THE DEATH OF PAPER

By Steve Waterhouse,

Partner, Pantera Capital

I spent a few days in Moscow recently. On the way in, I found that Aeroflot had mislaid my bag. I, in turn, had mislaid my baggage claim ticket. In broken English and zero Russian, the Aeroflot associate and myself traded strong words until, finally, my bag reappeared alone on the conveyer belt.

I was struck at the time how a single piece of paper could hold the key to all of my belongings. Shortly after this I was back in San Francisco and handed the keys of my car to a valet in exchange for a small piece of paper with a number on it. “Hang on”, I thought. I just gave away my car for a small piece of purple paper. Once again, I was struck by the absurdity of how we willingly trust valuable possessions to people who we have no reason to trust in return for a disposable piece of paper. Add to this absurdity: my personal issue (that I’m sure many people suffer) in which if you give me a piece of paper, it will be lost within minutes. You may begin to see why I have become very focused on an idea I call “The Death of Paper”.

I imagine a different world, which will be upon us very soon, in which instead of representing ownership of physical objects using paper we represent them digitally. Instead of accepting a ticket from a valet, perhaps you will receive a digital representation of your car from your phone and assign the valet temporary rights to drive and store your car for a set period of time.

I believe in the near future all these pieces of paper which represent ownership of items and rights will be represented as digital certificates and accessed conveniently from our smartphones. The certificate will bind the identity of the item, your identity, and the identity of the person you are trusting with the item — whether it is Aeroflot or the car valet company. I also believe that the way will we achieve this evolution is through the Blockchain.

The Blockchain is a new kind of database. It is “write-only” (you can’t change entries, only add new ones). Encryption and computing power secure the database, as opposed to risky 3rd-parties, promises and flimsy paper. For this reason the Blockchain is the ideal solution for storing permanent records, such as authenticity certificates, land title, stock ownership and many more applications.

Bitcoin and the Blockchain

Bitcoin shot to fame and notoriety in 2013 and 2014 as a result of a meteoric rise in price and salacious news reports of hacking, sketchy use cases, and a libertarian dream to change reserve currencies and government.

In the years since I began working in this space, I have witnessed a dramatic change in use and sentiment around this technology. Now the headlines I read are about major venture firms investing in companies and large financial institutions adopting the technology behind Bitcoin known as “Blockchain”.

What’s going on here? We’ve gone from being sometimes ridiculed for being exclusively focused on Blockchain to now having the likes of Goldman Sacks and NYSE invest in Blockchain companies, and having Citibank, BBVA, and Nasdaq announce initiatives in the Blockchain space.

The Blockchain

The Blockchain solves a problem in computer science known as the Byzantine General’s problem. Simply put, in a network of nodes (participants of the network) in which any node can publish something that has a truth-value, how do you know which nodes are trustworthy and who to trust? Some nodes may be faulty, some may be malicious.

The Blockchain solves this conundrum by forcing each node in the network to solve a hard problem. The first node to solve the problem earns the right to publish the transaction in the network and all other nodes verify that the solution to the problem is correct and then update the global ledger of information.

For the first time in history, the Blockchain enables the secure exchange of value between two entities without the need for a third party. The network inherently ensures that counterparty risk is eliminated.

The most straightforward application of the Blockchain to date has been simple numerical value transfer, i.e., bitcoin. However, bitcoin is only the first application of this powerful solution.

Blockchain Eats Paper

The Blockchain will be the framework by which all paper records and contracts will be stored updated and exchanged.

The advantages of the Blockchain for securing records of ownership in a digital framework are as follows:

1. Independence:

The Blockchain is a distributed peer-to-peer network with no central point of control, unlike many modern network architectures. This design improves the scalability of the system and protects it from failures of a single node (single point of failure). It also provides the ability for an organization to offer transparency and enjoy new standards of efficiency.

2. Security:

Nodes in the Blockchain network earn the right to enter a transaction into the ledger by solving a hard computational problem. Over the last 7 years of growth of the Bitcoin network, the difficulty of those problems has increased significantly to a point where custom, highly expensive “ASIC” chips are required to solve them. The combined power of the processors in the Bitcoin network is now greater than the world’s largest supercomputers combined, albeit for solving a very specific problem.

