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How the blockchain inaugurates a new form of trust

417XJdJGkdL Blockchain is one of the biggest words of technology today. But confusion Exists on exactly what it is: blockchain is often mentioned in the same breath as bitcoins and other cryptocurrencies, but it includes much more than that.

Kevin Werbach, a professor of legal studies and business ethics at Wharton and a blockchain expert, has written a book that explains this technology with great depth and precision. For example, he points out that the bitcoin refers to the cryptocurrency, while Bitcoin includes the bitcoin network.

He recently joined Knowledge @ Wharton to talk about his book, The Blockchain and the new architecture of trust. Below is a modified transcription of the conversation.

The knowledge @ Wharton: What interested you in bitcoin and blockchain?

Kevin Werbach: Study emerging technologies. I'm a law scholar with training courses, but I'm interested in Internet-related technologies that have significant impacts on the business. And like many people, I first heard about bitcoin several years ago, when it was still very small, and I found it fascinating.

The idea that it was possible to create money – something that stored value in a decentralized way – and that really worked, that people actually believed it was valuable, I found it extremely interesting. But it was only after the entire blockchain space developed and turned into a larger business environment a few years later that I began to focus more and more on my research in this area.

Because in reality the blockchain is a fusion of law, economics, technology, economics – all these different areas where I have some skills and where I think there are really huge opportunities to create new types of organizations and new types of [businesses].

The knowledge @ Wharton: It's really in your wheelhouse. One thing about your book that struck me is that it makes a great effort to be precise about a topic that confuses many people. So maybe we could start with your explanation of the difference between bitcoin and blockchain.

Werbach: This is important. One of the reasons I wrote the book was because I was talking to many people – senior business executives, policymakers and others – who were smart people, people with technical knowledge, who told me, "I do not take it this blockchain thing. "Or," I do not understand this bitcoin thing. "I do not necessarily reject it, I simply do not understand what's going on." And so, I tried to write something that was a profound and substantive treatment of the problems. It enters into legal issues and political questions, but this begins with the articulation for a wide audience of what is happening here.

"Blockchain is basically a family of transaction ordering technologies, to have a decentralized database type where there is no actor controlling it".

The first piece of this is that there are actually several different related phenomena. Bitcoin was the first piece to come on the scene. The bitcoin white paper was released on Halloween in 2008, and the Bitcoin network started operating at the beginning of 2009. So it's now about a decade. Bitcoin is a form of private digital money. So, the idea with bitcoin was: we can create something that has the same functions as money – which means that people trust that it is still valid, can be used as a medium of exchange, or a store of value, or a unit of account in theory – without a central entity issuing or validating the transactions?

This was really the starting point for the entire blockchain space. Although it turns out that, when considering bitcoin technically, it was actually based, in many cases, on previous work done in related areas, which has now been used in some of these implementations other than bitcoin.

The knowledge @ Wharton: Blockchain is the technology behind bitcoin, and is this what makes it different?

Werbach: Bitcoin is what is called a cryptocurrency. And a cryptocurrency is fundamentally a sign of value on one of these decentralized networks. The broader term for decentralized networks is Distributed Ledger or DLT technology. And that includes a wide range of things.

On the one hand, [we have] those that are called open systems and without authorization as bitcoins – there are now something like 1,600 other cryptocurrencies that are out there, although most of them are not particularly used or valuable – and this allows anyone to be on the network. Not just anyone can make a transaction, but in most cases, anyone can be a validator, can be in the role of verifying that transactions are accurate. And what's extraordinary is that these technologies make it reliable to have this system, even if anyone can be on the network.

Those are the cryptocurrencies. And they are based on these underlying networks called blockchains. And blockchain is basically a family of technologies to sort transactions, to have a decentralized database type where there is no actor controlling it, where most parties have control.

But there is still confidence that everyone sees exactly the same thing. The network enters what is called "consent". So at any moment, you can be sure that we all see the same information – the same transactions in the same order. For something like bitcoin or cryptocurrency, it means that we all see the same cash balances in our accounts. But it is much wider.

The knowledge @ Wharton: A lot of people think that, when it comes to bitcoin blockchain, it's really a system that does not need trust. Instead, you are arguing that the blockchain actually represents a new form of trust.

Werbach: This is one of the key mistakes I see people doing. And again, one of the things that motivated me to write the book, I saw all these conversations in the blockchain and cryptocurrency world talking about this technology without trust. And the idea was that, well, trust is dangerous. If we trust someone, they could abuse our trust. They could take advantage of us. We see it with private companies.

For example, people stored their data with Equifax and their data was stolen, so they trusted something unreliable. Or Facebook, which has had all these problems with Cambridge Analytica and privacy violations, and so on. This is part of the concern. So the topic is: let's get rid of trust. We make a system where we do not have to trust anything but technology. And we can look at the code, and it's based on cryptography, which is the security of mathematical information. And that's all we need.

