Blockchain Revolution (updated) Read online

  You may hear about other consensus mechanisms. The first version of the Ethereum blockchain—Frontier—also uses proof of work, but the developers of Ethereum 1.1 expect to replace it with a proof of stake mechanism. Proof of stake requires miners to invest in and hang on to some store of value (i.e., the native token of the blockchain such as Peercoin, NXT, etc.). They needn’t spend energy to vote. Other blockchains, such as Ripple and Stellar, rely on social networks for consensus and may recommend that new participants (i.e., new nodes) generate a unique node list of at least one hundred nodes they can trust in voting on the state of affairs. This type of proof is biased: newcomers need social intelligence and reputation to participate. Proof of activity is another mechanism; it combines proof of work and proof of stake, where a random number of miners must sign off on the block using a cryptokey before the block becomes official.9 Proof of capacity requires miners to allot a sizable volume of their hard drive to mining. A similar concept, proof of storage, requires miners to allocate and share disk space in a distributed cloud.

  Storage does matter. Data on blockchains are different from data on the Internet in one important way. On the Internet, most of the information is malleable and fleeting, and the exact date and time of its publication isn’t critical to past or future information. On the blockchain, bitcoin movement across the network is permanently stamped, from the moment of its coinage. For a bitcoin to be valid, it must reference its own history as well as the history of the blockchain. Therefore, the blockchain must be preserved in its entirety.

  So important are the processes of mining—assembling a block of transactions, spending some resource, solving the problem, reaching consensus, maintaining a copy of the full ledger—that some have called the bitcoin blockchain a public utility like the Internet, a utility that requires public support. Paul Brody of Ernst & Young thinks that all our appliances should donate their processing power to the upkeep of a blockchain: “Your lawnmower or dishwasher is going to come with a CPU that is probably a thousand times more powerful than it actually needs, and so why not have it mine? Not for the purpose of making you money, but to maintain your share of the blockchain,”10 he said. Regardless of the consensus mechanism, the blockchain ensures integrity through clever code rather than through human beings who choose to do the right thing.

  Implications for the Blockchain Economy: Rather than trusting big companies and governments to verify people’s identities and vouch for their reputations, we can trust the network. For the first time ever, we have a platform that ensures trust in transactions and much recorded information no matter how the other party acts.

  The implications for most social, political, and economic activity are staggering. It’s not just about who married whom, who voted for whom, who paid whom, it’s about any endeavor that requires trusted records and assured transactions. Who owns what? Who holds which rights to this intellectual property? Who graduated from medical school? Who bought guns? Who made these Nike shoes, this Apple device, or this baby formula? Where did these diamonds come from? Trust is the sine qua non of the digital economy, and a platform for secure and reliable mass collaboration holds many possibilities for a new kind of organization and society.

  2. Distributed Power

  Principle: The system distributes power across a peer-to-peer network with no single point of control. No single party can shut the system down. If a central authority manages to black out or cut off an individual or group, the system will still survive. If over half the network attempts to overwhelm the whole, everyone will see what’s happening.

  Problem to Be Solved: In the first era of the Internet, any large institution with a large established base of users, be they employees, citizens, customers, or other organizations, thought little of their social contract. Time and time again, central powers have proven that they’re willing and able to override users, warehouse and analyze user data, respond to government requests for data without users’ knowledge, and implement large-scale changes without users’ consent.

  Breakthrough: The energy costs of overpowering the bitcoin blockchain would outweigh the financial benefits. Satoshi deployed a proof-of-work method that requires users to expend a lot of computing power (which requires a lot of electricity) to defend the network and mint new coins. He was inspired by cryptographer Adam Back’s solution, Hashcash, to mitigate spam and denial-of-service attacks. Back’s method required e-mailers to provide proof of work when sending the message. It in effect stamped “special delivery” on an e-mail to signal the message’s importance to its sender. “This message is so critical that I’ve spent all this energy in sending it to you.” It increases the costs of sending spam, malware, and ransomware.

  Anyone can download the bitcoin protocol for free and maintain a copy of the blockchain. It leverages bootstrapping, a technique for uploading the program onto a volunteer’s computer or mobile device through a few simple instructions that set the rest of the program in motion. It’s fully distributed across a volunteer network like BitTorrent, a shared database of intellectual property that resides on tens of thousands of computers worldwide.

  To be sure, this shields the network from the hands of the state, which could be good or bad depending on the situation—say a dissident in a totalitarian country fighting for women’s rights versus a criminal in a democratic country conducting extortion. Totalitarian regimes could not freeze bank accounts or seize funds of political activists. States could not arbitrarily seize assets on the blockchain as Franklin Delano Roosevelt’s administration did through FDR’s Executive Order 6102, which required citizens to turn their “gold coin, gold bullion, and gold certificates” over to the government or risk fines or imprisonment.11 Josh Fairfield of Washington and Lee University put it bluntly: “There’s no middleman to go after anymore.”12 The blockchain resides everywhere. Volunteers maintain it by keeping their copy of the blockchain up to date and lending their spare computer processing units for mining. No backdoor dealing. Every action or transaction is broadcast across the network for subsequent verification and validation. Nothing passes through a central third party; nothing is stored on a central server.

