Four Fundamental Reasons There Is More To Crypto Than Its Price: Part 1 — Trust
Bitcoin and Ethereum have once again increased in value rather significantly in a short amount of time. Bitcoin has hit new all-time highs in price and Defi burst onto the scene this year with record levels of adoption. Over the next several months, I suspect people will cover Bitcoin and other cryptocurrencies because of the price swings. Don’t get me wrong, Bitcoin’s store of value use case is stronger than ever. But I witnessed two previous bull runs in 2013 and 2017, so I find it helpful to revisit the fundamental reasons I’m so bullish on this sector in order to remain objective in the face of price volatility.
While speculation and store of value are today’s dominant narratives about cryptocurrencies, I believe there are more fundamental reasons crypto is so disruptive and will ultimately become much bigger than the dominant narratives describe. Twelve years after Satoshi released the Bitcoin whitepaper, we are still early in a transition that will continue to play out over the coming decades. This post covers the first of those four reasons. You can read the other three here, here and here.
A New Computing Paradigm Built on Trust
Historically, new models of computing have tended to emerge every 10–15 years: mainframes in the 70s, PCs in the 80s, the internet in the early 90s, the cloud in the early 2000s and smartphones in the late 2000s.
Each of these new computing platforms started out as inferior in most aspects except for one or two key characteristics. When Apple first launched the iPhone in 2007, it didn’t have nearly the computing power compared to a PC at the time, the battery life was terrible, the touchscreen was widely considered inferior to a keypad, and many complained that the screen was too small for web browsing. In fact, it wasn’t until a year after the initial launch that you could even install third party apps onto the phone. The first iPhone was exclusive to AT&T and ran only on AT&T’s notoriously slow and unreliable network which led to the running joke at the time that the thing the original iPhone did worst of all was be a phone. However, what it did have that computers did not was a GPS, a camera, and was with you at all times. This allowed mobile native companies such as Instagram (which took advantage of the camera), Uber (which took advantage of the GPS), and WhatsApp (which took advantage of messaging) to leverage these inherently native features to create massive companies.
Each new computing paradigm had limitations early on but introduced one or two novel advantages that would be the reason it would go on to disrupt the previous paradigm. For instance:
- The PC had limited storage, functionality and originally required programming knowledge to operate. However, once a simple operating system was established (Microsoft), PCs were small enough to fit on a desk and allowed individuals to complete complex tasks more efficiently, forever changing the business world and our personal lives.
- The internet was slow and had so little bandwidth early on that even the simplest of pictures would take minutes to load. However, it made it easy for people to communicate (email), access information (Google) and connect with each other (Facebook).
- When AWS first launched, security and speed was a real concern for the cloud. However, it was scalable and cost effective in a way that on-prem servers never were, which enabled SaaS business models and an entire generation of companies built on the cloud that have gone on to disrupt nearly every industry (See Bessemer Cloud Index).
It’s interesting to note that speed and performance are common early limitations whenever a new computing paradigm is first introduced. These limitations are also the most common explanation that people give as to why the new technology will never achieve mass adoption. The PC didn’t have the power mainframes had when it was first released, the internet was hampered by poor dial up connections, the cloud had performance and security concerns, and the smartphone was inferior to PCs in just about every performance metric conceivable when the first iPhone was released. In time, engineers solved these challenges and each of these technologies drastically improved.
Today, many are quick to point out the limitations of throughput in blockchain based systems. They are correct that currently, the number of transactions any blockchain can perform pales in comparison to some legacy systems, but I would not bet against the best engineers in the world solving this challenge over time.
“Each of these new models started out looking limited and insignificant, but each of them unlocked a new market that was so much bigger that it pulled in all of the investment, innovation and company creation and so grew to overtake the old one.”
– Benedict Evans, What Comes After Smartphones
So, what is the inherent feature blockchains possess that previous computing systems do not? I would argue the novel feature is trust. While the number of transactions on any given blockchain may be slower than existing legacy systems, blockchains engender trust in a way centralized, legacy systems will never be able to match through decentralization, immutability, and transparency.
The first way Blockchain platforms create trust is through decentralization. Blockchain systems neutralize counterparty risk thereby enabling two parties to transact directly with each other without the need for middlemen or third parties. Say we had a seller of a used car that found a potential buyer. The Seller knows if she has the title to the car in her possession, but the buyer may not. Perhaps the car is stolen or perhaps the seller is a con artist. The Buyer, on the other hand, knows if she has the funds available but the Seller does not. In the traditional world, there is an asymmetric information problem that exists between the two parties that is material to the transaction which is why we rely on third parties such as car dealerships, eBay or PayPal for online purchases, and banks to verify funds.
However, the process of transacting on a blockchain eliminates this asymmetric information risk for both sides because the blockchain ensures that the seller does in fact own the asset and the buyer does in fact have the necessary funds. Neither party has to rely or pay a third-party bank or service to ensure these criteria are met. The ability to transact directly in a fully trusted manner is one aspect of how decentralization creates trust.
Another component of decentralization is security. In a fully decentralized system, if one node on the network goes down, the network carries on uninterrupted. The Bitcoin network, for example, has never been hacked. That’s more than a decade without a single breach in security. However, we have seen the consequences of a central authority getting hacked, as was the case with Target, Equifax, and many others. Centralized systems actually create incentives for hackers to attack, whereas the potential payout of hacking a well architectured decentralized system is not worth the time and effort.
