Three Elements to Understanding Blockchain & Its Greatest Opportunity
Over the past two years, we have seen the ground-swell of exuberance at the possibilities of blockchain technology from ensuring our food safety, employing self-governed global digital identities, to decentralized virtual governments. But with numerous initial coin offering (ICO) scams, millions of dollars stolen from cryptocurrency exchanges, and lack of widespread adoption of pretty much anything blockchain-based except for possibly Bitcoin itself, our hopes for application of this new technology seem to have been eroded.
While I don’t believe blockchain will solve every personal, social and business challenge to come, I do believe that blockchain technology presents a tremendous opportunity to contribute advancements to the next generation of the internet and to society as a whole. If we think of blockchain technology more like a teen-ager going thru growing pains, giving it a little more time to mature, getting to know its capabilities, and thinking a bit outside the box, we will have a better foundation to identifying where it might be best leveraged, recognizing where it may have significant positive impacts, and imagining uses we haven’t even conceived of just yet.
Blockchain can be an overwhelming technology to process, but by conceptually understanding three central blockchain capabilities, Consensus, Gamification, & Openness, we can more easily grasp what makes this technology tick and where it might best apply for existing and future applications. To get some perspective of these three elements let’s take a brief step back at what prompted the development of blockchain in the first place.
Almost a decade ago, on September 18, 2008, the headlines of the Wall Street Journal were as follows: “Worst Crisis Since ’30s, With No End Yet in Sight”
The US had just gone thru a financial meltdown as a result of the subprime mortgage crisis, causing the collapse of several large US and European investment firms and banks.
Three months later the following email was sent by a Satoshi Nakamoto to a group of cryptography developers.
Subject: Bitcoin v0.1 released
Announcing the first release of Bitcoin, a new electronic cash system that uses a peer-to-peer network to prevent double-spending. It’s completely decentralized with no server or central authority.
The full list of emails from Satoshi can be found here.
At its essence the Bitcoin network is based on what we now call blockchain technology. A blockchain is a distributed application that consists of a ledger or database of transactions and possesses the ability to perform exchanges of value directly between two or more parties on its network. Blockchain technologies have the unique capability to verify account ownership, confirm balances and store the results of the transaction without the need of an intermediary or central source like a bank or financial institution. The creator, or possibly creators, of Bitcoin sought to remove the dependencies we have on centralized organizations today to execute these kinds of activities. Examples of centralized organizations are national reserves, central trading exchanges and investment banks. Typically we have limited control of these types of institutions and limited visibility into their overall governance. The stability of these systems is primarily based on three things: internal controls, regulation, and external trust. To enact regulations we generally establish oversight groups to monitor the activities of these types of institutions and organizations. Example regulatory entities are the Federal Reserve Board (FRB), The Federal Deposit Insurance Corporation (FDIC), and the Securities Exchange Commission (SEC).
Bitcoin was an attempt to create a system of exchange that incorporated transparent oversight within its own processes. It is the implementation of consensus, gamification, and openness that make this possible. While you may not understand every underlying technical detail behind each of these, the following explanations should help you better understand impacts to variations of their implementations.
1) Consensus
In everyday life we deal with transactions. We use GooglePay to purchase a cup of coffee, a public transit card to ride the train to work. We receive the title of a vehicle after paying off its loan. In all of these cases we are relying on one or more central authorities to verify ownership and balance of an account or asset, and the parties involved to comply with terms set forth by the business representing the product or service. For example, after paying for something with a credit card or online check, the service provider knows whether we have the money to pay for it because according to my bank’s central ledger we have the money to pay for it.
But when paying a bill in the decentralized world of blockchain, the service provider knows we have the money to pay it because enough participants on the blockchain agree we have the money to pay it. The idea of getting a majority of people to agree on the ownership and balance of an asset is called consensus, and consensus is a major component of every blockchain. Rather than making any one organization the authority of my account balance, blockchain technology distributes that authority to individuals. It does this by replicating copies of the entire transactional database (or ledger) to every individual who is running a blockchain node (server) on the network. Using an algorithm built into the blockchain software, each node uses the same process to verify account ownership and account balances. Similar to establishing an email account and password, individuals can create blockchain accounts or wallets. Transactions are related to an account based on their their sender and receiver, similar to sending or receiving email. By looking at all the messages or transactions sent and received for a particular address, we can then determine the balances of any asset. Like passwords, individuals have private keys for their wallets, and only the owner of that key can control how their assets are spent. Assets can be be bitcoin, concert tickets, gold, oil, or even digital kittens.
