Blockchain: it’s not the thing.

(originally written in September 2018; updated in November 2019)

Bitcoin, blockchain, decentralized ledgers, smart contracts. This domain emerged just in the past 10 years, and already has attracted technical wizards and bankers and politicians and scam artists and lawyers. Most cryptocurrencies and coin offerings soared, plunged and soared again, but remain deeply down from all-time highs.

What to make of this? How to build strategy amidst this? Here, I argue that bitcoin and blockchain and the rest of the ecosystem are not the dazzling outcome itself: they’re the tools that enable the outcome. It’s not the thing: it’s what gets us to the thing¹.

We’ll explore some analytical ways of dissecting the issues around Bitcoin and blockchain. We’ll see that the elements of blockchain are likely to endure and have great lasting value, even if current implementations fade away.

Notes, and disclosures:

• None of this is intended to be or should be considered to be investment advice. You want to buy or sell some cryptocurrency? Get advice from a knowledgeable professional, if you can find one.
• I have no holdings in cryptocurrencies, in any way, and have never had any. I was a co-founder of a startup, Banyan Infrastructure², that is developing a blockchain-based platform to de-risk infrastructure investments, and am a minority equity owner, but inactive in the firm; I’ve been supporting the Dweb community, and I’m leading a project, Muinin, that has a decentralized ledger at its core³, but have no active role with any cryptocurrency company or project.
• Footnotes and links are at the end.
• This article was first published in late 2018; much has changed since then, but this article has only been refreshed, not rewritten.

The end of the beginning

The Bitcoin tulip has wilted, is suspected by some as a Ponzi scheme or by others as the way China will overtake the US dollar. Initial Coin Offerings seem passé. Facebook’s Libra launched to a reception of support, opposition and puzzlement. Is the hard work of building a new industry underway, or is this a wrong turn in technical history? Here are some recent quotes to summarize⁴. In general, older writings were more enthusiastic, newer ones blend the downright morose with utopian:

• “ most of those who invest in bitcoin are effectively participating in a pyramid scheme either as a future victim or a perpetrator” (Jonathan Harris, CFAInstitute.org, November 2018)⁵
• “Central banks are getting closer to issuing their own digital currency. If they do, the dollar might finally face real competition as the world’s dominant currency.” (Wall Street Journal, September 2019)⁶
• “ ethereum will achieve the original ‘world computer’ vision within the next four years” (Christine Kim, CoinDesk , August 2019).⁷
• “ Ether is all but useless in the expanded feature set and merely needed to help keep the Ethereum network to be tamper-resistant, it can be ignored.”. (Eric Lamison-White, Hackernoon, September 2019).⁸

This is not the end, we believe, but the end of the beginning. The future, the thing, the destination, is that electronic and decentralized systems rewrite the rules of money. But the ways in which this will occur are only emerging.The key question to thinking about decentralized technologies is to ask what capabilities are really needed:

1. What technologies are needed for digital payments
2. Where decentralized ledgers add significant value
3. When it makes sense to tie transactions to the decentralized ledger
4. When the currency itself should be decentralized

1. Digital payments and digital currencies are inevitable, but may not need blockchain.

Electronic payment schemes first became wildly successful in Kenya (M-pesa⁹) as a means of allowing poor people, without access to banks, to have better security than is feasible with currency. M-pesa transactions now are about the same as the nation’s GDP. Other benefits include better tax compliance and lower corruption.

In the last few years, mobile payments have achieved similar success in China, where the payment tools of (WeCash and AliPay¹⁰) have all but replaced paper cash. The same benefits as in the M-pesa case, plus the certainty of government oversight. Clearly: conversion to digital payments at the consumer level, at large scale, with low transaction costs, is feasible without blockchain.

And a permanent ledger is not a great feature for most transactions. Who cares, ever, if I stop to buy a bag of onions? Or to hand $25 to someone in need? Even in aggregate, such trivial transactions aren’t worth keeping on any ledger for any long period. (If I get home and find half of the onions are bad: should I do nothing, or go back and argue, or decide to not go to that merchant again? A fancy ledger isn’t that helpful in any case.)

The value of digital ledgers for small transactions

• Small or even mid-sized transactions don’t need fancy ledgers; a reasonably secure SQL database should suffice. There will — or should — always be some level of transaction not worth counting: either because the value of the transaction is too small (and its impact as short-lived as a bag of onions), or because a healthy society may want to keep some transactions outside the all-seeing eyes of government and corporate oversight.

