Blockchain Revolution
Exploring the purpose and architecture of the blockchain
The idea of cutting out the middleman has always been an attractive concept because doing so promises to lower costs and produce potential benefits for both sides of a commercial transaction. However, the role of intermediaries in the economy has persisted in a number of areas for very good reasons. The most obvious example of an intermediary involves financial institutions. The role of a bank, in very simplified form, has always been to attract deposits from those with excess capital and to lend out that capital to borrowers in need of funds. The reward for acting as an intermediary is the bank’s net interest margin – the difference between the interest charged to borrowers and the interest paid to depositors.
The world is full of other intermediaries that facilitate transactions between producers and consumers. For example, Uber and Airbnb are both essentially middlemen that take a cut of all transactions in exchange for providing a platform. Platforms allow providers of a service to be visible to a large number of potential consumers. In addition, a platform is supposed to provide a safe and secure means of transacting and also disseminates information on reputation. The retail world is full of intermediaries. For example, a car dealership theoretically exists in order to connect drivers with manufacturers and provide additional value-added services.
Anyone who follows developments in financial markets is familiar with bitcoin, the cyptocurrency conceived by a pseudonymous person or group known as “Satoshi Nakamoto” in 2008. Bitcoin has been shrouded in mystery and intrigue ever since it was created. The value of bitcoin has fluctuated widely, ranging from under a dollar when it was created to nearly $1,200 today, and the currency has not been free of scandal and controversy. What gives this currency any intrinsic value? Is it real or a ponzi scheme? As interesting as these questions are, the real story has been largely missed in the media. The technology that makes bitcoin possible, called blockchain, is arguably far more important that bitcoin itself. This is the topic of Blockchain Revolution by Don and Alex Tapscott, a father and son team that set out to interview dozens of important players immersed in this emerging technology and to make sense of the implications for the economy in general.
Blockchains represent encrypted digital distributed ledgers that do not rely on any form of centralized storage or control. Blockchains are public and transactions are verified by multiple nodes on the network. Each set of transactions in a blockchain is stored in a unit called a “block” which is linked to the preceding block. This creates an immutable chain of transactions that is permanently time stamped. It is impossible to alter the contents of any transaction without somehow taking control of a majority of nodes in the network and rewriting the history of all subsequent transactions in the chain. In the case of bitcoin, significant computing power is required to process transactions and those who provide such resources are known as “miners”. In exchange for proof of work solving a non-trivial problem, miners are awarded with bitcoin for facilitating and verifying transaction activity. No central authorities are necessary or required with all transactions in a bitcoin block being verified every ten minutes, on average.
The book provides a general overview of how blockchain works but those who desire a more technical description will be disappointed. The Tapscotts appear to have targeted their book toward the “business reader” – in other words, individuals who are in a position to utilize the technology rather than those who would implement it. The problem is that without a technical appendix, the more technical reader may lack confidence in the claims that the authors make regarding the safety and efficacy of the distributed network.
Perhaps the most exciting aspect of blockchain is the potential within the field of financial services. The authors present an important case study regarding the difficulties facing migrants who routinely send funds to relatives in their home countries. The costs imposed by intermediaries such as Western Union can be extremely high relative to the modest sums that are sent. The concept of using blockchain to facilitate these transactions promises to eliminate the middleman and dramatically lower, if not eliminate, costs. With the widespread adoption of mobile phone technology in the developing world, there is no theoretical reason why migrants in rich countries cannot utilize blockchain to send funds directly to relatives in their home countries. The need for the 500,000 Western Union locations throughout the world would disappear with widespread adoption of the technology.
The authors believe the blockchain has the potential to facilitate direct contracts between consumers and service providers, effectively cutting middlemen like Uber and Airbnb out of the equation. Blockchain has the ability to handle very complex contracts and transactions and can also disseminate trust information through the chain. For example, it would be possible for an American to directly seek out homeowners in Paris who might have an extra room available, to read reviews from others who have used the room, and to establish contractual payment terms that set out the details of when funds should be released. The blockchain could even handle the transmission of a smart code to unlock the home once payment has been verified, eliminating the annoying need to personally receive a key. The need for Airbnb would be eliminated along with its cut of the transaction.
While the concept of blockchain holds a great deal of appeal, the book begins to get repetitive in later chapters and the authors perhaps reach too far when it comes to the promise of blockchain to “rebuild government and democracy”. The conceptual idea of using blockchain to improve voting practices and solve related problems might be attractive but it will take a very long period of time before such technologies are accepted and well understood, if such a time ever comes. People understand and generally have confidence in low technology solutions like paper ballots that can be recounted. Will such confidence exist with the blockchain proposals the authors make to improve the democratic process?
Returning to the question of bitcoin, one must closely examine the incentives government has when it comes to cryptocurrencies that have no central banking authority and leaves government with no control over monetary policy. The U.S. government has insisted on treating bitcoin as an asset, meaning that every single transaction involving the currency will involve a capital gain or loss for the user. This is a non-starter in terms of allowing bitcoin to operate as a medium of exchange. It is likely that those who are transacting in bitcoin today are doing so in order to profit from changes in the price of the currency rather than to utilize it as a medium of exchange. Governments are not going to readily accept the lack of control over monetary policy or the anonymity possible through the blockchain.
Blockchain Revolution presents an interesting concept and attempts to simplify the details to the point where the general business reader will understand the potential of blockchain. It could be an interesting read for those who wish to approach the subject with these limitations. However, many readers will seek a deeper understanding of blockchain. In addition, those who just want a surface level overview could accomplish that objective by reading a number of free resources on the internet. One cannot help but get the feeling that this book could have been condensed into a much shorter format or, alternatively, supplemented with a much more technical appendix. The end result is that it is not entirely satisfying for either the business or technical reader.