Blockchain also uses cryptography to create tamper-proof transactions. Every transaction and every block are run through a one-way calculation known as a hash, which takes a set of predefined inputs (e.g. the current date and time, the hash of the previous block of transactions, and the content of the transaction itself), and then outputs a single unique string of a specified length and format.
Here’s an example of a 32bit 64 character hash:
00000000000000001e8d6829a8a21adc5d38d0a473b144b6765798e61f98bd1d
If someone were to attempt to modify a transaction, e.g. changing it from I received 5 BTC to I received 500 BTC, the hash result would change and would no longer match everyone else’s hash for this transaction, thus making it invalid.
Consensus is also used to prevent someone from spending the same coins twice, i.e. for two different transactions. Doing so is known as double-spend, and solving the double-spend problem of electronic currency is one of Bitcoins greatest accomplishments.
Because blockchain enables individuals to verify transactions without knowing or needing to trust each other, transacting on a blockchain is often referred to as trustless. Some blockchain consensus protocols even allow for verification of balances without knowledge of the actual balances themselves. This is known as a zero knowledge proof. Eventually, when enough nodes making up at least 51% of the blockchain’s computing power verify a block of transactions, the block is considered officially on the blockchain and a record of truth.
Consensus among nodes is also required if someone wants to make a change to the rules of the blockchain itself. If someone were to control of 51% of a blockchain’s computing power, they could essentially make the rules and give themselves all of the coins. This is why the more nodes in a public blockchain network, the stronger the network.
In the Bitcoin blockchain for example, it would require more than 250 times Google’s current CPU capacity to take over 51% of the Bitcoin blockchain. The bitcoin blockchain network is growing at approximately 35 Googles per month. This ensures the difficulty for any one group to take control.
As of this writing, the Ethereum blockchain has more than 16,000 nodes across the globe and is growing at a rate of approximately 10% per month. Not only does network size fend off massive takeovers, it also makes the system extremely fault tolerant. If, for whatever reason, several blockchain nodes were wiped out, we’d still have thousands more to keep the system running.
But having consensus is not enough. There also needs to be enough incentive for someone to spend the time and resources to set up and support a node. This is why gamification is the next most important concept behind blockchain technology.
2) Gamification
While a major contributor to the collapse of the US financial markets in 2008 was the desire to accumulate wealth, this is actually a central component to the stability of blockchain.
Anyone can set up a node for any public blockchain on their own personal equipment and begin verifying transactions. Blockchain consensus processing is successful because through gamification, individuals compete to earn rewards for doing the work that helps keep the network running and adds to the overall value of the community.
The process by which a node performs work, verifies and adds transactions to the a blockchain is called mining. Miners compete to get small fees for verifying transactions, and earn even a larger reward for being the first to package up a unique set of transactions into a block (a Bitcoin block is 1MB) and put that block onto the network. This is known as a block reward.
To pay for these rewards each blockchain has its own currency or cryptocurrency and generally most blockchains are named after their currency. E.g. the Bitcoin, Ethereum, and Neo blockchains.
Individuals or things that initiate transactions generally pay the transaction fees, whereas a block reward is paid by the blockchain itself by minting new coins or tokens. This approach can vary based on the rules of the particular blockchain.
To earn a block-reward some blockchains like the Bitcoin blockchain require that each node generate a large random number, like a lottery, that must fall within a very small range. And that range keeps getting smaller and smaller until all coins have been minted. This requires significant computation or work to be the first to succeed (aka Proof of Work), thus, forcing the networking to continually get stronger and keep pace with the volume of transactions and ensure your node uses the latest technology. Other blockchains require nodes to have a significant stake in the system over a certain period of time to process a block (aka Proof of Stake). Having more stake and seniority enables you to perform more verification processing and earn more fees. Proof of stake ensures nodes operate in the best interest of the network but use much less CPU and energy.
A Bitcoin block reward (12.5 BTC) at the time of this writing is worth about $100,000 and an Ethereum reward (5 ETH) about $3000. Bitcoins will have a finite amount minted with the reward amount gradually decreasing over time. Eventually the reward will go to zero at which time miners will solely depend on transaction fees. In fact, eighty percent of all BTC has already been produced, but Ethereum on the other hand has no production limits. At this time there are approximately 97M ETH.
