In this book, I set out to explain the basics of bitcoins and blockchains, and I hope that it has been easy to follow. At the very least, I have provided some ideas about concepts and terms for you to research further, and perhaps ignited a curiosity that you may not have had before.
Amid the hype, it is important to understand that the blockchain industry, including cryptocurrencies, business blockchains, and tokenisation of assets is very much in its infancy. Two important things seem to have been created:
1.New censorship resistant financial assets, methods of value transfer, and transparent automation
2.New technologies for business-to-business data and asset transfer
We can call these, respectively, a ‘crypto’ story and a ‘blockchain’ story.
The crypto story
Public blockchains are creating a new wave of censorship resistant digital assets and unstoppable automated computations. For the first time in history, people can transfer value electronically worldwide without needing specific third parties to approve the transaction. Payments can be sent to transparent smart contracts that guarantee certain outcomes without manual steps or needing to trust a third party to do what they have promised. Public blockchains are being explored for a wide range of uses from online micropayments through to remittances, fundraising and record keeping.
The blockchain story
Businesses are investing in private and public blockchains to see if they can reduce costs and risks, increase revenues, or create new business models. Private blockchains are a more recent idea than public blockchains, and are rapidly evolving and improving. These multi-party database systems promise to remove duplicative processes and allow digital assets and records to move freely between businesses, reducing reliance on expensive intermediaries.
Are these blockchains a bubble or fad? In my view, no. Both public and private blockchains have their roles and will continue to evolve and deliver value in ways we might not even be able to envisage today.
In the public cryptocurrency industry, innovation will continue to accelerate as tokens create financial incentives that attract developers and other staff. The speed and intensity of innovation will increase if popular cryptoassets increase in price. Many developers personally hold cryptocurrencies and tokens, and so are directly financially incentivised to make their projects successful, even more so than staff at traditional startups who often only have a tiny sliver of equity.
We will continue to see the tokenisation of assets, products, and services. Computer game items are a good candidate for this. Imagine being able to own the unique sword that a famous gamer used to defeat an opponent. Imagine owning the signed digital football that was used in an e-sports World Cup final. Or owning the digital shirt that a popular character wore during the match. There is an entire market of digital collectables that will be opened up. The confluence of e-gaming and cryptoassets is going to create some extremely exciting opportunities and new markets. E-sports and cryptoassets are a trend, not a fad, and it would be unwise to bet against them245.
ICOs will continue to be popular, and the industry will begin to standardise with best practices and common investor expectations. Perhaps one day we might figure out a way to value tokens. Regulations will become more clear, and this will enable those currently on the side-lines to participate.
Whether bitcoins, Ether, and other cryptocurrencies become more price-stable or not, we will see cryptoassets that have a stable price with respect to fiat currencies246. We can call these stablecoins or crypto-fiat. Fiat currency, or a near equivalent, will be tokenised and recorded on blockchains. Whether these crypto-fiat tokens are best issued by central banks, banks, e-money businesses, or somehow managed by smart contracts is still to be determined. There are a number of initiatives to create these price-stable tokens on both public and private blockchains. Stable cryptoassets will enable another cycle of innovation.
However, public blockchains are suffering growing pains as they grow in transaction volume and throughput. In recent years both Bitcoin and Ethereum have had periods of stress where miners couldn’t process transactions quickly enough, causing backlogs. Engineers are working on solutions to these problems, and concepts such as sharding and state channels can allow public blockchains to scale.
Forks and chainsplits will become more problematic due to the confusion that they create (which is the ‘real’ blockchain and which is the fork?). Proof-of-work is energy intensive and is polluting the planet. Ethereum may move from proof-of-work to proof-of-stake, a much less energy intensive block-writing mechanism, and if successful, other blockchains may follow suit.
As the amount of value recorded on blockchains increases, governance will too become increasingly important. Platforms with no formal governance may not be acceptable to some users. A public ledger called Hadera Hashgraph is experimenting with having a formal governance structure over a public and accessible distributed ledger.
Private blockchains will be adopted by businesses, perhaps first in small groups for specific uses, and then sooner or later they will come together to form larger networks, just as the internet was formed from individual private networks.
Assets and records represented digitally will change ownership at the speed of email with fewer steps and costs. We will learn how to use this technology to move documents across organisational boundaries—invoices, purchase orders, packing lists, certificates of origin, certificates of guarantee, health records, rental agreements… the list goes on. These documents are assets that can all be represented as tokens on distributed ledgers, with much stronger authenticity guarantees due to the use of digital signatures. Many digital documents should only be represented once, with the right parties having visibility into the latest version.