2. Decentralized ledgers have great value, sometimes

Decentralized ledgers start to become important when there is a concern that the records (for example, of a financial transaction, but perhaps of a contract or a legal record) will be fudged. The alteration could be accidental (loss of digital media) or deliberate by malefactors. The immutable ledger of Blockchain sounds particularly appealing where there are real assets in question: real estate. As de Soto has noted¹¹, a robust ledger of property records (and an independent judiciary) are vital to the accumulation of wealth for farmers, among others. It’s been vital in enabling the financial successes of Britain and the USA. Adding a technically advanced, unimpeachable, permanent record won’t add much value to the already-robust systems of title registration and protection in these nations.

In contrast: emerging nations, lacking clean written property records or a reliable judiciary. The attributes of a usable immutable ledger could be of revolutionary value in, for example, De Soto’s Peru. He describes a world ripe for the benefits of decentralized ledgers: The poor in weaker economies: “… hold these resources in defective forms: houses built on land whose ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located where financiers and investors cannot see them. Because the rights to these possessions are not adequately documented, these assets cannot readily be turned into capital, cannot be traded outside of narrow local circles where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.” The benefits of decentralized ledgers for real property in many emerging economies seem so strong that one can imagine that the only opposition would arise from those with vested interest in the current, wholly inadequate systems not changing.

The value of decentralized ledgers:

• The value of real estate transactions, and the presence of an enduring, underlying asset fits with having a system of permanent, unalterable records, maintained at some considerable cost.
• But the those records do not necessarily need to be intimately tied to a transaction mechanism. (Indeed, since real estate changes hands rarely, and banks change ownership more often and governments change sporadically, and technologies evolve, tying a real estate ledger to a specific transaction means could be counter-productive).
• The decentralized, trustworthy ledger is the thing of value in the context of real estate. But this can be accomplished by multiple means, including Blockchain smart contracts — but also other multi-copy validation tools. One, for example, pre-dates Blockchain by four or so years: LOCKSS: (Lots of Copies Keeps Stuff Safe)¹². LOCKSS may offer simpler, less expensive means than Blockchain.

3. Tying transactions to the ledger

The core idea of many cryptocurrency / ledger solutions (think: Ethereum) is that the smart ledger is written on the basis of secure transactions. There is no peeling apart of the transaction from the trustworthy ledger. So, whereas high-value, but slow-moving transactions may need a secure ledger (but not one integrated with a transaction engine), plenty of commercial transactions need a more intimate coupling, and fast, fluid completion of transactions.

To see the value, let’s imagine two cases.

• In case one, a large car maker buys materials — wheels and electronics and engine parts — from dozens of vendors, all arriving just in time, and integrates them at its factory to make cars. Today, this is likely handled via a complex manufacture-and-vendor EDI software platform, bought by and hosted on behalf of the car maker, from a company such as Oracle or SAP. Blockchain might enable the vendors to feel more secure that they — and not their customer — is writing the records, but it’s still the car maker that calls the shots. Further, the constant, multi-year relationships of the firms make dispute resolution a constant.
• In case two, a large international consortium gathers to finance and build a power grid in an emerging country. There are banks and big power systems makers and software companies, shipping companies, government agencies, local truckers and hiring agencies and builders and … the list is endless. Nobody knows all the other parties; the technical, national and currency risks are great. José-with-a-truck is worried that he’ll get paid his tens of dollars for delivering tools just as much as the tool vendor is worried that it’ll get paid the millions of dollars it is owed. Further, the consortium is ad hoc, and won’t come together again for any other purpose. No party is likely to have enough clout to dictate use of its own software platform, and everyone is concerned that they get paid per the terms of the contracts. Dispute resolution mechanisms need to be transparent. Here is where a decentralized platform with integrated payments becomes essential. It’s a boon to the bankers — who can see that their monies are being disposed in accordance with contract; it’s also a boon to the big vendors — the big tool maker — who can watch their assets moving toward use — and to José-with-a-truck, who wants payment to be automatic upon completion of task.

