Blockchains in a Competitive World

Costs and competitive alternatives will determine whether decentralized distributed ledgers have applications beyond cryptocurrencies. If blockchains want to provide mass-market applications, cloud services are the real competition.

Image by Rachel Skiba

This is a guest post by Professor Joshua Gans of Rotman School of Management, University of Toronto, and Professor Neil Gandal, Berglass School of Economics, Tel Aviv University, contributing advisors to the Orbs project.


The hype surrounding the Blockchain goes something like this: “Yes, Bitcoin and cryptocurrencies may be the latest reincarnation of the ‘Dutch Tulips.’ The Blockchain on the other hand, is a revolutionary technology that will change the world as we know it.”

Halaburda (2018) throws some cold water into the mix. As she writes, “a careful look into the technology finds that most of the proposed benefits of so called blockchain technologies do not really come from elements unique to blockchain. Instead, they come from more conventional elements such as encryption and smart contracts. Moreover, even those applications that would benefit from a distributed system may benefit more from a distributed database designed differently than blockchain.”

Halaburda points out that the new aspect of the Bitcoin blockchain is that it is a public, permissionless, distributed ledger that “cryptographically” insures incentive compatibility without the need for a trusted third party. However, to the “neutral” observer, permissionless is a feature rather than a goal. Moreover, features have to be evaluated based on cost-benefit analysis.

Ultimately, permissionless decentralized blockchains will have to compete with other “technologies.” In the realm of payment systems, the competition is centralized players like Visa, Master card, and PayPal. If blockchains want to provide mass-market applications, cloud services are the real competition.

A key aspect of competition is cost. Decentralized blockchains are costly to run, since incentive compatibility requires high payments for transactions — and scalability is not easy. Hence, it is not clear that the lower costs associated with decentralization (if there are lower costs) will overcome the high transaction fees and the difficulty of scalability.

Halaburda concludes that while new encryption tools and smart contracts have clear benefits, decentralized distributed ledgers may have a limited appeal. After all, benefits from smart contracts and encryption tools can be realized with traditional databases.

One promising area for decentralized blockchains is land registry. This is, in part, because, unlike mass- market applications, scalability is not needed for such an application. However, even here, the competition from government run centralized platforms with traditional databases need to be accounted for.

In the end, costs and competitive alternatives will determine whether decentralized distributed ledgers have applications beyond cryptocurrencies like Bitcoin.

References

Halaburda, Hanna: Blockchain Revolution Without the Blockchain, Bank of Canada Staff Analytical Note 2018–5, revised: 21 Sep 2018’ available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3133313