Whether between or within organisations, when data sets need to be passed from one system to another, the receiving system needs to be confident that it has the complete set of data, and the data hasn’t been corrupted in the process. This situation happens a lot in banking—often huge lists of trades need to be sent from one system to another. Often, there is a process, called a control process, that reconciles the data between the sending and receiving system. This reconciliation is yet another process that needs to be set up and monitored. But if the trades can be recorded and sent with a reference, a hash, to a previous trade in the set, then the receiving system can know for sure both that it has the complete set of trades, and that the data within the trades has not been altered by accident or malice. This means that a receiving system may be confident about the completeness and accuracy of data received, without performing a reconciliation against the sending system.
In the future, it will make little sense to manage any document or data set that needs to cross organisational boundaries using anything other than a blockchain.
These improvements will increase the velocity of business done within countries and across borders. This has a huge impact not only for the financial services industry, which is mostly about the movement of assets, but also for the real economy.
Smart contracts will enable business-to-business automation in a guaranteed way that hasn’t been possible before. Automation has tended to stop at the boundaries of businesses, with each business checking that the other one has performed according to the rules of the particular deal. With smart contracts, these rules can be automated and validated automatically, so duplicative processes can be made much more efficient, even eliminated.
Blockchains enable atomic transactions, transactions that make multiple changes to the ledger simultaneously or not at all. Atomic, because the changes are bundled together and indivisible. If two banks are engaging in a trade, perhaps one is buying a bond from another, two things happen: the bond changes ownership and the cash changes ownership. These transactions currently occur on separate ledgers, and one leg can fail while the other succeeds. This creates an operational risk that can lead to financial disaster247. On a blockchain, an atomic transaction can be created that includes both changes of ownership, the cash and the bond. That transaction is committed in its entirety, and either succeeds as a whole or fails. In finance this concept is called ‘delivery vs payment,’ and historically we have paid agents to guarantee this. Blockchain technology now provides the technological means to do this. This itself has the capacity to make entire business ecosystems operate more smoothly with less risk, while removing the need to pay third parties to perform the escrow service.
There are some potential uses for ‘special purpose money,’ for example, grants or charity contributions that may legitimately end up in only certain pre-agreed accounts. This has social and economic implications and we will need to learn how to use these tools ethically.
At first, private blockchains will be used to do the same kind of business as today but better, faster, and cheaper. They will improve how businesses interact. Later, there will be a shift, and industries will start to evolve their processes. They will improve what businesses do. Intermediaries who were once necessary will be sidestepped and their business models made irrelevant. This will drive down transaction costs and return value to the real economy. This will follow a similar curve to the adoption of desktop computers in businesses in the 1980s. First they were used to automate existing processes for individuals, then people began to see a whole new world of potential opening up.
The financial services industry is particularly at risk of disruption from this technology. Before blockchains, third party intermediaries were needed to keep track of digital assets. The ledger containing your money is controlled by your bank; the ledger containing your shares is in the hands of your share custodian. You’ve never been able to digitally own and directly control a financial asset: it has always been kept by a third party. The financial services industry is full of intermediaries who hold your assets. They are the ones who keep track of who owns what, and it is their job to prevent double spending. And they are rewarded handsomely for doing so, a cost you bear. However, with cryptoassets you really can hold and control your assets, though this has its risks. The blockchain is the ledger. So this technology must result in fewer intermediaries, and that is probably a good thing overall. Fewer financial intermediaries means fewer businesses that extract profit from the real economy.
There is a possibility that the distinction between public and private blockchains fades away, or that assets can jump between one blockchain and another with such ease that the blockchains themselves become a matter of preference and matter as little as which device you use to check your email.
We have already seen the start of disintermediation. In ICOs, huge sums of money are being transferred around the world without a bank in sight. In June 2016, I personally helped to arrange the custody of almost 25,000 bitcoins seized as proceeds of crime, worth $16m Australian dollars at the time248. The bitcoins were held in custody by EY, a professional services firm, for a month before being transferred to winners of a global auction. No bank was paid. No bank needed to be paid.
Financial intermediaries are scrambling to adopt blockchain technology to figure how they can evolve their business models to work in the new environment. Far-sighted companies at risk of disruption are already jostling for a position to adopt new roles in the new ecosystem.
Whether you are a proponent of public blockchains or private, whether you believe in the long-term viability of specific cryptocurrencies or not, and whether you think that decentralisation is a good thing or not, this industry is certainly delivering for society the most interesting and potentially radical instruments of change. Whether these tools will be used for good or for bad depends on how the technology is adopted, by whom, and for what purpose.