Smart Contracts Enable “Cellular” Complexity
In the previous part of ‘On the Origin of Blockchains’, I described Bitcoin as appearing from the “primordial soup” because it was a convergence of technologies that had previously existed. The genius of Satoshi Nakamoto was bringing all of these constitutive blockchain elements (genes) together to solve the double spend problem without the need for a trusted authority or central server.
In this fifth part of ‘On the Origin of Blockchains’, I will delve further into biology and the genesis of life in order to make some striking comparisons with the evolution of blockchain and the role of smart contracts.
noun — A piece of code housed within the blockchain intended to digitally facilitate, verify, or enforce the negotiation or performance of a contract without 3rd parties.
The incorporation of smart contracts into blockchain networks brought with it a new level of complexity.
In a manner analogous to the progression of prokaryotes into complex eukaryotes during evolution, the emergence of smart contract platforms facilitate a level of complexity that was not possible with first generation blockchains such as Bitcoin.
Bitcoin’s emergence from the “primordial soup” is similar to the genesis of life on our planet, when bacteria (prokaryotic life forms) emerged approximately 3.5 billion years ago. They existed in relative peace for around a billion years, until the evolution of a new form of life referred to as a eukaryote.
noun — a microscopic single-celled organism which has neither a distinct nucleus with a membrane nor other specialised organelles, including the bacteria and cyanobacteria.
noun — an organism consisting of a cell or cells in which the genetic material is DNA in the form of chromosomes contained within a distinct nucleus. Eukaryotes include all living organisms other than the bacteria and archaea.
The origin of the eukaryotic cell is a milestone in the evolution of life as it allowed for the existence of complex cells and multi-cellular organisms. The emergence of smart contract platforms had a similar effect in the blockchain world insofar as it facilitated a level of complexity not possible with first generation blockchains.
Next generation blockchains permit additional functionality compared to their first generation counterparts. Smart contracts are more easily deployed and with more potential variability on next generation blockchains than those that can be executed on relatively simple blockchain protocols, such as Bitcoin.
Consequently, the emergence of smart contract platforms allows for the colonisation of other fundamental niches beyond the niche of money.
Smart Contract Platforms
The emergence of a nucleus to house the DNA in a eukaryote was key to facilitating complexity. It contains almost all of the organism’s genetic material and permits easy coordination between genes without interference from other intracellular components.
The nucleus was the first example of a cellular organelle. In addition to a nucleus, eukaryotic cells contain a variety of other membrane-enclosed organelles within their cytoplasm. These organelles provide compartments in which different metabolic activities are localised.
noun — any of a number of organised or specialised structures within a living eukaryotic cell.
In nature, the genome is localised to a specific part of the cell. In smart contract platforms, there is a centralised DNA in so far as all protocols built on top of smart contract platforms sit within the same execution space.
This means they can freely interact and interoperate, which is not possible with blockchains of different species. At least, not yet.
Ethereum was the first true smart contract platform, launched in July 2015. Its development team positioned it as a “World Computer” and it sat as a base layer protocol upon which second layer protocols could be deployed. Its native cryptoasset, known as Ether (ETH), is used as payment to prosecute the business logic contained within smart contracts and as a reward for miners to include those operations within the blockchain.
Second layer protocols are effectively smart contracts that offer extensibility to the base protocol. However, this means that any individual who wants to interact with a second layer protocol or smart contract must, by definition, also interact with the base layer protocol.
Primary vs. Secondary Metabolites
As described in part three of ‘On the Origin of Blockchains’, “metabolites” (cryptoassets) are the awards for participating in the incentive mechanism that is encoded in every blockchain protocol.
The base layer awards cryptoassets for activities such as mining or validation or any other activity that is fundamental to the survival of the host. I shall refer to these as Primary Metabolites.
Earlier in this piece, I described how organelles provide compartments in which different metabolic activities are localised. Similarly, second layer protocols also have incentive mechanisms which award other forms of cryptoassets to those participating in their respective networks.
They therefore also perform their own metabolic activity and produce their own metabolites, or cryptoassets, which I shall refer to as Secondary Metabolites.
It should be noted that these cryptoassets require the host organism. They can have their own value but they are reliant upon the primary metabolites to function - this is considered ‘platform risk’.