Decentralization goes far beyond just security and disintermediation. This is one reason why money is such an interesting first use case for this technology. Fiat money, in its current state, has a top down, hierarchical structure in which fiscal and monetary policy is centrally controlled by a small number of people. The dollar, for example, has its interest rates and money supply determined by The Fed. Thus, the dollar is no longer based on a free market system. Rather than letting the market clear at prices where supply meets demand, supply and interest rates are set by a single entity which leads to sub optimal outcomes including bigger economic bubbles.
Prior to fiat currencies becoming the dominant unit of exchange, gold emerged in a bottom-up manner due to its inherent properties (more on this in my next post) rather than governments declaring its people had to use it (ie: top down). When we were on the gold standard, the central banks and IMF played a much smaller role because gold was much closer to a free market driven monetary system. Since moving off gold standard in 1971, we have been using a monetary system that is much more susceptible to political manipulation. In contrast, no one person or small group of people control the monetary policy of a fully decentralized system such as Bitcoin. The price of Bitcoin is purely determined by supply and demand and its supply schedule is pre-determined and fully transparent. The Crypto industry is community based, bottoms up, free market driven where the best ideas and products have a better opportunity to emerge. It is a much more meritocratic system which is more fair, unbiased and therefore engenders trust.
Finally, decentralization reduces platform risk. We have seen the power these centralized platforms have which inherently creates platform risk for any company building on top of these centrally controlled networks. Facebook has a long history of changing the rules for developers on its platforms and cutting access to thousands of apps based on the fact that those projects had similar functionality as Facebook. App Store developers are at the mercy of Apple, Amazon uses data on it platform to track the best selling items and sell their own copycat version with prioritized search ranks, and Google essentially co-opted Yelp, Trip Advisor and others into its own search results. In contrast, if you are a developer building on a decentralized blockchain such as Ethereum, you can trust that the there is no one authority that will engage in anti-competitive behavior and pull the rug out from under you.
A second way blockchains engender trust is through immutability. Once a transaction is recorded on a blockchain, it can’t be reversed or tampered with. This engenders trust as once a transaction is recorded, it can’t be erased, altered or falsified. In a centralized system, we are forced to rely on expensive, third party audits to verify the information in a standard database hasn’t been tampered with. Even then, those audits aren’t infallible (Enron), and we must trust whoever performed the audit did her job appropriately. Contrast that to a decentralized blockchain that, for the first time ever, enables Triple Entry Accounting where anyone can methodically and mathematically prove the integrity of the data at any time.
What is Triple Entry Accounting? Today, accounting is done via double entry accounting in which all debits and credits are recorded for every transaction. While this is effective in recording transactions, the biggest downside is these ledgers do not communicate with each other and therefore require constant reconciliation (which costs time and money) as well as lack transparency and verification (ie: the possibility of fraud). Decentralized Blockchains such as Bitcoin make it possible for all network participants to record, view and verify every transaction on the blockchain. For the first time ever, these ledgers are connected and sync’d in real time. Once verified using this “third entry” of accounting, the transactions are recorded in an immutable manner. The benefits of Triple Entry Accounting are numerous including reducing the chances of errors, fraud or manipulations.
Many new companies and use cases will likely be launched that leverage this immutability & Triple Entry Accounting feature. For example, using Blockchain for voting would ensure that everyone, down to the individual voter, could verify that their vote was casted accurately and counted in an election. Publishing your last will and testament to a blockchain would ensure it doesn’t ever get lost, deleted, or altered. It could also automatically execute that will exactly as intended upon your death. Property rights and transfer deeds published to a blockchain would provide a full proof way of ensuring property rights. A well-functioning global supply chain requires logistical coordination among multiple parties and because blockchain has verification and time stamp capabilities built into it, it has the potential to improve efficiency and transparency for nearly every industry worldwide.
The third way decentralized blockchains enable trust is through transparency. Anyone can see and verify any transaction that has ever happened at any time. More transparency means more trust. But it goes much further than that.
While the internet democratized access to information, crypto is democratizing access to data. One unintended consequence of the internet was the centralization of data and the power that resulted from controlling those proprietary data sets. Advancements in AI over the last decade only enhanced the power of incumbents due to the availability and control of such large amounts of data, network effects, and ability to attract engineering talent. Crypto is fundamentally a new architecture, based on open source and transparency of data. Thus, there is an availability and abundance of data for everyone in crypto making it the most data rich capital market. Anyone and everyone can see every transaction in a pseudonymous manner (transactions are recorded but identities are not) which levels the playing field.
And it’s not just the open access to data, it’s the granular nature of it as well. For example, anyone at any time can calculate the exact money supply and number of transactions in a network. We can calculate the distribution of value in a network or that 63% of all Bitcoin hasn’t moved in over a year. In comparison, our current economy is full of rough estimates with different sources producing wildly different estimates. It’s impossible to know exactly how many dollars actually exist, let alone more detailed analyses, because there is no exact way to track and measure fiat transactions. The transparency and level of granularity with regards to data is far superior in blockchain based architecture.
Trust is the key feature of this new computing paradigm and it’s no coincidence that it comes at a time in which trust in the physical world is in sharp decline. There is less trust than ever in governments, financial institutions, news and media, tech companies, middlemen and gatekeepers. There could not be a better time for a technology built on trust to emerge. This is also why I believe in public blockchains and frankly not excited by permissioned ledgers as I believe it takes away the core differentiating advantage blockchain technology possesses.
Each new computing wave saw the rise of new companies that took advantage and were built around that inherent new feature. I expect the same to happen in the crypto industry as new companies, native to blockchain technology and starting with new core assumptions, are built and become the next generation of enduring companies.