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Because we have to regulate the blockchain

Ken Thompson, the co-creator of the Unix operating system, received the prestigious Turing Award from the Computer Computing Association in 1984. In his acceptance speech, he did something strange. He chose not to speak of Unix at all; instead, he spoke of trust. Computer security can never be proven unquestionably, said Thompson, because the software writer can incorporate malicious code that is invisible to external observers. "You can not trust the code that you have not completely created yourself," he concluded. Instead, you must trust the people who wrote the code. Humans are always in the cycle.

Three decades later, that principle remains true. With Bitcoin, Satoshi Nakamoto has created a new decentralized trust architecture. It did not exceed the need for trust. Just as a map is not the same as the territory it covers, a computer system implemented in the real world never corresponds to its idealized description. Many ideas that look great on paper shrink in the face of the complications of the real world. Most people do not change their behavior during the night. Building technology platforms that work on a large scale and integrate with existing systems takes time and often involves false starts. Sometimes the real problems are not those that the blockchain can solve. Sometimes the incentives for adoption are not as strong as it seems in the bubble of blockchain fans. Incumbents have significant advantages and are not necessarily stuck in the face of innovation. Success is far from guaranteed.

Several examples of revolutionary blockchain opportunities failed to meet expectations. A pioneering venture to register land titles on a blockchain in Honduras, thereby empowering individuals, has failed among disputes with local officials. A company that according to the observers would "transform the music industry" with the blockchain technology offered to the singer / songwriter "Tiny Human" on Ethereum with great fanfare … and generated a turnover of $ 133, as reported by the critic blockchain David Gerard. A prominent and well funded start-up blockchain, which promised to cut the cost of remittances between immigrants and their families, took two years to start in its first country and had fewer than seventy-five users a day the next year . None of these examples means that the companies involved, or the use cases promoted, are doomed to failure. Perhaps they were simply too early. But they should be warning notes for those who consider the triumph of the blockchain as inevitable.

Furthermore, Internet experience should pause those who make reliable predictions about the social impacts of Blockchain. The Internet is an extraordinary tool for freedom of speech all over the world, but it is also the mechanism that repressive governments now use to control their populations. Social media have united people, but they have also nurtured communities of disinformation campaigns sponsored by the state and hate. Uber provides people around the world with efficient access to transport, but also offers a huge power to society that has repeatedly abused. The blockchain has similar potential to use for good and evil. The same corrosive forces that gave rise to the modern crisis of confidence could weaken or corrupt its solutions.

Just because the blockchain provides a better mousetrap does not mean it will restructure the world. The main systems established are generally more resilient than they appear. For example, the longitudinal research of Professor Thomas Philippon of New York University (NYU) concluded that "the unit cost of financial intermediation seems to be high today as it was around 1900." Despite the introduction of the telephone, the computer, the Internet, the cloud and all the other technological innovations of the last century, it costs more or less the same in real terms to carry out transactions in the financial markets as in the past. The volume and sophistication of assets grew dramatically, but transaction costs were also represented in the financial services sector. Philippon speculates that when basic services become goods, new, more expensive products emerge, such as asset management, in a continuous effort to beat the market.

An interpretation of this result, from NYU colleague David Yermack, is "that there is really a desperate need for technology to come, to reduce the cost of financial intermediation, probably by order of magnitude. Opportunities for innovations in financial technology (fintech) including distributed ledger technology, but the question is why these innovations would be more likely to change these dynamics.Financial transactions on a distributed ledger could be much cheaper than doing it through a collection of reconciled databases and could give rise to many new services, the same goes for moving from paper documents to computer records, from mainframes to room-size to cloud storage of the Internet. today's JPMorgan Chase is more sophisticated light years than the firm created by John Pierpont Morgan in 1895. T uttavia occupies a similar role in the interstices of finance.

What would really change the economics of financial services – and other sectors – is a fundamental change in the structure of the sector. The tokenization model, in which the value resides in the network rather than in its control operator, offers this potential. If the big players in the middle no longer got a comparative advantage from their size, they could actually produce the dramatic changes in power described by the blockchain buster. Entrepreneurs with great ideas would no longer be at the mercy of venture capitalists and other financial porters. Musicians and authors should not give excessive control and most of the profits to music labels and publishers. Developers of innovative technologies would overcome the inertia of less efficient incumbent approaches. The economic opportunity would be open to more people around the world, especially in low-income regions. Governments would be more effective in serving their citizens and at the same time meddling in their lives less. Even looming businesses could benefit, but they would need to become more transparent and more dedicated to serving their users.

All these potential transformations are tremendously exciting. But they are not inevitable. And as the financial sector illustrates, even the technological transformations that preserve the structures of the market can produce enormous innovations. The correct answer to the blockchain, therefore, is not to get out of the way of inexorable rupture, but to get involved. What matters is not the industries that technology could theoretically transform, but the markets and practices that will actually change. The way to separate the two is to immerse themselves under the superficial commotion of press releases, loan announcements and cryptocurrency prices.