Value Creation and Value Capture
This biological analogy is particularly useful in outlining two fundamental mechanisms that underpin Joel Monégro’s seminal 2016 thought piece, Fat Protocols.
Joel argued that value created by second layer protocols would trickle down to the base layer and more importantly that “the market cap of the [base] protocol always grows faster than the combined value of the applications built on top, since the success of the application layer drives further speculation at the [base] protocol layer”.
The first mechanism is network rent. Each “organelle” (second layer protocol) must pay rent to the host network (the base layer protocol) in order to prosecute its smart contracts on its host’s blockchain.
The second mechanism is network synergy. The more “organelles” that exist, the more functionality the network has and the more attractive it appears as an investment opportunity. Thus, more “organelles” sit atop of the base layer and more synergy is created.
As a result, ETH is getting locked up to be used as collateral in a whole host of different decentralised financial instruments, creating a velocity sink for the cryptoasset. This is analogous to a feed forward loop, which is an incredibly important “motif” for encouraging stimulation in network biology¹.
The “gas” that second layer protocols must pay to the base layer to prosecute smart contract logic is analogous to a commodity, similar to oil in the real world. In the same way that currencies and commodities power the real world economy, cryptocurrencies and cryptocommodities will power the digital economy.
With the birth of decentralised applications (DApps), a market for these commodities will emerge. The commodities will be traded and subject to the market forces of supply and demand.
Cryptocommodities differ to cryptocurrencies in that they are consumable assets that power the digital economy. This influences which genes (blockchain elements) are most suitable for which species (network).
The most important cryptocommodities are:
Second layer protocols (most DApps) will need to pay rent (in gas) to the base layer on which they reside to prosecute their smart contracts and store their “state”. Different base protocols allow colonisation of niches according to which properties of the blockchain trilemma (security, scalability and decentralisation) they address.
The blockchain movement is about taking back control of your data in the age of surveillance capitalism. Users will be able to control who has read and write access to their encrypted data and how counterparties are allowed to use it, enabling new models of data monetisation
More complex computation will be conducted “off chain” when it is too expensive for the data to be included within the blockchain. A DApp would not want to rely on centralised services (e.g. AWS) otherwise what is the point in being decentralised? This “fog” computing is crowd sourced.
Other distributed ledger technologies (DLTs) may have much higher throughput than their more decentralised counterparts. This will enable them (and their second layers) to capture different fundamental niches especially those requiring higher transactional throughput or less network security.
Informing ID Theory’s Investment Themes
Next generation blockchains have emerged with advanced smart contract functionality. Second layer protocols (organelles) can be built on top of them, each targeting specific fundamental niches and potentially creating great value.
However, I have argued that base layer cryptoassets will accrue a proportion of this value from a fee based economy for organelles to live within the host. Additionally, base layer cryptoassets will benefit from the synergy generated between all organelles within them.
Firstly, innovation and advancements in technological capacity should increase cumulatively and continually. Secondly, the network will grow naturally when value accrues to its cryptoasset and vice versa. Thirdly, different base layers are preferred hosts to target particular niches according to scalability, security and decentralisation. Moreover, protocol-specific developer activity is a barometer of advancement and is easily tracked with open source software.
Beyond the gas for smart contract prosecution, there are other necessary consumable cryptoassets that provide network participants with decentralised possibilities, including storage, computing power and bandwidth. Because these commodities are consumables, it can be argued that Proof of Stake consensus mechanisms are preferable over Proof of Work mechanisms more suited to cryptocurrencies.
Continuing ‘On the Origin of Blockchains’
Having explained how fundamental niches can be filled by decentralised blockchain networks and how Bitcoin has performed this role within the store of value space for money, in this piece I delved into how next generation blockchains can address other niches.
In the sixth part of ‘On the Origin of Blockchains’, I will investigate a third key area of blockchain evolution and investment potential — specialisation in second layer protocols.
 Structure and function of the feed-forward loop network motif, S. Mangan and U. Alon, PNAS October 14, 2003 100 (21) 11980–11985
ID Theory may hold positions in some of the assets discussed in this post. This post is strictly for informational and educational purposes only and does not in any way constitute an offer or solicitation of an offer to buy or sell any investment or cryptoassets discussed herein. Always perform your own research and conduct independent due diligence prior to making any investment decisions.