Because of this design, the Blockchain ledger is inherently secure and immune from tampering or adjustment. This security means that the network is unquestionably trustworthy. Contrast this with a centralized design, in which a single entity runs a ledger database. The entity would be subject to scrutiny because of its ability to adjust the database for its own gain, or be vulnerable to hackers, who could penetrate the network and adjust the ledger for their gain or some other malicious intent.

3. Transparency:

In the basic Blockchain architecture, any node in the Blockchain network can observe the entire ledger, which contains all transactions that have ever been made. Although new designs, such as ZCoin, are pointing towards more heavily encrypted transactions, the default architecture promotes an unprecedented level of transparency relative to traditional databases, ledgers, and networks.

Examples

Today almost everything we transact has paper associated with some aspect of it including:

1. House title

2. Collectibles e.g. Rolex authenticity papers

3. Stock transfer.

Each of these paper-based transactions will become fully digital and the Blockchain will be the digital platform that is used to track them. Selling a watch or a house will be as easy as clicking a button on your smart phone with greater efficiency and certainty than more traditional methods.

Papering a Deal

The phrase “papering a deal” refers to the process of converting a business agreement into a legal framework which finalizes the deal.

The back offices of financial institutions are some of the most antiquated environments from a technology perspective. While the hard-core cutting-edge technology is reserved for the high frequency trading engines, back office workers still must use faxes to clear trillions of dollars of trades a day. In fact it is estimated that in the syndicated loans business alone, over 25 million faxes are sent a year in the U.S.

Since Goldman Sachs invested in the company Circle in early 2015, there has been a series of announcements of large financial institutions investing in Blockchain technologies. Chain recently revealed major financing from VISA, Capital One, Citibank, Nasdaq, and others.

What are all these major financial institutions doing with Blockchain? The answer lies in the complexity of the back office of these institutions. Every deal that is inked — whether it is a corporate stock issuance or a syndicated debt deal — has a series of contracts that underpin it, and a team of lawyers and administrative staff ensuring that the contract reflects the deal correctly. There is a massive opportunity in financial services to streamline and automate these manual processes.

Perhaps the most widespread and disruptive change brought on by blockchain technology will be the digitization of paper contracts. Contract terms will be encoded as statements in a scalable distributed database secured by the computational power of the Blockchain mining network. APIs and the imminent Internet-of-Things will automate the carrying out of these contracts, checking environmental data to see if contract conditions have been met.

Art, Collectibles, and Provenance

In many commercial transactions, verifying the authenticity and provenance of an item is very important. For example, in the art world, great care is taken to establish authenticity. The street artist Banksy has his own art sales agency called “Pest Control”, which ensures that he receives a piece of every secondary market transaction by informing buyers that if they buy or sell any Banksy work outside of Pest Control, they will never be able to buy an original Banksy.

The art world has long debated the issue of artists not receiving compensation for their work in the secondary market. While Banksy has implemented his own “walled garden” approach, California and EU law makers have enacted legislation which codifies this intention (the “California Resale Royalty Act” and “Directive 2001/84/EC”, respectively). These acts have no teeth, however, since there is currently no way to track the sales of art between private parties, no central registry of art ownership, and therefore no reliable basis with which to enforce the laws.

The Blockchain fixes this problem by enabling digital provenance to be recorded in a decentralized registry which is free from corruption or manipulation. Various companies including Verisart, founded by Robert Norton, a renowned figure in the art world, are working on this problem. Our portfolio company Chronicled is providing a provenance solution along these lines for luxury sneakers and other consumer goods. Another incredible example of this is being implemented by a company called Everledger in London. Everledger has recorded 830,000 diamonds on the Blockchain, promising to reduce or eliminate the billions of dollars worth of fraud that afflicts the diamond industry.

Everywhere we look Blockchain solutions are being used to replace paper solutions for recording and transferring ownership of property. We envisage the entire world of commercial transactions moving to a world of “digital commerce” where all ownership records and transfer records will move to the Blockchain, bringing greater security, clarity and certainty to the innumerable transactions and rights that arise every day.

About the author

Steve Waterhouse is a Partner at Pantera Capital, a investment firm exclusively focused on Blockchain technology and its applications. For more information: http://panteracapital.com.

Steve holds a PhD in Engineering from Cambridge University. He is an experienced entrepreneur and investor.

http://linkedin.com/phoenix1

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