  Satoshi also distributed the mint by linking the issuance of bitcoins to the creation of a new block in the ledger, putting the power to mint into all the hands of the peer network. Whichever miner solved the puzzle and submitted proof of work first could receive a number of new bitcoins. There is no Federal Reserve, central bank, or treasury with control over the money supply. Moreover, each bitcoin contains direct links to its genesis block and all subsequent transactions.

  So no intermediaries are required. The functioning of the blockchain is mass collaboration at its best. You have power over your data, your property, and your level of participation. It’s distributed computing power enabling distributed and collective human power.

  Implications for the Blockchain Economy: Perhaps such a platform could enable new distributed models of wealth creation. Perhaps new kinds of peer-to-peer collaborations could target humanity’s most vexing social problems. Perhaps we could solve the crisis of confidence and even legitimacy in today’s institutions by shifting real power toward citizens, equipping them with real opportunities for prosperity and participation in society, rather than through PR trickery.

  3. Value as Incentive

  Principle: The system aligns the incentives of all stakeholders. Bitcoin or some token of value is integral to this alignment and correlative of reputation. Satoshi programmed the software to reward those who work on it and belong to those who hold and use its tokens, so that they all take care of it. Sort of the ultimate Tamagotchi, the blockchain is a globally distributed nest egg.13

  Problem to Be Solved: In the first era of the Internet, the concentration of power in corporations, combined with their sheer size, complexity, and opacity, enabled them to extract disproportionate value from the very networks that endowed them with rights. Large banks exploited the financial system to its breaking point beca
use “incentive structures for most of the top executives and many of the lending officers of these banks [were] designed to encourage short-sighted behavior and excessive risk-taking,” according to economist Joseph Stiglitz. That included “preying on the poorest Americans.” He summed up the problem: “If you give people bad incentives, they behave badly, and they behaved just as one would have expected.”14

  Large dot-coms dangled free services in retail, search, and social media in exchange for user data. According to an Ernst & Young survey, nearly two thirds of managers polled said they collected consumer data to drive business, and nearly 80 percent claimed to have increased revenues from this data mining. But when these firms get hacked, it’s the consumers who have to clean up the mess of stolen credit card and bank account information. It’s not surprising that, in the same survey, nearly half of consumers said they’d be cutting off access to their data in the next five years, and over half said they were already providing less data, including censoring themselves on social media, than in the previous five years.15

  Breakthrough: Satoshi expected participants to act in their own self-interests. He understood game theory. He knew that networks without gatekeepers have been vulnerable to Sybil attacks, where nodes forge multiple identities, dilute rights, and depreciate the value of reputation.16 The integrity of the peer-to-peer network and the reputation of its peers both diminish if you don’t know whether you’re dealing with three parties or one party using three identities. So Satoshi programmed the source code so that, no matter how selfishly people acted, their actions would benefit the system overall and accrue to their reputations, however they chose to identify themselves. The resource requirements of the consensus mechanism, combined with bitcoins as reward, could compel participants to do the right thing, making them trustworthy in the sense that they were predictable. Sybil attacks would be economically unviable.

  Satoshi wrote, “By convention, the first transaction in a block is a special transaction that starts a new coin owned by the creator of the block. This adds an incentive for nodes to support the network.”17 Bitcoin is an incentive for miners to participate in creating a block and linking it to the previous block. Those who complete a block first get a quantity of bitcoins for their efforts. Satoshi’s protocol rewarded early adopters handsomely with bitcoin: for the first four years, miners received 50 bitcoins (BTC) for each block. Every four years, the reward per block would halve: 25 BTC, 12.5 BTC, and so on. Because they now own bitcoin, they have an incentive to ensure the platform’s long-term success, buying the best equipment to run mining operations, spending energy as efficiently as possible, and maintaining the ledger. Bitcoin is also a claim on the blockchain, not just as an incentive to participate in mining and transacting with others but through ownership in the platform itself. Distributed user accounts are the most basic element of the cryptographic network infrastructure. By owning and using bitcoin, one is financing the blockchain’s development.

  Satoshi chose as the economic set the owners of computing power. This requires these miners to consume a resource external to the network, namely electricity, if they want to participate in the reward system. Every so often, different miners find two equally valid blocks of equal height, and the rest of the miners must choose which block to build on next. They generally pick whichever they think will win rather than building on both, because they’d otherwise have to split their processing power between the forks, and that’s a strategy for losing value. The longest chain represents the greatest amount of work and therefore participants choose it as the canonical state of the blockchain. In contrast, Ethereum chose owners of coin as its economic set. Ripple and Stellar chose the social network.

