Who is gonna make it? We’ll find out in the long run.
There are a multitude of potential applications of distributed ledger technology – including financial transactions applications, control of one’s electronic identity, accounting applications, inventory control, and back-office securities clearing, to name a few. This article, and my others, focuses on financial transactions applications.
The debate rages on between the “permissioned” blockchain establishment — the big banks, such as Bank of America (NYSE:BAC), Citigroup (NYSE:C), JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), UBS (NYSE:UBS), and others investing in their handmaidens, such as R3-CIV and Digital Asset Holdings — and the “public” outcasts, such as Bitcoin and Ethereum. I find myself vacillating.
My conclusion is that Bitcoin will most likely be the dominant public blockchain, and public blockchains will ultimately be far more important than private blockchains. But that in the coming decade, permissioned blockchains are likely to accomplish more. In other words, for public blockchains to meet their enormous potential, patience is required.
The reason I expect the development of public blockchains to be so slow is that they are more than a technology. They are a nascent political and social movement.
Case for a public blockchain. The public blockchains, such as Bitcoin and Ethereum, include the most startling and drastic changes in technology in the distributed ledger field. In my recent article, ” Remember Satoshi: Blockchain Economics And Law,” I discuss the first of these three changes. In his September 10 article, ” The Blockchain: An Experiment in Governance Without Power,” Ariel Deschapell provides a fascinating discussion of the other two changes:
- Mining. Bitcoin, the innovative platform from which practical blockchain technology was launched, converts the costs associated with hacking borne, without being accounted for, by the existing firewall technology, into a valuable economic resource. This is accomplished by attracting the computing power that might otherwise be employed by hackers, to more profitable use in information protection by miners.
- Trustlessness. The verification of transactions depends on the economic incentives of the verifier, so a trusted identity is pointless. The choice on the Bitcoin network of a single block is a choice based on each miner’s self-interest. There is no need for “consensus” or other forms of ad hoc approval from miners, or other authorities with dubious provenance – such as the Etherium overlords who disastrously intervened to “fix” the DAO hack. (For background on the DAO hack, see my discussions of the DAO hack and cogent comments by Jason Cawley, Martin Lowy and others, in ” Ethereum’s ‘Smart’ Fantasy World Dies: The Effect On The Banks” and ” Too Big To Fail And The Ethereum DAO Hack“).
- Governance without individual delegation of power. The dawn of a different kind of governance, where unilateral power does not exist. Something better than, or at least different from, democracy. Legal scholars call this “Polycentric Law.” Polycentric Law, explains Tom W. Bell, here, is law that “… regards the legal services that governments provide-defining rules, policing their application, and settling disputes-as a ripe field for competition.” Bell adds, “In contrast to the legal monopolies most of us think of as ruling our lives which, due to absence of competition, neglect our needs, in a polycentric system, providers of legal services care more about what consumers want. They have to, if they don’t want to go out of business.”
These are big, bold, ideas, yet elegant in their simplicity. What is amazing is that they were so easily and successfully applied with Bitcoin.
Case for a permissioned blockchain. Jerry Cuomo, Vice President of Blockchain Technologies at IBM (NYSE:IBM), presents a case for permissioned blockchains here. Permissioned blockchains differ from public blockchains because of the underlying goal. The design of the permissioned blockchain network imposes control upon users.
The three functions performed by users of any blockchain network are: read, write, and validate.
- Reading: the ability to read the data that resides on the blockchain.
- Writing: the ability to append data to the blockchain.
- Validation: filtering out the entries of writers deemed invalid by validators; then deciding on the exact order for the remaining validated transactions.
Every writer’s entries begin their lives on the network as proposed transactions. Once approved by validation, an approved transaction becomes part of the collection of valid transactions.
Cuomo argues for two reasons why only permissioned blockchains may be applied to financial transactions:
- Regulatory requirements. Permissioned blockchains alone can conform to data protection regulations. He states:”permissioned blockchains are the only systems that can enforce policies that can constrain both access to data, and participation in the network, based on identity.” This is necessary in the case of financial transactions, due to government-mandated protection of personal data maintained by financial institutions. In addition, regulations require that data validators must be vetted and known. There must be a method for adding and deleting validators from the system, assuring that they meet regulatory requirements.
- Controlled data consistency. The second issue raised by public blockchains, that permissioned blockchains avoid, is the temporary creation of a “soft fork.” What is a soft fork? In a soft fork, for whatever reason, two validators approve different blocks. This is temporary because as the other validators examine these blocks, one of the two inevitably attracts more validators, resulting in abandonment of the invalid block. Yet, as Cuomo observes, in the split-second decision-making of financial transactions, many decisions could be mistakenly based on an ultimately abandoned block. Permissioned blockchains, says Cuomo, do not have soft forks.
What to make of this debate? Through the filter of Bell’s Polycentric Law, it becomes clear that Cuomo’s argument for permissioned blockchains is based on Bell’s Monopolistic Law. The regulatory rules Cuomo describes are either promulgated by a single lawmaker or by few lawmakers that reach agreement in the form of a single set of regulations. Permissioned blockchains are thus native to a single set of laws and regulations.
One can thus look to Deschapell’s description of Bitcoin to see that one essential genius of the Bitcoin network is that it allows for competing regulatory systems to coexist on a single Bitcoin network. Contrary to the common belief about governance expressed by Francis Fukuyama,
What we may be witnessing … is the end point of mankind’s ideological evolution and the universalization of Western liberal democracy as the final form of human government.”
Bitcoin has the putative capability to permit multiple financial systems, with associated regulations, each on a different subnetwork.
This ability creates an opportunity for each user. Based on the user’s desired set of regulations; the capabilities of the subnetwork, such as speed of transaction execution; and the capabilities of the other network users; the choice of sub-network can be made. As these subnetworks compete for users, opportunities for users would multiply through competition among network regulators and service providers.
This completion will work beautifully for blockchain service providers such as IBM. Every subnetwork will need their help building permissioned blockchains. For a discussion of how IBM, Microsoft (NASDAQ:MSFT), and Accenture (NYSE:ACN) are like storekeepers in a gold rush, see my recent ” What Will Microsoft And IBM Do In The Blockchain World? It’s good to be a shopkeeper in a gold rush.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.