The Blockchain Revolution
door Jochem Wieringa
- A blockchain is a technology that enables transactions to be conducted between any combination of parties reliably and indisputably without the need of a central authority.
- Blockchains have several advantages over central authorities as a means to process a transaction:
- Transactions will become free or almost free to process.
- Services like banking and digital payments become available to people in developing countries.
- Blockchain technology introduces a higher level of privacy and financial freedom to consumers in countries that have oppressive or censoring governments.
- Second generation blockchains like Ethereum introduce even more features than financial transactions, like self-executing smart contracts and Decentralized Autonomous Organizations. These will be the building blocks that are fundamental to far-reaching future developments like the Internet of Things.
- Adoption of blockchain technology is still in a very early stage. This fact combined with the huge potential impact and momentum it is gaining, make the next few years very interesting from an investor perspective.
What is a blockchain?
We are a blog about investing in blockchain technology. This article explains what a blockchain is, what our vision is on blockchain technology and why we believe in it as an investment opportunity.
Blockchain technology is the result of 20 years of research. Most people associate blockchain technology with Bitcoin. But Bitcoin is just the first commonly known implementation of blockchain technology. Apart from transfering Bitcoin from one user to another, blockchains can be used for many things. Some examples:
- Transfering other types of digital or even regular money (dollars, euros, etc) between parties,
- Issuing stocks in a company and trading them,
- Signing a contract between two parties that automatically executes,
- Setting up a secure communication between parties
And many other examples. The common denominator in using blockchain technology instead of “regular” technology for these examples, is that there is no need for a central authority, and authority is instead decentralized between peers.
A blockchain is a technology that solves the so called “Byzantine Generals Problem”, which is an old problem in game theory: how can you reach consensus among peers if you don’t know which peers are to be trusted and which have malicious intent? Historically this problem has been circumvented by introducing a central authority. For instance a bank or creditcard company that vouches for creditworthiness of a consumer that wants to make a payment. Or a government that issues an ID to prove the identity of a person.
In contrast to this, all transactions on a blockchain are secure, irreversible and indisputable without the need of a central authority. How? Instead of a central organization acting as the authority, a blockchain is a ledger or database that is stored at all nodes (being computers of users) in the network of that blockchain. In case of Bitcoin, the nodes in the network are the computers of Bitcoin users that decide to run a small program that contains the code that defines the rules of the Bitcoin blockchain. The reason that no central authority is needed to legitimize a transaction, is that even if some nodes of the network decide to input fraudulent information or are malfunctioning, an algorithm ensures that the majority of the nodes in the network reach consensus about the state of everything in the entire system, overruling the input of the fraudulent nodes.
One might say that a service built on a blockchain is more robust than one built around a central authority. Replacing the central authority with redundancy among nodes means you remove a possible single point of failure from the system. There is no longer a central point in the system that is prone to outages and hacks or that can be compromised by bad intentions or policy within that central point.
There are many blockchains. The more nodes a blockchain has, the more difficult it is for a fraudulent actor to own a majority of nodes. The Bitcoin blockchain is currently the most well-known and contains the most nodes. Therefore it is the most robust and trustworthy blockchain at the moment. Even though Bitcoin has the most commonly used blockchain, other blockchains have been developed or are under development with different properties, such as faster transaction times, a smarter algorithm to prevent fraud, stronger privacy features, etc.
Which blockchain will prevail is as of yet uncertain. While the Bitcoin blockchain is the oldest, it has some serious downsides, like slow transaction processing. It might still prevail simply because it already has the most users, which attracts more users than a new blockchain without existing users. It is most likely that several blockchains will gain momentum parallel to each other. Each of those blockchains might be optimized for specific use cases, like the transaction of money, stocks, the processing of contracts, communication on a private network, and so on.
Why mistakes are unavoidable and not a big deal
You might be thinking by now: “But what about all this news about hacks, scams and black market deals that I keep reading about in relation to Bitcoin? Won’t that prevent blockchains from ever going mainstream?”
One reason that you read a lot about those negative things, is that a scam makes a better headline than a promising new startup. The other reason you read a lot about those negative things is that they do happen relatively often in the Bitcoin scene.
The current state in the Bitcoin scene can be compared to the Wild West in the 1850’s. The Californian Gold Rush. It was a time of great opportunity, entrepreneurship, growing wealth, and innovation. Because mining for gold was new for most people, most participants in the scene were in fact amateurs and a lot went wrong. Mines collapsed, infrastructure didn’t scale fast enough and robbers had an easy time stealing from badly protected storage and banks. The West matured however, and has gotten less wild. It formed the foundation for its current economic prowess.
The Bitcoin scene is in a similar state. A lot of users don’t really know what they are doing and are getting scammed. Some exchanges (like was the case with Mt. Gox) were owned by amateurs that didn’t know how to run an exchange or didn’t do enough to protect it from hackers. And hackers use their wit to profit from the fact that most people are still learning how this new technology works.