When any of these rules are updated, the chain forks into a new chain of transactionsruled by the new logic. New rules are considered a new currency. This is why there is a bitcoin gold (BTG) and bitcoin cash (BCH), all variants of the original bitcoin (BTC). Each currency represents a different set of governance for a different purpose. One might be for faster processing. Another might be for more efficient storage of transactions. And another might be for lower fees. The supply of each currency is regulated by very specific and transparent rules, and as previously mentioned, any changes to these rules require node consensus.
By now your head may be spinning from all these rules, but imagine having a network finally in place to perform a set of business or social processes with a specific model of fees, rewards, and benefits, and then without warning the rules are changed and benefits removed. Deciding who can participate and who has the right to change the rule of governance is the third element of blockchain. It is this level of openness that has the potential for the most impact on how we will interact in the digital world of the future.
3) Openness
Public participation and examination has long been a staple of American culture, and is a basis for our democracy. It has also been especially ingrained in the idea of the internet.
The Linux operating system itself, which runs 67% of the worlds web servers and more than 80% of the worlds mobile phones, was based on open collaboration of hundreds of software developers. The group which managed Linux , the Free Software Foundation established in 1985, used a free and open source licensing model. Created in 2001, Wikipedia is another example based on the idea of open collaboration and cooperation to create a trustful set of universal knowledge. Wikipedia with more than 38 million articles in 250 different languages is considered the world’s largest single repository of human knowledge.
With the concept of implementing decentralized organizations governed by open-source software, The DAO crowdfunded $150M in June of 2016. Built on similar blockchain technology as the Bitcoin blockchain, The DAO was technically a government of sorts, whose rules and enforcement were strictly based on the concepts of transparency, logic, cryptography and mathematics. It was to be a system completely auditable to the public rather than a cloaked set of processes potentially influenced by a limited group of individuals.
Logic could be executed in a space that was publicly available for examination so that governments, social networks, property exchanges and financial transactions could be built upon agreements that anyone could create and that would self-execute upon specific mutually agreed upon conditions. e.g. Sell 50 widgets or more and receive 15% commission otherwise receive 10% sales commission.
Despite an initial failure of The DAO due to an exploited vulnerability, repairs were eventually made to prevent the issue from happening again and the new version of the DAO became the Ethereum (ETH) blockchain network we know today.
While Bitcoin was primarily designed to make payments, Ethereum was designed to run decentralized programs or smart contracts. Anyone has the ability to examine the code/logic behind a smart contract on the Ethereum blockchain. Smart contracts can be leveraged for tracking the title to your property, overseeing a gambling wager, or for creating an energy sharing neighborhood smart grid.
Like the internet itself, public blockchains generally have foundations that help oversee or coordinate significant changes, but are essentially run independently of any one person, government or organization. Anyone can access and use public blockchains like Ethereum, Bitcoin, NEO, or NEM.
In the same way a private company may have a private LAN or private client portal, there are in fact ways to create private or membership-based blockchains. These are also known as permissioned-ledgers. Because the players in a private blockchain are already trusted, they generally do not require the same amount of processing as a public blockchain to authenticate and verify transactions, and thus operate much faster. Also, unlike public blockchains, private and semi-private blockchains do not requires 51% consensus for any changes to their logic.
Private blockchains have the potential to make significant improvements in many common business areas like supply chain, accounting and international currency exchange. However, while private and semi-private blockchains may have a performance advantage over public blockchain, it could be argued that these benefits are weakened by the fact that a limited group of individuals can make decisions regarding their governance.
Recognizing a need for both public and private blockchain services, Disney has been quietly developing what we might expect to see from blockchain platforms during the next decade. DragonChain (DRGN) is a blockchain development platform that provides five different blockchain implementations from fully public to fully private, each combining variations of consensus, gamification and openness.
As the need for central authorities is not expected to disappear in the foreseeable future, we can expect to see a proliferation of both public and private decentralized services that can be executed and orchestrated in harmony with centralized services. For example, online services we use today could be written that leverage or offload specific tasks to blockchains to perform services such as proof of ownership, payment, asset exchange, transaction history maintenance, and automated enforcement of contracts. With increased concern over the handling of our personal data, blockchain will also begin to take a central part in ensuring our data is used as promised. Once this foundation of decentralized service becomes more commonplace, I believe the real opportunity of blockchain is where its emphasis is on public use and accessibility.
Looking back to the first large-scale US market crash of 1929 and the 1930’s depression that followed it, two initiatives under the leadership of President Franklin Delano Roosevelt, deserve some credit for helping to get the US stabilized and back on its feet. The first initiative was the creation of new oversight groups like the 1934 Security Exchange Commission (SEC) which helped ensure more business transparency and limited the amount of risk that could be taken by organizations like central trading exchanges, investment banks, brokers and advisors. The second initiative was the implementation of a job works program known as the New Deal. The New Deal resulted in the creation of the Civilian Conservation Corp, Tennessee Valley Authority, and the Works Program Administration (WPA).