  The paradox of these consensus schemes is that by acting in one’s self-interest, one is serving the peer-to-peer (P2P) network, and that in turn affects one’s reputation as a member of the economic set. Before blockchain technologies, people couldn’t easily leverage the value of their reputation online. It wasn’t only because of Sybil attacks, where a computer could inhabit multiple roles. Identity is multifaceted, nuanced, and transient. Few people see all sides, let alone the subtleties and the arc of our identity. For different contexts, we have to produce some document or other to attest to some detail of our identity. People “without papers” are confined to collaborating with their social circle. On blockchains like Stellar, that’s an excellent start, a means of creating a persistent digital presence and establishing reputation that is portable well beyond one’s geographic community.

  Another breakthrough to preserve value is the monetary policy programmed into the software. “All money mankind has ever used has been insecure in one way or another,” said Nick Szabo. “This insecurity has been manifested in a wide variety of ways, from counterfeiting to theft, but the most pernicious of which has probably been inflation.”18 Satoshi capped the supply of bitcoins at 21 million to be issued over time to prevent arbitrary inflation. Given the halving every four years of bitcoins mined in a block and the current rate of mining—six blocks per hour—those 21 million BTC should be in circulation around the year 2140. No hyperinflation or currency devaluation caused by incompetent or corrupt bureaucracies.

  Currencies are not the only assets that we can trade on the blockchain. “We’ve only begun to scratch the surface on what’s possible,” said Hill of Blockstream. “We’re still at that 1994 point in terms of applications and protocols that really take advantage of the network and show the world, ‘Here’s what you can do that is totally groundbreaking.’”19 Hill expects to see different financial instruments, from proof-of-asset authenticity to proof-of-property ownership. He also expects to see bitcoin applications in the Metaverse (a virtual world) where you can convert bitcoin into Kongbucks and hire Hiro Protagonist to hack you some data.20 Or jack yourself into the OASIS (a world of multiple virtual utopias) where you actually do discover the Easter egg, win Halliday’s estate, license OASIS’s virtual positioning rights to Google, and buy a self-driving car to navigate Toronto.21

  And, of course, there’s the Internet of Things, where we register our devices, assign them an identity (Intel is already doing this), and coordinate payment among them using bitcoin rather than multiple fiat currencies. “You can define all these new business cases that you want to do, and have it interoperate within the network, and use the network infrastructure without having to bootstrap a new blockchain, just for yourself,” said Hill. 22

  Unlike fiat currency, each bitcoin is divisible to eight decimal places. It enables users to combine and split value over time in a single transaction, meaning that an input can have multiple outputs over multiple periods of time, which is far more efficient than a series of transactions. Users can set up smart contracts to meter usage of a service and make tiny fractions of payments at regular intervals.

  Implications for the Blockchain Economy: The first era of the Internet missed all this. Now we have a platform where people and even things have proper financial incentives to collaborate effectively and create just about anything. Imagine online discussion groups where participants have reputations worth enhancing, in part because bad behavior will cost them financially. Trolls need not apply. Imagine a peer-to-peer network of solar panels where home owners receive real-time compensation on the blockchain for generating sustainable energy. Imagine an open source software project where a community of developers compensates supercontributors for acceptable code. Imagine there’s no countries. It isn’t hard to do.23

  4. Security

  Principle: Safety measures are embedded in the network with no single point of failure, and they provide not only confidentiality, but also authenticity and nonrepudiation to all activity. Anyone who wants to participate must use cryptography—opting out is not an option—and the consequences of reckless behavior are isolated to the person who behaved recklessly.

  Problem to Be Solved: Hacking, identity theft, fraud, cyberbullying, phishing, spam, malware, ransomware—all of these undermine the sec
urity of the individual in society. The first era of the Internet, rather than bringing transparency and impairing violations, seems to have done little to increase security of persons, institutions, and economic activity. The average Internet user often has to rely on flimsy passwords to protect e-mail and online accounts because service providers or employers insist on nothing stronger. Consider the typical financial intermediary: it doesn’t specialize in developing secure technology; it specializes in financial innovation. In the year that Satoshi published his white paper, data breaches at such financial firms as BNY Mellon, Countrywide, and GE Money accounted for over 50 percent of all identity thefts reported that year, according to the Identity Theft Resource Center.24 By 2014, that figure had fallen to 5.5 percent for the financial sector, but breaches in medical and health care jumped to 42 percent of the year’s total. IBM reported that the average cost of a data breach is $3.8 million, which means that data breaches have cost at least $1.5 billion over the last two years.25 The average cost to an individual of medical identity fraud is close to $13,500, and offenses are on the rise. Consumers don’t know which aspect of their life will be hacked next.26 If the next stage of the digital revolution involves communicating money directly between parties, then communication needs to be hackproof.

  Breakthrough: Satoshi required participants to use public key infrastructure (PKI) for establishing a secure platform. PKI is an advanced form of “asymmetric” cryptography, where users get two keys that don’t perform the same function: one is for encryption and one for decryption. Hence, they are asymmetric. The bitcoin blockchain is now the largest civilian deployment of PKI in the world, and second overall to the U.S. Department of Defense common access system.27