Even when distributed ledger technology is applied in contexts where it can add significant value, there are significant uncertainties and dangers. Satoshi Nakamoto has come up with a new and valuable approach to distributed trust, but is far from a perfect solution. Some challenges can not be overcome by any technology. The same wave of hype that has produced Whoppercoin leads many to think that the blockchain can not fail. In fact, even if the fundamental security of a distributed consensus remains intact, many things can go wrong. And there are many reasons why pilot projects or start-ups announced with great fanfare do not achieve their stated goals.

To reach their potential, systems built around blockchain technology will need strong confidence. The blockchain vision considers trust as a public good rather than a source of private advantage. Participants in public blockchains will have to trust a decentralized model in which no one, apparently, is responsible. Companies on networks of authorized distributed registries will have to trust that they can share control. And across the board, governments will have to trust that their citizens will be protected, taxes will be paid and abuses can be controlled. This means that blockchain-based solutions will have to interact with governance and law mechanisms.

The limits of decentralization

The decentralization of the Blockchain has limits. This is also true for Bitcoin, perhaps the purest decentralized cryptocurrency. Bitcoin users trust the code issued by the main developers, and that code incorporates hard-coded elements such as "checkpoints", beyond which the blockchain can not be bifurcated. And bitcoin companies are actually quite concentrated. According to an analysis at the end of 2017, only 1,000 accounts contained 40% of the currency and 100 held more than 17%. The concentration of some initial token tokens (ICO) is even more extreme. Brave raised $ 35 million, but two-thirds of tokens went to just twenty holders.

The main points of residual centralization for public blockchains, however, are the miners and the main developers. Bitcoin works because the consent of Nakamoto aligns the economic interests of the miners and users of the network. The vision of the Bitcoin whitepaper was that mining would be a low-intensity activity that normal users could engage in. There would be millions of miners all over the world, all of whom would put the processing power at work for the hope of earning prizes. In fact, for the early years of Bitcoin's existence, this was a relatively accurate description.

However, as the price of bitcoin – and the corresponding benefits from mining – increased, the competition between miners increased dramatically. Dedicated mining companies have started to create specialized hardware optimized for Bitcoin puzzles. In the end, they moved to design their own custom chips, called application-specific integrated circuits (ASICs), to power huge racks of mining computers. The performance of these ASICs was much larger than the alternatives that, in effect, mining became a game of scale. Operators like Bitmain and Bitfury have achieved a lasting advantage thanks to their mastery of ASIC design.

Mining basins have accelerated this trend. Each Bitcoin miner had to compete with others to earn block premiums, but mining groups realized that they could achieve better results by joining their earnings. Instead of each miner who has received nothing most of the time and a boon when he successfully solved a block, the pools divide their payments in proportion to the hashing power he has brought. This has made payments more stable and more predictable, further accelerating the marketing of the mining sector. The fact that ASIC developers could outsource some of their risk of hardware obsolescence to small-scale miners was another incentive.

The final step towards mining consolidation was the transition to the mining economy when processing power increased. The costs of hardware and bandwidth have become a smaller percentage of total expenses than electricity to power the computer and to prevent overheating of the machines. Therefore, those with access to cheap or free electricity, especially in premises that have made it easy to use and cool massive server farms, have had an advantage. Relations with local or national authorities that control electricity supplies have become a competitive differentiator for miners.

Less than ten groups dominated the extraction of Bitcoin by 2017. Most were Chinese mining tanks. (Bitfury, which manages its data centers and sells hardware only to large buyers, is the main exception). Ethereum mining is also very concentrated, even if its consent algorithm is designed to be resistant to ASIC. The concentration of mines calls into question the basic premise that public chains are decentralized. Collusive miners could, like the Japanese keiretsu networks of the major corporate groups, create a competitive external market that actually serves a small coalition of private and government interests. Increasing the price of cryptocurrencies also increases the amount of money that must be earned through labor proof. The mining operations for Bitcoin and Ethereum now generate several million dollars a day of revenue from their blocking premiums. And with the downsizing challenges Bitcoin has faced, transaction fees have also increased. It can be expected that mining pool operators maximize their profits. There is no reason for them to promote the decentralization of the Bitcoin network if this conflicts with their economic interests.

Ethereum and other networks hope to limit the miners' power by switching the consent algorithm to the stake test. The mail proof replaces computationally intensive mining with coin stakeout. Even if he succeeded, however, the pole test could promote the centralization of a different type by giving large holders of cryptocurrency – which have more chances to bet – a greater power over its development.

