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cryptocurrency

Whom Do You Trust? America or Facebook?

Do we need it anymore?

The promise of cryptocurrencies is that we can create a widely-acceptable medium of exchange without having to trust anyone.  Cryptocurrencies have no central authority, no government agency to vouch for them. We don’t need to trust a government or a bank or a stock exchange. Elites can’t cheapen our currency because no elites are involved. Indeed, no one is involved. The currency is distributed across multiple computers and multiple networks. To manipulate the currency, one would need to control all the computers in the world – a seemingly impossible task.

In the original conception, the value of a cryptocurrency is based on nothing more than supply-and demand. Value is not linked to any physical asset like gold or oil or even paper currencies like dollars. Since there is no asset behind the currency, no one can manipulate the value of the currency by manipulating the underlying asset. Rather than trusting a government or an agency or a bank, we place our trust in an algorithm distributed around the world.

(The distributed nature of cryptocurrencies also makes them quite slow. Speeding up transactions is a major challenge for blockchain researchers. The most promising solution seems to be “sharding” – a technology worth keeping an eye on.)

Traditionally, we’ve trusted governments to create and maintain the value of national currencies. That’s been a pretty good bet in the United States, less so in Venezuela. But, really, do we need a nation to create a widely acceptable currency? Cryptocurrencies suggest that the answer is “no”.

But there’s a not-so-subtle problem with cryptocurrencies. The elephant in the room is that many people (myself included) view cryptocurrencies as a new version of the Wild West – a territory populated by libertarians, wild-eyed visionaries, snake oil salesmen, drug dealers, scam artists, and terrorists. And, by the way, some person created the algorithm and could potentially manipulate it for illicit purposes. Simply put, the current cryptocurrency scene does not inspire trust.

To fill the trust gap, several “trusted” agencies have stepped forward to offer cryptocurrencies based on a trusted brand and/or on physical assets. Case in point: J.P. Morgan Chase’s “JPM Coin”. Announced earlier this year, (click here, here, and here) JPM Coin is backed by a major bank and based on a physical asset: the U.S. dollar. The company touts JPM Coin as a simpler, faster way to make and clear payments.

This past week, of course, another “trusted” organization – Facebook – announced that it will introduce a new digital currency called Libra next year. (Click here and here). Facebook wraps its announcement in humanitarian gauze – it’s simply providing an effective payment service to the world’s unbanked citizens. As Evgeny Morozov points out, however, Facebook is actually doing two things:

  • Preparing to take on China’s social media giants, Tencent and Alibaba, which already combine payments and communications.
  • Positioning itself as a “as a rebel force against mediocre bureaucrats and sluggish corporate incumbents”. It’s doing battle against a coalition of lazy, inept, corrupt – untrustworthy – bankers, bureaucrats, and politicians. Morozov suggests that Facebook is activating its populist supporters to keep regulators at bay. More broadly, it’s a “plan to break the global financial system.”

Could Facebook’s Libra actually become a global currency at the expense of the dollar, yen Euro, and renminbi? Facebook currently has 2.38 billion active users. That number makes even China’s population look small. If a significant portion choose the Libra over existing currencies, then the money we know today could become irrelevant. If a nation’s currency is irrelevant, how relevant is the government?

Given all this, here’s a basic question — whom do you trust more: 1) the American government; or 2) Facebook?

(Note that JPM Coin and Libra are not truly cryptocurrencies, at least not in the original sense of the word. A cryptocurrency has three elements: 1) No central authority, agency, governing body or processor. Clearly J.P. Morgan and Facebook are centralized governing bodies. 2) No physical assets backing the currency. JPM Coin, uses the U.S dollar as its backing asset – it’s a digital currency based on a fiat currency. Facebook says that Libra will be based on physical assets, though it hasn’t quite defined them. 3) Permissionless – you don’t have to ask anyone’s permission to use a cryptocurrency. To use JPM Coin, you need to have an account at J.P. Morgan. To use Libra, you’ll need a Facebook account. Given this, it’s probably best to call JPM Coin and Libra “digital currencies” as opposed to “cryptocurrencies”.)

Bitcoin, Blockchain, and Five Years

What’s next?

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:

  • The Peruvian economist, Hernando de Soto, has suggested that we can combat poverty by storing land ownership records in blockchain systems. Land ownership disputes in Latin America can last for centuries. Blockchain could simplify the process and ensure that those who hold title to land can’t be cheated out of it.
  • De Soto’s proposal eliminates the government as the arbiter of land titles. This is part of a broader trend to disintermediate governments. Why should governments be information czars? Better to store our records in blockchain. This could include land titles, personal identification, health records (including our DNA), the provenance of art works, stock ownership, international fund transfers, and self-enforcing contracts.
  • Tim Wu suggests that we’re moving our trust from governments to code. But we’re only part way there. In our first step away from governments, we put our trust in giant Internet companies like Facebook and Google. We’re now discovering that these entities are no more trustworthy than governments. Indeed, they may be less trustworthy. What’s the next step? Many suggest that it’s the blockchain.
  • Meanwhile, afraid of being disintermediated, governments are starting to plan cryptocurrencies of their own. Russia has proposed a digital currency with several former soviet socialist republics. Sweden and China are both interested in their own cryptocurrencies and have established study groups. But the first government out of the gate seems to be Venezuela, driven by a financial crisis. Venezuela’s printed currency, the Bolívar, suffers from inflation rates around 4,000%. So the government has just announced a new cryptocurrency called the Petro, based on the nation’s oil revenues. The government is essentially saying, “We’re incompetent to print paper money but you can trust the Petro because it’s based on code, not a bumbling bureaucracy. We humans can’t interfere with it.” Will it work? Stay tuned.

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?

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