Around Technology: Blockchain
Why SmartContract’s might be the future of finance?
Nowadays, everybody, from a Wall Street broker to your corner baker knows what a cryptocurrency is. The word has been spreading about the fortune some people have made by betting on cryptocurrencies, since the surge of Bitcoin’s price in 2014. Since then, the industry has evolved rapidly; myriad of different currencies are now available, more and more people are investing, and private companies are eyeing the usage of the cryptography in their business processes. Who knows, maybe the next sponsor of such technology might be governmental or institutional. To comprehend how such enthusiasm is possible, it is important to understand the underlying technology.
Cryptography is defined as the method of encrypting a process in such a way that no one else but the accredited parties have access to it. In a nutshell, it is the art of hiding something from someone. Do you remember the round wooden box Tom hanks tries to solve in The Da Vinci Code (2016)? It recalls one of the oldest cryptographic techniques know to date, the cipher. Over the ages, the cryptographic techniques have evolved to guard secrets, as was Enigma. The Nazi machinery used that technology to transmit orders from the Reich around the world. Although both encryption techniques have been cracked to unveil their deepest secrets, the newest version of the cryptography, blockchain encoding, is theoretically, and as far as experience has shown, unbreakable.
The blockchain encryption method used two essential cryptographic operations to achieve its secrecy goal: the hashes and the keys. Without going into too much detail, a hash is the footprint of a dataset.
Whenever, a new data point is inserted, changed, or removed the hash changes. It means that a combination is per essence unique. Moreover, the complexity and the number of possible iterations, already increasingly high with a 20-digit-and-letter combination, is complemented by another classifying number “the 72608”. Thereby, the number of combinations is close to infinite.
The above explanation represents a block. The blockchain encryption, as its name reveals, is an aggregation of multiple blocks, each linked to the previous one with the precedent hash. As explained previously, the hash represents the unique, unforgeable, footprint of a dataset. When multiple blocks are aligned to create a chain, each previous hash influences the following hash.
An important feature, which is still to explain, is the mining process of a block. The mining allows the block to be “solved” and then accepted in the chain. The solving of a block depends on a pre-stated, arbitrary definition of the solution. It can be four zero, as it could be your birthdate at the beginning. Anyway, only a solved block grants access to the further block to be mined. Indeed, a useable and readable blockchain is only composed of solved blocks, with unique hashes.
Here comes the magic. For a block to be accepted as genuine, its hash is compared to other mined and solved blocks from the accredited parties. In the case of Bitcoin, whose chain is around 680’000 blocks long, it is compared to the multitude of users who have mined the same chain. Due to the uniqueness of a hash and the concatenation of many to obtain the chain, it is easy enough to check if a chain has been altered. In the case of modification in the chain, the hash would therefore not match the previous ones and the chain would thereby be discarded. This process hence ensures the authenticity of the chain at any point in time. That is the fundamental “distributivity” component of blockchain.
Now that the concept of blockchain has been vulgarized, it is essential to understand what can be composed in the datasets. It can be an grocery list, a mathematical model, or an algorithm. In the case of smart contract, it would be automated transactions, under the form of a code. You may wonder what the utility of automated transaction is. The essence of our capitalist systems reposes on the fact that nothing is free. Therefore, at any time when someone is involved in something, that person has the right to claim a compensation, most of the time under the monetary form. You might now have a hint of its utility, let me help you further. Since each person involved in the process is requesting a share of the pie, but nobody wants to see their share shrink, the pie must expand, and so does its price. For instance, the price you pay for the milk you pour in your cereal is not the same if you buy it from the grocery store or directly from the farmer because of the intermediary. Therefore, smart contracts could enable you to override the intermediary and consequently decrease the price of the traded good.
Nonetheless, let’s not forget the essential component of the cryptography, secrecy. If you do not want people to know what brand of milk you buy, it would be better not to leave your name on the record of the transaction. Here comes the second component of blockchain: the keys. In order to preserve secrecy and removing the name of a customer, the developers have imagined two types of keys, a private key and a public key. The public key which is disclosed to the rest of the world on the records, is associated with a private key, which only the owner knows. Thereby, the anonymity of the transactors is preserved.
