My buddy, Yancey, is a Bitcoin broker. He’s been arranging deals part-time for several years now. About a year ago, he went full time. He seems to be doing fine.
It’s ironic that the Bitcoin needs a broker. In my opinion, the best thing about Bitcoin, and the underlying blockchain, is the potential to disintermediate transactions. By eliminating middlemen, blockchain systems may deliver two major benefits:
Conceivably, the blockchain can produce a world of frictionless commerce where we no longer need trusted intermediaries. It’s ironic that Yancey serves as an intermediary for a technology that aims to eliminate intermediaries.
This suggests the blockchain has not yet reached its full potential. My question for Yancey: will it ever? I chatted with Yancey for about an hour last week. Here are some of the highlights.
Additionally, the structure of the blockchain itself can help prevent fraud. What’s stored in the blockchain can’t be changed. A bad actor could conceivably add to the blockchain but such additions are easy to identify and trace.
I first wrote about Bitcoin on this website five years ago today. (Click here). I decided not to buy any at the time because the price had surged to well over one hundred dollars! Clearly it was a bubble. If only I had known that the price would peak at $18,000 a few years later. (Today, the price is about $6,800).
So what’s happened over the past five years? Let’s look at Bitcoin’s benefits and then investigate some of the ways that it has changed our world.
Bitcoin is based on a blockchain stored in multiple locations. This gives it two major advantages: it can’t be erased and can’t be tampered with. Simply put, it’s like writing checks in ink rather than in pencil, using paper that can’t be destroyed. A blockchain can record transactions and ensure that they will always be available as a matter of public record. Bitcoin uses this feature to buy and sell things. Each transaction is recorded forever, meaning that you can’t spend the same Bitcoin more than once.
Bitcoins can also reduce inflation because they can’t be printed at a government’s whim. Instead, they’re “mined” through complex mathematical calculations. The process gradually grows the supply of coins. The money supply grows in predictable ways. This appeals to anyone who worries that governments will artificially inflate their national currencies.
Bitcoin is also anonymous – just like cash. Unlike cash, however, it’s not physical. It can easily be moved around the world as electronic blips. That makes transactions convenient and inexpensive and could conceivably cut out banks as middlemen. This makes Bitcoin attractive to many groups, especially criminals.
So, what’s happened? First, the idea of the blockchain has spread. There’s no reason to limit the blockchain to currency transactions. We can store anything in blockchain and ensure that it never disappears. In other words, we believe that it is more trustworthy than government or financial entities.
As Tim Wu writes, we are undergoing, “… a monumental transfer of social trust: away from human institutions backed by governments and to systems reliant on well-tested computer code.” Wu notes that we already trust computers to fly airplanes, assist in surgery, and guide us to our destination. Why not financial systems as well? A well-organized cryptocurrency could become the de facto standard global currency and eliminate the need for many banking services.
But we don’t need to limit the blockchain to financial transactions. Any record that must be inviolate can potentially benefit from blockchain technology. Some examples:
Of course, we can also use blockchains for less noble pursuits. The blockchain can store any information, including pornography. That’s a problem but it’s the same problem that was faced by myriad new technologies, including VCRs and the Internet itself. Criminals can also use cryptocurrencies for ransomware attacks, and to traffic in contraband or avoid taxes. We can ameliorate these problems but we probably can’t eliminate them. Still, the advantages of the technology seem much greater than the disadvantages.
So … what happens over the next five years? The New York Times reports that venture capitalists poured more than half a billion dollars into blockchain projects in the first three months of this year. So, I expect we’ll see a shakeout at the platform level over the next five years. Today, there are many ways to implement blockchain. It reminds me of the personal computing market in, say, 1985 – too many vendors selling too many technologies through too many channels. I expect the market will consolidate around two or perhaps three major platforms. Who will win? Perhaps IBM. Perhaps R3. Perhaps Ethereum. Perhaps Multichain. Rather than buying Bitcoin, I’d suggest that you study the platforms and place your bets accordingly.
In the meantime, we need to ask ourselves a simple question: Are we really willing to forego our trust in traditional institutions and put it all into computer code?
Last week, I wrote about the process of disintermediation and how it will disrupt banks and bankers. By encrypting transactions and distributing them across a peer-to-peer network, we will no longer need banks to serve as trusted intermediaries in financial transactions. We can eliminate the middleman.
Can we eliminate lawyers as well? You bethca.
We have lawyers for the same reasons that we have bankers: we don’t trust each other. I don’t trust that you’ll pay me; I want your bank to guarantee it. Similarly, I don’t trust that you’ll honor our contract; I want a lawyer to enforce it.
But what if we could create a contract that didn’t need a lawyer to interpret and execute it? We could eliminate the lawyer as an intermediary. That’s exactly the idea behind smart contracts (also known as self-enforcing or self-executing contracts).
First proposed by Nick Szabo back in 1993, smart contracts use software to ensure that agreements are properly executed. Not surprisingly, smart contracts use blockchain technologies spread across peer-to-peer networks. If you think that sounds like Bitcoin, you’re right. Indeed many people think that Szabo created Bitcoin using the pseudonym Satoshi Nakamoto.
So how do smart contracts work? Here’s how Josh Blatchford explains it:
“… imagine a red-widget factory receives an order from a new customer to produce 100 of a new type of blue widget. This requires the factory to invest in a new machine and they will only recoup this investment if the customer follows through on their order.
Instead of trusting the customer or hiring an expensive lawyer, the company could create a smart property with a self-executing contract. Such a contract might look like this: For every blue widget delivered, transfer price per item from the customer’s bank account to the factory’s bank account. Not only does this eliminate the need for a deposit or escrow — which places trust in a third party — the customer is protected from the factory under-delivering.”