The value from tying transactions to the ledger

These simple cases illustrate is that a tight connection between a decentralized ledger and transactions — the basis of most cryptocurrencies — is essential when:

• The sums of money are large enough to support the inherent complexity
• The projects endure for months or years
• No one actor (or group of actors) can force a software platform on the others
• Trust is anemic, because of country risk, currency risk, and the transient nature of the consortium

A further, interesting group of values might be for companies who seek to create better financial instruments for banking that is congruent with the expectations of Islamic law. For, if a transaction is legally tied to an underlying asset, can it then pass the tests of Islamic scholars?¹³

4. When do cryptocurrencies have value?

Bitcoin was not built as a ledger to support complex smart contracts and multiple transactions, but was instead, at least in large part, a reaction to the fiscal mayhem of the period 2005 to 2008 in which banks and governments gambled, debased and squandered money with profligate abandon until there wasn’t any left. If you can’t trust banks and governments, the thinking went, who can you trust? The answer, it seemed, was nobody and everybody. A decentralized ledger of cryptocoins, pervasive encryption, a new electronic cash system that’s fully peer-to-peer, with no trusted third party. The properties were to include:

• Double-spending prevented with a peer-to-peer network.
• No mint or other, centralized, ‘trusted’ parties.
• Participants can be anonymous.
• New coins are made from Hashcash style proof-of-work.
• Proof-of-work for new coin generation powers the network to prevent double-spending.

Resolution of payment without a ‘trusted’ intermediary is critical. Consider case 2 above: the large consortium building a power grid in a not-trusted country. Do major participants need to buy troves of cryptocurrency to be sure to be able to meet their contract obligations? Or, can they take on call obligations drawable in (e.g.) Swiss Francs and transferred as currency into the recipient country, with those obligations resolved by smart contracts? If the latter, then the cryptocurrency holdings can be transitory — for periods measured in seconds or minutes — as funds emerge from lenders in Zurich or London, are recognized against the contract, and transferred into the recipient’s ledger, perhaps in local currency, perhaps in $US. The “buy troves of cryptocurrency” option seems best only if the cryptocurrency’s risks are lower than those of dealing with the myriad of fiat currencies otherwise involved.

The value for a cryptocurrency

Under what circumstances would use of cryptocurrency work? Is it best achieved by currencies based entirely on proof-of-work (or proof of other IT-related value), versus creating some obligation that ties to a tangible asset — such as gold or oil or diamonds? In principle, Venezuela’s attempt to re-work its currency by creating a cryptocurrency that foots to oil should be better than the hollowed-out collapsed currency, but such is the disaster there that nobody even trusts the “government” in Caracas to not fiddle the books on that¹⁴.

If, however, there’s another banking crisis, and if governments and banks can’t dig their way out, Satoshi-style currencies may seem better than printed money. If. May. Perhaps. In such a case, a holding of Bitcoin, for example, could make sense as an alternative to a failed currency. Otherwise, it seems that the base case is one in which Ethereum or other cryptocurrencies are most useful as the language of currency within smart contracts, with all externals in fiat currencies.

Blockchain is not the thing (it’s the thing that gets us to the thing)

In late 1999 and early 2000, the web, and IP-denominated services quite suddenly came to the fore, as it became obvious that IP was the platform for all future telecom. Skills in building IP-based network services were in high demand. One consequence: for a while, starting in March 2000, Cisco Systems, then the preeminent maker of routers and other IP networking gear, was the most highly-valued firm on the planet. Today, the highest-value, publicly-traded firms are Apple and Amazon; Google and Facebook are not far behind; Cisco’s market cap is a fraction of theirs¹⁵.

This is not (just) a tale of corporate mis-steps at Cisco. It’s more a tale of how the value shifted from the platform to the services built on the platform. At the moment that Cisco was the world’s most valued firm, its preeminent knowhow in IP networking was seen as seminal in the new Internet economy. That preeminence faded as others learned how to do IP networking as well as Cisco. Then, once that had happened, IP networking was a functionality, a tool, a reliable platform on which others could build value. Cisco did not fade away: the point of greatest value creation moved up, and away.

35 years ago, the emergence of integrated circuits made IC companies flower and created a moment of high valuation. Then, personal computers made PC brand companies highly valuable. Then, their value was overtaken by software and applications. This is a constant story for information technologies.

So is it likely to be here. The idea of blockchain emerged, steadily, from the 1990s; Bitcoin emerged over a decade ago, with the Satoshi paper, in the swirling smoke of the 2007–2009 financial crisis; coin offerings burst into large-scale awareness in 2017. The ability to build a functioning blockchain product was rare; the languages most used for smart contracts and Ethereum exchanges (Solidity and Go) are just two or three years old.