Smart contracts, by the medium of cryptocurrencies, are therefore ensuring the uniqueness of a transaction, assuring the anonymity of its users, and as a result offering the opportunity to shorten and simplify the supply chain. But why has it not been broadly adopted, yet?
Although the place of cryptocurrency in society is rapidly growing, reaching a market capitalisation of $2.15 Tn dollar (in 2021) compared to $200 Bn in 2018, the crypto market is considered unstable for three reasons. First and foremost, there are a tremendous number of cryptocurrencies on the market. On the report of Statista there are about 6,000 types of tokens available in 2021 and the number grows by the minute. The main concern with that diversity is their siloed usage. None of the currencies are tradeable directly against another and they are globally not yet usable at scale. They lack interoperability.
Second, these tokens are often limited in number, which by following the simple principle of supply and demand, makes them scarce, thus, expensive. As the world has seen, the bitcoin came from $1 valuation to more than $54,000 in 2019. The simple explanation is that the less there are, the more they are worth for people that want it. Yet, the issue with that principle is that the currencies are by extension not scalable, since as more incumbents enter the market, the more it costs to maintain and operate each of them.
Finally, the ecosystem of cryptocurrencies is not yet sustainable. Here sustainability does not refer to the environmental issues, which will be discussed later, but to the possibility to be prosper over time. The underpinnings for that unsustainability are twofold: The governance and the funding issues. So far the direction of these currencies is unclear, nobody knows how to trade them and use them beyond the sake of immediate return on a lucky day. The upgrades of each system are not coherent to the overall ecosystem and therefore it lacks the long-term perspective. On the other hand, the cryptocurrency development is most likely supported by private investors. Although the freedom of concurrence is praiseworthy, nobody is yet willing to invest billions of dollars in the refinement of the evolution of the practice and consequently hinders the research and development process of the technology.
Nonetheless, the cause is far from lost. The cryptocurrency world has attracted and continues attracting great minds, amongst them many Nobel Prizes and smart individuals, who try hard to palliate the aforementioned issues. Many companies are emerging with solutions, expecting to breakthrough in the next years, and some have already started. For instance, the Ethereum 2.0, planned for use in 2022, with ambition to solve the throughput issue and optimize the resource consumption. Cardona, which is aiming to bring all the cryptocurrencies under the same umbrella, and provide easy-of-access smart contracts, and its rival Solana are few examples of the innovations coming.
The effervescence of the crypto world is indeed fascinating, albeit frightening. It represents one of the biggest disruptions in human history and according to the pioneers and innovators of today, it might change the way we envision financial institutions. Despite the fast-paced evolution of the practice, which has seen gigantic changes over the last decades, the role of government and major institutions should not be undermined. The creation of central banks and regulatory organs originally emerged to protect the financial world from extreme volatility and insecurity, which are common in the cryptocurrency world. Therefore, although a shift in social norm, demonstrating the inclination of the population to play with cryptocurrencies, is perceptible, the future lies in the hand of governments and major financial actors.
Despite the general reticence of governments, there is one that has stamped history on Thursday September 9th, El Salvador accepted Bitcoin as a legal tender. With this tremendous change, the inhabitants will now be able to purchase any goods with the cryptocurrency. The decision was made to eliminate the huge fees applied by intermediaries when El Salvadorian workers, living aboard, send money back home to their family living in the territory. To favour the usage of bitcoin, the country massively invested in the financial system modernization on top of the direct investments of $25 million in the currency. Although that amount would not be sufficient to lower the volatility of the currency, it demonstrates the ambition of El Salvador to act as a pioneer in the crypto currency world. Moreover, Panama is also considering the introduction of cryptocurrencies in its legal and financial framework. Unquestionably, the change is happening and its consequences on the users are yet to be seen but as the currencies enter the governmental scope, so might the smart contracts.
Nonetheless, our world is facing the consequences of our irresponsible behaviour and that of our ancestors and the environmental crisis is hard to deny. Therefore, it would be essential to assess the real implication of blockchain mining and the continuous creation of tokens on the environment. However, that component goes beyond my field of knowledge.
My personal opinion is that we should stay aware of the changes that are about to revolutionize our world, in the financial domain as well as in other innovation projects, for example energy or telecom, but without losing the sense of reality and that planet we live on which has limited resources.
Embrace the future by respecting the future.