The point I am making is that, although it is true, and I think it is true, and these cryptocurrencies and blockchain systems have been able to develop a solid trust in the ledger itself – in the fact that this resource has gone from this person or this cryptographic private key for this other – it takes more than that to have reliable transactions. You must have confidence in the system as a whole, because there could be abuses.

"There is nothing inherent in technology that will necessarily make him use it for illegal activities".

You do not necessarily have to know who you're dealing with. There are other parties involved in that process of validation, in the development of the code and so on. And there are all kinds of situations in which, even if people are not bad actors, there are disputes. And you need a way to resolve the dispute. So, the topic I do in the book – and it's basically the title – is that blockchain is not the end of trust. Blockchain is a new structure of trust, what I call a "new architecture of trust" that recreates trust in a different way.

The knowledge @ Wharton: When people listen to the words "system without trust", the connotation is that it is a lawless system. And I think in your book you say it's exactly the opposite. Is the blockchain compatible with the law?

Werbach: It is absolutely compatible with the law. But it does not incorporate the law in its native state. Absolutely, these blockchain networks can and are used in some cases to undertake illegal activities. People use bitcoins to engage in money laundering, to buy illegal drugs, and so on. Now, it turns out that law enforcement, in many cases, has an easier time tracking than on the bitcoin network compared to traditional financial networks.

When I go to make a cash transaction – money is a real carrier – it's hard to track it down. While with bitcoin, it's a public network. All transactions are public. You just have to associate that cryptographic private key with a human person or entity. And it turns out that there are a variety of sophisticated ways to do it.

There is this illegal activity. There is also fraud in progress. For example, there are those that are called Initial Coin Offerings, where companies offer these fund-raising tokens. There is a lot of scams and frauds in that world. The point I am making is that there is nothing inherent in the technology that will necessarily make it use for illegal activities. And indeed, there is a great deal of legitimate legal activity happening.

Companies are implementing blockchain technology because they see it solve real business problems. The challenge is how to safeguard and promote legal activity and minimize illegal activity and do it in a way that does not create too much friction in the process. This, unfortunately, requires a fairly slow and sometimes cumbersome process to understand how to put the blockchain together with laws, regulations and governance. [I spend a lot of effort in] the book that illustrates how that process actually works.

"Companies are implementing blockchain technology because they see it solve real business problems."

The knowledge @ Wharton: How should regulators get closer to the blockchain? You mentioned three questions in the book that you should ask to determine whether or not to act.

WerbachFirst of all, regulators must ask: "Is this a system designed for legal or legitimate purposes?" There are bad actors out there. There are systems that make it fundamentally harder to track transactions and make it easier to execute illegal transactions, where this is the point of the system. We saw it 20 years ago with peer-to-peer file sharing, with systems like Napster and so on, where services were clearly designed to facilitate copyright infringement. They were closed.

Then there were other systems that use a very similar technology. BitTorrent is a good example. The company that makes BitTorrent – which for a while was a huge percentage of Internet traffic because it was used for video sharing – has never been sued. It has never been closed by the government because it built a technology that was really valuable, in reality, for companies that wanted to share multimedia files, and did what it could to limit illegal use. So, the first question is: who is behind this? And what are the indications that they see potential illegal uses as the goal, or something that they want to work on minimizing?

The second question is: what are the mechanisms to achieve the purpose of the government? People in technology – entrepreneurs and people like cryptocurrency advocates – often think governments rule because they want to control things. I was a regulator. I have been to the Federal Communications Commission at the beginning of my life. Governments generally do not. They regulate because they want to face their goals, serve their missions.

If your mission, for example, is to fight money laundering and terrorist financing and to use money to facilitate crime, then you will want to create a system that does that. So, the question is: what are the mechanisms that governments can use? As I said, in the case of things like bitcoin, it turns out that governments can effectively track transactions on the blockchain, as opposed to preventing transactions from happening when those could be legitimate transactions. So, the second question is: what are the alternatives to meet the needs of the government?

The third is costs and benefits. There are huge benefits, directly, in terms of regulation to prevent people from losing their money, and [to curb] illegal activity. But there are also greater benefits for the blockchain community. Return to trust. We need a reliable environment in which ordinary people and existing companies are willing to commit their money and commit their resources to this new, exotic, bizarre, decentralized technology. It must be trusted. Regulation can actually play a good role there.

The regulation also has costs. It may be too broad. It can limit innovation and so on, if it is not well designed. Regulatory authorities must carefully consider these costs and benefits. I think if they ask these three questions together, they will be well positioned.

The knowledge @ Wharton: Let's move on and talk about the potential of the blockchain. How do you think blockchain technology can be used pragmatically today or in the near future? How do you see that it is adopted?

Werbach: There are three adoption buckets I see. One is cryptocurrency, which is the most radical, but also the least mature part of this world. And that you use something like bitcoin as a substitute for money or the use of these cryptocurrency tokens to enhance decentralized applications, because basically a blockchain is a kind of distributed computer and it's possible [have] applications – just like we have applications running on the Internet – running on these decentralized general ledger systems.

"The real revolution is seeing this at a deep level as a new framework for trust."