Building robust applications, with smooth user interfaces, is becoming more important than building the plumbing on which those apps run. Next: firms that deliver large-scale, secure, consumer- or enterprise-facing decentralized systems and applications will be more valuable than those building blockchain plumbing.

The ‘thing’, the long-term outcome, is one of financial transactions intimately tied to execution of tasks, and of immutable documents being the norm. These will become features embedded in contracts and finance; embedded and inextricable.

Blockchain: This isn’t the thing, it’s the thing that gets us to the thing.¹

Sources and footnotes

1. “It’s not the thing; it’s the thing that gets us to the thing”. From the wonderful TV series: Halt and Catch Fire, which was set in and depicted the rise of the era of personal computing — and illustrates the exhilarating, depressing, terrifying mania of being in high-pressure startups. Haven’t watched it (yet)? Back away and do so. In this context: the first ‘thing’ is the personal computer; the second ‘thing’ is the worldwide web. https://en.wikipedia.org/wiki/Halt_and_Catch_Fire_(TV_series), https://www.imdb.com/title/tt2543312/
2. https://www.banyaninfrastructure.com/
3. My other work — Forthcoming: dweb.org (see https://medium.com/decentralized-web and my note at https://medium.com/decentralized-web/why-decentralize-5d8e9dcedb2c); www.muinin.net; www.johnconorryan.com
4. David Rosenthal’s thorough note on the origins of and technical challenges for blockchain makes for essential reading, while not yielding any cute soundbites. https://blog.dshr.org/2019/07/blockchain-briefing-for-dod.html See also the well-curated piece at https://gizmodo.com/whats-going-to-happen-with-bitcoin-1837940506
5. https://blogs.cfainstitute.org/investor/2018/11/08/bitcoin-cryptocurrency-or-pyramid-scheme/
6. https://www.wsj.com/articles/the-coming-currency-war-digital-money-vs-the-dollar-11569204540
7. https://www.coindesk.com/what-the-next-4-years-of-ethereum-look-like
8. https://hackernoon.com/everything-wrong-with-ethereum-in-2019-r63gl3wr8
9. M-Pesa ingeniously enabled pre-paid minutes as a surrogate for cash. Originally conceived as a tool for micro-finance (where it never took root), it rapidly, and organically supplanted small-cash transactions, and international remittances, and then became a staple of financial transactions in Kenya. https://en.wikipedia.org/wiki/M-Pesa
10. WeCash https://chinatechscope.com/2018/10/13/the-story-of-fintech-startup-wecash/ and AliPay https://en.wikipedia.org/wiki/Alipay and https://www.standard.co.uk/business/no-cash-no-cards-paying-by-phone-rules-in-china-s-cultural-revolution-a3983501.html
11. Text quoted from de Soto’s “The Mystery of Capital”,published in 2000: https://archive.org/details/Hernando_De_Soto_The_Mystery_Of_Capital_Why_Capitalism_TriumphsIn_The_West_And_Fails_Everywhere_Else But also this, from 2016: “ Providing the world’s poor with titles for their land, homes and unregistered businesses would unlock $9.3 trillion in assets, de Soto estimates, an unprecedented sum to reduce poverty.” https://www.reuters.com/article/us-global-landrights-desoto/property-rights-for-worlds-poor-could-unlock-trillions-in-dead-capital-economist-idUSKCN10C1C1
12. LOCKSS- https://www.lockss.org/about
13. “ …the Islamic concept of riba forbids the payment or collection of interest. …Islamic banks are only allowed to create debt when it is backed by goods and services; specifically, transactions must have material finality, — they must be connected to a real underlying asset, like gold. This stipulation rules out options, futures and most derivatives, which naturally makes working with Western financial firms tougher.” https://www.forbes.com/sites/andrewdepietro/2018/07/11/blockchain-islamic-banking-benefits/#79853cea3af2
14. https://www.bloomberg.com/news/articles/2019-05-10/venezuela-s-failed-cryptocurrency-is-the-future-of-money Nice headline to the article, sad commentary on the dismal state of Venezuela’s economy.
15. Ominously, Saudi Aramco’s planned IPO would give it, for a while at least, higher valuations than any of the tech firms. Perhaps for the last time, a fossil fuel giant will top the capital charts. https://markets.businessinsider.com/news/stocks/saudi-aramco-ipo-bofa-values-listing-700-billion-under-2-trillion-goal-2019-11-1028654648