In Consensus Algorithms We Trust

Full text

In Consensus Algorithms We Trust
insightmagazine.uk/in-consensus-algorithms-we-trust/
Theodor Beutel discusses the potential of blockchain.
Beyond BitcoinFirst on the agenda is payment. Initially proposed in 2008, Bitcoin is both the oldest and the
highest capitalised (more than 100 billion USD as of November 2017) blockchain. Through the decentralised
nature of blockchain technology, Bitcoin was the first to establish a trusted payment system without trustworthy
intermediaries such as banks, central banks, and governments. To many, these attributes seem appealing, hence
Bitcoin’s high valuation. It is, however, easy to overlook that blockchain, as a concept, has much more to offer
beyond Bitcoin.
Analogy with the Internet From the 1970s onwards, we notice a similar pattern with the emergence of the
Internet. Back then, the world wide web was yet to be invented; however, email services were gaining traction. As
the first mainstream internet application, email paved the way for the internet as we know it today with endless
opportunities for innovation and instant, cheap, and global communication. Building on the foundations of the
Internet, entrepreneurs all over the globe set up encyclopaedias, marketplaces, news sites, social media, etc.
which previously could not be realised. Due to its fundamental importance for innovation and its wide-reaching
effect on the global economy, the internet is considered a general purpose technology.
Blockchain as a General Purpose Technology Could it be that Bitcoin is to blockchain, what email was to the
Internet? Can we expect blockchain technology to mature and eventually become the foundation of a whole new
field of innovation, just like the internet? It may not be too far-fetched to assume that Bitcoin merely represents a
single, early-stage application of blockchain out of a plethora of further applications as a potential general purpose
technology.
The potential of smart contracts The evolution of blockchain technology is underway and progressing at a high
pace. In 2014, it became apparent that there may be more to blockchain than securing payment transactions
when Vitalik Buterin proposed the Ethereum blockchain. As opposed to Bitcoin, Ethereum is an example of a new
kind of blockchain which combines the idea of smart contracts with distributed consensus algorithms. Smart
contracts are essentially software code representing contractual terms and instructing computers to automatically
process certain steps of a digitized contract. Smart contracts distinguish themselves from non-blockchain based
software through their distributed architecture, meaning that there is no single entity which validates transactions
and keeps information. Instead, a blockchain-based smart contract is virtually immutable and tamper proof, as it is
validated from a distributed, decentralised network.
Platforms for Smart ContractsBlockchains capable of smart contracts evoked a paradigm shift. Blockchains
such as Ethereum, EOS, and NEO are not only able to secure transactions but automate them, which extends
their scope significantly. These blockchains typically act as a foundation for software developers to build
applications which inherit the trusted, decentralised principles of blockchains. Therefore, blockchains such as
Ethereum should not only be seen as yet another cryptocurrency, but rather as a fundamentally new way of
programming which happens to rely on the same principles as cryptocurrencies. It is argued that the primary
purpose of Ether (ETH; the cryptocurrency connected to Ethereum) is less a payment method, but rather a tool to
power the processes behind Ethereum’s smart contracts
1/2
Dec 6, 2017

Capabilities of DApps Why are smart contracts considered such a powerful mechanism and in what ways would
they impact present structures? Several smart contracts taken together allow the creation of decentralised
software applications, so-called DApps. In appearance to a user, these DApps may essentially look like any
software application they are familiar with today; with the exception that DApps are not owned or supervised by
intermediaries and skip the man-in-the-middle.
Economic benefits of decentralisation For all of human history, intermediaries were to play an important role on
markets in meeting supply and demand and keeping a share of a transaction to themselves as a reward. With
recent funding rounds valuing ride-sharing platform Uber at $68 billion and room-sharing platform AirBnB at $29
billion, it can be assumed that this reward is not insignificant. Consulting our Econ 101 textbook, we learn that
monopolies are more efficient with increasing economies of scale, but do not allocate resources efficiently when
maximising for profit. Similarly, digital platform businesses tend to be ‘winner takes all’-markets, allowing platform
owners to engage in monopolistic behaviour which is not necessarily good for consumers.
DApps’ potential for innovation With DApps, however, a platform is effectively owned and maintained by each
user to the extent they engage with the platform. Thus, a user is also a shareholder, which can be referred to as
platform ‘cooperativism’. A platform’s decentralised counterpart therefore combines efficiency gains from
economies of scale with efficient pricing due to its distributed power balance. This is inherent to decentralised
applications, as crypto-economic principles incentivise everyone accordingly. Whether it be marketplaces (eBay,
Amazon), media providers (Spotify, Netflix), social media (Facebook, Twitter), or the sharing economy (Uber,
Airbnb); DApps could effectively replace these centralised platforms with peer-to-peer platforms. Following the
sharp rise of platform businesses in recent years, we soon may face just yet another case of Schumpeterian
creative destruction.
Barriers, Standards and (lack of) Regulation As promising as these developments may seem, it is clear that the
technology is still in its infancy. We see Bitcoin and many other cryptocurrencies being highly volatile in their
valuation due to its absence of intrinsic value, its mathematically ensured scarcity, and plenty of speculation.
Adoption wise, it has yet to ‘cross the chasm’ between early adopters and early majority of users and still a long
way to go until mass adoption. While end-users tend to find the technology lacking in everyday-life use cases, are
organisations and institutions deterred by insufficient scalability of blockchains and unpredictable volatility of
cryptocurrencies. For instance, it takes up to 20 minutes (and used to be more than an hour in the early days) for a
Bitcoin transaction to be validated which seems unthinkable compared to the few seconds it takes an average Aldi
employee to scan all your grocery items.
Furthermore, from a regulatory perspective, cryptocurrencies and blockchain applications are still highly
unregulated in most regions of the world. While some countries (including Bolivia, Ecuador, Kyrgyzstan,
Bangladesh, and Nepal) declared Bitcoin illegal, most regulatory bodies choose to remain observing the
technology for now. Concerning investments relating to decentralised applications (so-called initial coin offerings,
short ICOs), the U.S. Securities and Exchange Commission (SEC) recently declared certain kinds of ICOs as
securities – and therefore to come under its regulation. Even more, China and South Korea banned ICOs entirely
with other nations considering similar measures.
At the same time, the blockchain industry begins to sort itself out. Major organisations from tech, finance, and
other sectors join blockchain startups to form consortia (such as EEA, R3, and Hyperledger), which currently
compete for dominance in the field. In other cases, the industry has reached a consensus (such as with the
ERC20 standard for Ethereum smart contracts). However, efforts for standardisation and struggles for power will
surely continue to be present for quite a while.
Outlook Despite present barriers and scepticisms, it seems hard to believe that blockchain technology will not
fundamentally affect businesses and societies in the long term. Concerning its impact, it remains to be seen if
blockchain will be considered as significant as the internet However, establishing trust in such an unprecedented
scale and scope appears to be too much of a winning strategy that will convince people, organisations and
governments – and at times may even render the latter two redundant.
2/2