Smart contracts, in other words, precisely define the conditions of an agreement — not unlike dumb contracts. They also execute the terms of the contract by automatically (and irrevocably) transferring assets as the contract is fulfilled.
Blatchford wrote his description in VentureBeat – an online magazine that helps venture capitalists identify and invest in leading edge technologies. This suggests that the money to fund smart contract platforms is already flowing.
Indeed, the first smart contract platform – Ethereum – launched in July 2015. Ethereum’s website describes the endeavor as “… a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference.”
Ethereum seems to be essentially a developer’s platform today. Developers can use the platform to develop applications that eliminate the need for trusted (human) intermediaries. Should lawyers be worried? Not yet. But soon.
In 1979, Paper Mate introduced the world’s first ballpoint pen with erasable ink. Technology analysts considered it an important breakthrough and the news made headlines around the country. Many of us thought, “Wow! Finally I can write in ink and then erase it. How cool is that?” After a few moments of reflection, we had a second thought, “Why would I ever want to do that?”
Before erasable ink, we thought of ink’s permanence as a drawback and a disadvantage. After erasable ink appeared, we realized that ink’s permanence was actually its primary benefit. Write it once and you know it will never go away. If you might want to erase something, use a pencil.
In an odd way, permanence may also be the primary benefit of the blockchain technology that underlies Bitcoin. We think of databases as interactive, up-to-date records of the world as it is. The closer to real-time, the better. If you want to know what’s happening right this millisecond, high-speed databases will tell you.
But what if you want to know what happened some time ago? And what if you want assurances that the information you retrieve is tamper-proof and immutable? In other words, what if you want the electronic equivalent of permanent ink?
That’s exactly what blockchains on distributed ledgers give you. You can’t change the blockchain unless you can decrypt it – and that’s very difficult. Even if you can decrypt it on one network node, many original copies exist on other nodes. It’s fairly easy to restore the status quo ante. You can be very confident that the information you retrieve is unchanged from the original. It’s an immutable, permanent record.
The blockchain/ledger technology allows Bitcoin to keep a permanent record of all transactions. That’s important if you want to create a trusted financial system. But why stop at financial transactions? Are there other transactions that might benefit from permanent, tamper-proof records?
Indeed, there are. Here are a few that are in production or beta today:
I could go on and on. (If you want to dig deeper, click here, here, and here). While Bitcoin popularized the technology, blockchain extends far beyond the financial world. Indeed blockchain may disintermediate and disrupt supply chains around the world. If so, the world will get much more efficient. Is that what we want?
When I need a ride, I no longer call a dispatcher. Rather, I call a driver directly, using a service like Lyft or Uber. When I want to watch a TV show, I no longer tune in to a local TV station and wait for them to show it. Instead, I just stream it to my computer.
In short, I’ve eliminated the middleman. The process is called disintermediation – I’ve eliminated the intermediary. We see it happening in publishing, lodging, ride sharing, television, even in adultery.
So what about banking?
Traditionally, banks are trusted intermediaries that allow us to conduct business with strangers. You buy something from me and I want to be paid. You give me some token of value. Can I trust you? Maybe not. So I turn to the banking system. Your bank can verify that you have the necessary funds on deposit. My bank can verify that your bank will actually transfer those funds to my account. It’s a valuable service and banks charge a significant fee for it.
As intermediaries, banks are subject to disintermediation. If we can eliminate them, we can create a simpler, cheaper, more efficient system. That’s the promise of Bitcoin, which uses an encrypted blockchain to enforce trust through software.
To date, Bitcoin’s fans include hipsters, drug dealers, terrorists, and libertarians — people who prefer anonymity and cash rather than credit. The fan club has given Bitcoin a seedy reputation. Mainstream financial institutions might well ask, With friends like those, who needs Bitcoin?
The short answer is: Anyone who can’t access a trustworthy banking system. As Jeremy Millar points out, that includes much of the third world. If you’re trying to run a business in, say, Greece or Argentina, you’ll encounter an array of financial obstacles, including currency controls and cross-border payment limitations. Your suppliers can’t trust that you will pay them promptly. Nor can you trust that your customers will. Since the banking system can’t supply a trusted intermediary, you turn to Bitcoin. According to Millar, Bitcoin will find a niche in the third world and expand from there. (If so, Bitcoin will closely follow Clayton Christensen’s model of disruptive innovation: 1) find a niche; 2) mature; 3) disrupt).
And who else might need Bitcoin? Well, the banks themselves. Bankers realize that they are likely to be disrupted. So why not disrupt themselves rather than waiting for someone else to do it for them?
That appears to be exactly what a Wall Street startup named R3 is planning to do. R3 doesn’t use Bitcoin per se but rather the cryptographic technology that underpins Bitcoin. In addition to the blockchain that identifies transactions, R3’s system uses distributed ledgers in a peer-to-peer (P2P) network. The system consists of many nodes that replicate information. (It’s similar to Napster). Since information is distributed across many nodes, there is no single point of failure. Since the nodes can be scattered around the world, no single government can control it. Since transactions are copied to multiple nodes, it’s also very hard to cook the books. The system builds trust through replication and encryption.
According to its latest press release, R3 has now signed up 42 major financial institutions. The list includes some very heavy hitters, including Banco Santander, Deutsche Bank, J.P. Morgan, Goldman Sachs, HSBC, Royal Bank of Canada, and SEB. The consortium is now building a technology platform that will allow members (and presumably non-members) to build global applications.
In essence, R3 plans to bring us a version of Bitcoin run by professional financiers rather than wild-eyed technology radicals. That’s not such a bad idea. But there’s also a darker side. If R3-like platforms succeed, the world’s financial system will be controlled by bankers rather than by governments. So we come back to a question of trust. Whom do you trust to run the global financial system: bankers or governments?