defined processes (escrow, verification, execution) that ensure that the parties involved (reinsurance-insured, creditor-lender, buyer-seller) transact bona fide. All these jobs can be replaced by a blockchain.

While thousands of teams are now designing blockchain platforms that enable the easy deployment of a marketplace, disruption will take time. Platform design is the first layer that needs to be built, just as TCP/IP, HTTP, SMTP and hundreds of other protocols had to be developed before the internet started to have any use.

Nevertheless, we can already see a few applications emerge:

• Insurance: Aragon is developing smart contract platforms to enable insurance parties to transact (i.e. receive premiums, verify incidents with third parties and reimburse accordingly), and BitPark’s team believes they can do it P2P
• Lending: Salt is a loan platform that holds your crypto-assets (e.g. Bitcoins) in order to provide you with a loan, and you will have to pay interest on it
• Trade Finance: Populous is developing an autonomous factoring marketplace, where companies can trade their invoices for collection by others
• Gambling: FunFair develops virtual casinos where you have as much chance to win as the House
• Prediction markets: Augur and Gnosis develop prediction markets where anyone can bet on the occurrence of a future event, democratizing arbitrage and hedging options (I would have bet on Brexit, given how much I suffered from it)
• Escrows: Most cryptocurrencies also cover the option to have a transaction only if the counter-party is fulfillable and fulfilled (see “atomic swaps”), which cover most needs for a notary or an escrow (while the latter is in any case programmable with smart contract code)

Blockchains can perform most tasks banks, insurance companies and notaries do — and do it more efficiently.

Note: While we only see blockchains taking over small parts of what these service companies do, this is typical of all low-end innovative disruptions: it starts with a small market and keeps growing with a lower cost structure to take a larger and larger share, while the incumbents have to focus on the more complex / high performance markets.

Blockchain’s New-Market Disruption is related to digital services

The advent of digital assets and services provide the opportunity to use blockchain to create new marketplaces that we could not have imagined before:

• Computing, Storage and Bandwidth: Golem is developing a network / marketplace to pay for computing power: if you have a computing job to be done, you can pay for running the algorithm through a decentralized computing; and if you have a computer, you can rent it for money. Filecoin and Siacoin develop similar marketplaces for disk storage. Mysterium creates a marketplace for VPN, so you could rent your US connection to allow a person in China to get access Google (and they will pay you)
• Copyright, Advertising and Research: Steem developed a content monetization system for bloggers that reward them based on genuine interaction. BAT is building a similar marketplace for advertisers. It is easier to build a system that tracks micro-transactions for fair compensation of information creation, even in case where the use of the information created is complex. Luna DNA develops a marketplace where users can publish their DNA (securely and anonymously) and get paid by researchers for for responding to surveys
• IoT: IoTa develops a marketplace for everything related to internet-connected objects, starting with a car that has to pay for parking, or gets money for transporting someone

These disruptions will take time, but should not be overlooked, given how profoundly they will impact everything we do. Blockchain’s efficiency and ability to deal with complex marketplaces make it possible to create markets based on micro-payments but that incentivize most parties to coordinate and develop new business models.

Blockchains could disrupt and replace more organizations

Organization that are based on process actually create value based on an algorithm. As an operations manager at Uber, I used to perform a new task to solve a problem, design a process to delegate the task, then automatize the whole process to do it with code. All tasks that follow a process could be decomposed into an algorithm involving various parties. Blockchains can replicate any such algorithm with code, servers and external data sources (see “oracles”).

Decentralized autonomous organizations (see DAO for a first attempt in 2016) are capable to execute tasks without human involvement, for which the blockchain can provide additional functionality, most importantly the checks and balances and complex incentive structures to replicate the interactions between several agents occurring in any organization.

Given the level of transparency, auditability and efficiency of DAOs, several teams are trying to build blockchain based organization that could challenge the global corporations that have too much influence today. If we look at the tech sector, this power is related to strong network effects, either based on data or on an established marketplace. Here are a few ideas that are discussed in the blockchain sphere:

• Rebuilding Facebook — The social media giant’s stronghold is the social graph. Facebook knows who our friends are, and that data is key to enable virality (and growth) for any other app. Creating a blockchain with social relations data would give the power back to the users, and empower new startups to create apps based on our connections
• Challenging Google — The search giant’s stronghold is user behavior data. Google knows what links you click on, which pages you spend time reading, and what is important to you and each person on internet. Chrome tracks all of these activities today, in addition to Google Analytics’ trackers. Given that new browsers are being developed to handle micro-payments with digital currencies (see Toshi or Brave), there is an opportunity to replicate such data on a blockchain with a currency that transfers value from the users of such data (search algorithms and advertisers) to whoever generates the data while browsing (internet users)
• Opening AI — Google is also designing the strongest AI algorithms based on user data. Given that Machine Learning requires a lot of data, it would make sense to have the user data needed to train AI algorithms trade on a public ledger and pay back users who create the data, rather than only compensating the shareholders of a large ‘cap. Most importantly, opening the access to user data for smaller companies to try new AI algorithms is essential to promote innovation (see Ocean Protocol)
• Replacing Marketplaces — Amazon’s stronghold is customer’s belief that they are the cheapest, fastest and most reliable shopping marketplace. This marketplace will be challenged by a blockchain that connects directly sellers, buyers and logistic companies with systems of reviews, without the need for Amazon’s cut. Similarly, it is possible to replicate all of Uber’s operations through an efficient all-digital solution that connects drivers (or driverless cars) with riders (and any additional stakeholder, e.g. restaurants, couriers) through a transparent, auditable blockchain based system (see INS World)

Blockchains were designed to bring power back to the currency holders. It worked, and unleashed the potential to do the same for the customers of the largest corporations in the world. Google, Facebook, Amazon, Uber and the like are phenomenal corporations that do a lot of good in the world, but there are serious concerns about their dominant positions. The teams working on blockchain technologies find new ways to replicate their strength through algorithms that do not require employees or capital. Algorithms for the people.

Beyond market considerations, the blockchain could also replace large parts of government. That’s where the Blockchain Revolution starts. That’s the subject of my next post.

In the meantime, I recommend reading previous posts on Bitcoin and Cryptocurrency Investing if you haven’t done so already.

Disclaimer: This is (obviously) not investment advice, and I may hold positions in some of the currencies mentioned in this article.