The WPA alone was responsible for creating more than 8 million jobs. These programs not only created the nation’s highways, airports, bridges, and extended our railroad systems, they were also responsible for scientific projects like building astromoical observatories, providing work for artisan labor, and even employing thousands of musicians for orchestras, music education, and festivals. At a time of significant racial inequality, a major factor of the WPA’s success was due to its inclusiveness.
Consensus + Gamification + Openness = Opportunity
Do the ideas of transparency, incorporating a level of governance, and public participation sound familiar? The New Deal was funded by the government, but now imagine globally funded public works in which anyone could participate as an investor, a worker, or even as an observer for quality control. According to the World Bank, 48% of the worlds population is bankless, 55% of those are women, and more than 40% indicated the reason was lack of funds. With the aid of blockchain oversight capabilities and the opportunity for open public participation, there is good reason to believe that the next generation of online services could leverage the same principles of success creating economic opportunity on a global level.
In addition to representing a digital or physical asset, the combination of a blockchain’s consensus method, gamification approach, and level of openness can represent the right to use a service, the right to perform work for that service, the reputation of someone or something performing that service, or a combination of all of these.
This representation of currency as an asset, work, usage, or reward, is called tokenization. While the lines between token types can blur and one token can perform multiple functions (aka a hybrid token), you can generally think of tokens as falling into five general types of categories.
Some blockchains like Bitcoin only create and verify transactions. In addition to being a digital asset token, Bitcoin can also be considered a usage token because it gives you the right to participate in the network. Some tokens simply represent a physical asset like Digix (DGD) which represents a portion of a unique bar of gold bullion. A token is considered fungible when there is no difference between one token and another like a Bitcoin, but can also be non-fungible, representing something that is unique like a collectable baseball card or a Cryptokitty.
A work token like Livepeer’s LPT is earned by nodes when performing distributed video streaming. Filecoin nodes earn work tokens when performing distributed storage management, and Gems nodes can oversee the completion and payment of humans performing microtasks like sorting or labeling images. This approach could also be extended to performing physical analog tasks as well like building bridges or teaching an art course.
The last type of token is a reputation or reward token. A reward token represents a score, gauge or reward for a person’s or thing’s performance. Steemit for examples rewards content contributors with STEEM based on views and likes of their work. Augur rewards participants with Reputation (REP) for making accurate predictions of sports, political, or financial events as well as verifying the results of an event. Livepeer uses and rewards the crowd to monitor the quality and performance of nodes that provide streaming capabilities.
Putting all these concepts together, we could create a purely public peer-to-peer rideshare service. Using asset tokens, We could enable participants to sell equity in their vehicles. Using work tokens we could enable them to rent their vehicles to drivers. Riders could then pay for rides with utility tokens. Using smart contracts we could perform rider and driver fee calculations, reward good drivers and loyal riders with reward tokens, and finally calculate and distribute profit and or dividends to all equity owners on a quarterly basis.
Note that from a regulatory standpoint, the SEC considers tokens falling into only two classes, utility tokens and security tokens. A token is considered a utility if it’s purchased to perform some type of work or service. Utility tokens are not regulated by the SEC. A token is considered a security if it’s intentionally purchased with the expectation of some kind of return like a dividend, profit sharing, or expected increase in value. For this reason, even tokens that appear to be utility, may be classified by the SEC as as security.
Summary
Despite current technical and usability challenges, blockchain technology will likely mature over the next decade to become an integral part of our technical landscape, not only aiding in the efficiency of tasks like proof of ownership, payment, asset exchange, transaction history maintenance, and automated enforcement of contracts, but also has the potential to ensure greater transparency and improved governance over larger centralized organizations like financial institutions, exchanges, and online services.
And although not a cure-all for every digital ailment, blockchain technology does present the possibility for new and intriguing capabilities for us to interact within a safer, secure and more inclusive digital world. We know from history, that the idea of inclusivity can have far reaching positive effects to communities and nations. With a better understanding of how consensus, gamification and openness, play a part in blockchain technology, we can start to imagine, implement, and participate in services that open up entirely new economic opportunities both on a local and global scale. What are your big ideas?
If you are interested in learning more about decentralized and personal data privacy technologies, feel free to connect with me at OneMe.io.