Miners are not the only group of concentrated blockchain interest. Developers working in basic software also tend to be small groups that exert a great deal of power. Satoshi Nakamoto and some colleagues created the original implementation of Bitcoin in 2009, but has since been significantly revised and expanded. The implementation of a scalable, reliable and bug-free network requires constant efforts. Hyperledger and R3 follow a more consolidated model for open source software projects of interest to large companies. They have corporate members who contribute to the funding and the code, along with consolidated governance structures for those members.

Coinbase co-founder Fred Ehrsam estimated in mid-2017 that there were only about fifteen primary developers each for the Bitcoin and Ethereum platforms. Important infrastructure projects such as Lightning Network, which hopes to create a new level of application that greatly improve the performance of the Bitcoin network, are managed with limited budgets. For projects that manage cryptocurrencies with assets of tens of billions of dollars, on which companies around the world have focused their future, these are small numbers. The small number of major developers keeps these projects agile, but raises the question of whether they can handle the load. Both projects have much larger communities of committed developers, but they depend on the work of the main group.

From the Bitcoin perspective, although there is a Bitcoin Foundation with the mission to promote the protocol, most key developers are paid by third parties such as the MIT Digital Currency Initiative, the Blockstream venture-backed startup and the ChainCode self-financed Labs. The Bitcoin Core developers are actually a very connected group, which often do not agree. Only a handful of these have "committed" access to update the official Bitcoin Core software repository, and there is no formalized process to guarantee this power.

The Ethereum Foundation has a stronger position in the Ethereum ecosystem. Thanks to its crowdsale 2014, it has resources to finance the main developers. He also has a "benevolent dictator" leading the project in Vitalik Buterin. Finally, the Ethereum community norms tend to be more collaborative than those of Bitcoin. This model is parallel to that of other successful open source projects, in particular the Linux Foundation led by Linus Torvalds, but it creates a certain tension with the notion of Ethereum as a truly decentralized system.

The distributed trust model of blockchain systems is based on the fact that power is concentrated in the network itself. Validators are encouraged to participate but have no control over transactions. Tokens that deal with token sales replicate this structure on the next higher level. The value of the network is in the currency, which is distributed between users and other token holders. It is not centralized in the network operator, unlike centralized information and social media platforms. The network is the infrastructure, which creates value for everyone. Yet nobody is automatically responsible for financing that infrastructure.

This creates the potential for a tragedy of common goods. Developers, users and applications token holders benefit from good engineering of blockchain platforms, but do not necessarily contribute to it. The networks that recorded profitable token sales during the ICO boom were able to monetize to support development before launch. Then again, they face expectations proportionate to the scale of their sales.

The fact that miners and central developers can exert influence on the direction of a blockchain system does not undermine the basic demand for decentralization. There is no entity that can launch a magic switch and alter the network. The power to alter the protocol, such as changing the block size, is different from the power to change the information recorded on the ledger. The immutability holds up as long as the network is collectively more powerful than an attacker.

What are the limits of the decentralization of blockchain means that governance and regulation issues can not be ignored. These systems depend on trust and trust depends on the collective decisions of those who shape the platform.

Centralization has benefits. In 2013, a Bitcoin Core software update accidentally triggered a potentially catastrophic hard fork. The Bitcoin community quickly recognized that the best course of action was to downgrade to the previous version by destroying the fork. The main developers were able to reach consensus in less than an hour through online chat conversations. The correction was implemented quickly because the BTC mining pool Guild, which controlled 20-30% of the Bitcoin mining power, put its weight behind the change. A more decentralized community may not have been able to respond in time to avoid a crisis.

On the other hand, if a country wants to repress a blockchain-based business, it has ways to get the purchase. The network could not be completely shut down if enough nodes were located outside its boundaries. It could, however, effectively threaten local users, miners and exchanges that convert cryptocurrencies into and out of legal currencies. China did just that in mid-2012. It banned Bitcoin exchanges and tokens, for worries about financial fraud and capital flight. However, shortly after Yao Qian, head of the Digital Currency Research Institute of the People's Bank of China, asked the Chinese central bank to issue its own cryptocurrency.

From all indications, the Chinese leaders understand very well how the soft economic power, embedded in mechanisms like the Marshall Plan after the Second World War and Treasury Bills as a global reserve currency, has helped make the United States the world's solitary superpower . Tokenising the Chinese renminbi before other major legal currencies is a potential path to such a soft power in the twenty-first century. Russia seems to have similar designs. The extraction of cryptocurrencies could even become a strategic technology for major nations, such as atomic physics during the Second World War or supercomputing during the Cold War.

These are speculative scenarios today. Whatever happens, the basic assumption that blockchain public networks are hostile to centralized private or public control must be qualified. If cryptocurrencies become more significant in both financial and political terms, those responsible today will not be powerless to shape them.

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Adapted from Blockchain and Kevin Werbach's New Architecture of Trust. Copyright 2018. Used with permission from The MIT Press.

Kevin Werbach

Kevin Werbach


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