Power exists potentially, they are not controlled by any entity. The platforms are not under the control of very powerful intermediaries who have an incentive to condition the system and restore its value. This is an area where there is a huge amount of fascinating experiments. People may have heard of things like CryptoKitties, where there are games that are built on it and real applications. But it is still very, very early – technically very early in terms of adoption.

The second bucket is the blockchain – general accounting solutions, which concern the monitoring of things. Whenever there are multiple organizations that need to collaborate on some business processes that do not completely trust each other, there's a cost, right? Because they have a duplication of information. Everyone wants to keep their own copy of information. They must reconcile and settle down. And you add it to all the global business, it's trillions of dollars lost in these processes.

Blockchain, creating a virtual ledger – a shared source of truth through organizations – can provide value in a wide range of these applications in almost every area that can be imagined. In that second category, there is a good deal of adoption. There are companies that are realizing real production systems – there is a consortium with which I have called Hyperledger which has 50 production networks operating on its technology, and this is just a platform – which are the current recording systems between real companies. But in most cases, it's still early enough. The volumes are still quite small. But it seems like it's coming.

In the third bucket are the ones I call "criptoassets", which is the one where actually there is the cheaper activity, because it is the least radical. This is basically Wall Street and the financial system that uses these as negotiable assets, basically saying, if I have a cryptocurrency like bitcoin or some other token, and there's a … sufficient certainty that it's a legitimate reserve of value, it is a native digital resource. It is something that can be securitized, which can have rights and responsibilities, can be the basis for derivatives, can feed this huge system of global financial transactions that we have.

This is actually the area in which, in the last year, there has been most of the business, and I think where we will see the most financial transactions in the short term. It requires a little bit of legal clarity. It requires some construction of interfaces and middleware systems, which is happening, but it does not have to change the basic structure of the market. And so, in that area, we are witnessing a real interest from institutions and traditional sources of capital. Because again, it's a more efficient solution for what they were already doing.

The knowledge @ Wharton: You write in the book that blockchain could change the world, but, and this is your quote, "in a crucial way, how and when to remain uncertain". What do you mean by this?

Werbach: This is always the question with transformation technology, right? Anything that is profound and meaningful enough to potentially affect global business is not something that will be a light switch. It is not something that will happen overnight. And it's not something that will be adopted in a uniform way because there are costs. Because this requires people to think about doing things differently. And there will be losers in the transition to this new system.

If you think of blockchain just as a way to speculate in these tokens, or you think of it as an alternative form of money that will only succeed if it replaces traditional legal currencies, then I think you miss the big picture. The real revolution is seeing this at a deep level as a new framework for trust. And when you look at where trust is important in business, it's everywhere. But because it is so broad, this means it will be a long and evolving process in which we do not know what the killer apps are.

"I do not … I think bitcoin or any other cryptocurrency will replace or replace the existing dollars and currencies we have."

I gave you a model of three buckets. But in particular, where this will be adopted, which countries, which parts of the world, which industries will move first – on closer inspection, it will all be obvious. With hindsight, we will say, "Yes, this is the killer app". Obviously, you should buy books on the Internet. And then of course you would buy everything on the internet on Amazon. Sure, advertising was a way to monetize research in this huge tens of billions of dollars industry. I can tell you, at the moment, none of these things were obvious. And people were skeptical about all these statements. So, it's a similar type of thing. Because the potential is so great here, that's why there's so much uncertainty about what the future path looks like.

The knowledge @ Wharton: It's been almost a decade since the bitcoin white paper was born. And the cryptocurrencies are very popular of course, but we do not see the adoption of the blockchain that reaches a stage of maturity that one would perhaps expect. So, according to you, based on your research and experience, is blockchain really a revolution?

Werbach: We'll see. I think some aspects are clearly revolutionary. If it really is a successful revolution, this is the open question. I'm very confident at this point it's not going away. It will be widely adopted and integrated into the business structure, just as many Internet technologies have been. We generally take them for granted now. But it took a long time, with many challenges, to get to the point where they were moving deeply in all these different societies around the world.

I think you have to choose a little bit. If you want the revolution, it's really exciting. But it also reduces the likelihood of it happening. For example, I do not think bitcoin or any other cryptocurrency will replace or replace the existing dollars and currencies that we have. I think that what actually happens is that the most important governments like the US government – and probably before that, the Chinese government and many others – will fine-tune their currency. They will use blockchain technology in an authorized way to digitize their fiat currency. Is it a revolution? In a sense, absolutely. It is not the same revolution in which we will buy everything in bitcoin. I think there is still a place for bitcoin and other cryptocurrencies, but perhaps not so much a radical revolution as people think in that vision.

Look, it depends on whether you are focused on the real upheaval of the way things are done, which happens very rarely. When it happens, it also has huge costs. Or are you saying, what will be important? What will really affect the business globally to the point where, in 10 years, nobody could ignore it? … I think this last one [scenario] it's where the blockchain is going. And if this is not a revolution, it's okay with me.

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