On the other hand, more and more very talented professionals are entering the Bitcoin scene. Seasoned investors, highly qualified developers, smart entrepreneurs. People from high positions at companies like the New York Stock Exchange, big banks and digital security companies. Even though the Bitcoin scene might currently be a bit scary for the layman, those professionals will mature the ecosystem and make it safe and easily accessible for the majority of people.
Notwithstanding the above, the best answer to the question whether the sometimes bad vibe around Bitcoin will hurt blockchain adoption, is that Bitcoin is just one example of how a blockchain can be used: as a means to transfer and store that particular currency. Whether Bitcoin prices are volatile, Bitcoin exchanges get hacked or shady deals are paid in Bitcoin, doesn’t change the fact that the underlying technology of blockchains has far-reaching potential. Compare this with the invention of gas-powered engines, which resulted in cars being created. The rise of cars introduced some negative by-effects like a rise in traffic accidents, car thieves and pollution. These by-effects don’t mean however that the underlying technology wasn’t extremely useful, boosted the economy and impacted the world at large.
Why blockchains will have a big impact
Because a blockchain removes the need for a central authority to act as a trusted party in a transaction, the current central authorities that do this will become obsolete unless they adapt. While that might be bad news for banks, creditcard companies, notaries, stock exchanges, payment processors, governments, and many other traditional central authorities, it is good news for users.
Let’s focus on just one of many use cases for a blockchain to illustrate this: financial transactions.
One advantage is that payments on a blockchain will be for free or almost for free compared to current payment methods. This is because there is no longer a central authority with a monopoly on executing that specific payment. Instead, each node in the network sets its price to confirm a transaction. That leads to competition among millions of nodes and the total price of a normal transaction will approach the cost of the energy used by the node to perform the required computation. We already see this happening in the Bitcoin network, where Bitcoin can be transferred almost for free. In advanced countries payment fees are around 2 to 3 percent of a transaction. That might not sound like much, but in a world where retailers make around 5 percent margin on a sale, you can imagine they are all eager to cut expensive payment processors out of the equation. Blockchain technology might even have a bigger impact in developing countries, where transaction fees are significantly higher: 8% on average for sending money person-to-person, which is a very common use case in those countries. Reducing that cost to almost zero is a huge saving, especially if you are in a situation where every cent matters.
Another advantage for consumers is that less need for central authorities means less power to those authorities and thus more privacy and more choice for consumers. While that might not be something that most people in western countries currently see as a necessity (though an increasing number do), it will bring major change to countries like China, Russia and Syria, where people are more limited in their options. The fact that cryptography is used in all communication over a blockchain means that transactions can be performed more anonymously and cannot be interfered by authorities. Neither is it possible for a government to censor information that is stored redundantly among peers in a network all over the world, instead of on a single website or server that can easily be blocked.
Blockchain technology will also have a big impact in developing countries where basic banking infrastructure is non-existent in rural areas, or not available to the majority of people because of low income. Blockchain technology will play the same role here as GSM technology did in bringing telephony services and internet access to areas that don’t have landlines. Most people in rural areas in developing countries now have mobile phones. Even using basic SMS functionality, it is possible to transfer money via blockchain technology. This is a big deal considering the fact that over 80% of the countries in the world don’t have a universally accessible banking system.
The examples above contain some idealistic element. While the opportunity for this technology to change the world for the better is one of the reasons we are very enthusiastic about it from a personal perspective, it is also a reason one might be enthusiastic from an investment perspective: Non-cash payments amounted $390 billion globally in 2014. Over 3 billion people don’t have access to a formal banking system. Around 2,5 billion people live in countries with authoritarian regimes. Apart from the social impact, those are huge potential markets to be able to tap into.
Longer term applications of blockchains
The examples above are some (of many) use cases of a first-generation blockchain like the Bitcoin blockchain, and are impactful examples that can be implemented in the short term. Currently several second generation blockchains are under development. A very promising one launched a few months ago: Ethereum. The Ethereum blockchain distinguishes itself from the Bitcoin blockchain in the fact that it is able to transfer not only property tokens (like Bitcoin) but also scripts, autonomously running pieces of code. If autonomously running scripts can move around a decentralized network, without the need for a central authority to enforce the outcome of the script, this will enable Decentralized Autonomous Organizations. These are companies or other organizations that can exist without a central authority running them. They can instead be run by communities, customers, or even run without input from people. Those scripts might become one of the building blocks upon which the Internet of Things might be built. If the Internet of things will be built on decentralized blockchain technology instead of on the infrastructure of centralized organizations like Google or governments, it will not be as vulnerable to corruption or political preference within those organizations and will be better suited to preserve personal freedom and privacy.
Again an idealistic point of view. But it might be exactly this opportunity of implementing the Internet of Things in a way that doesn’t give Big Brother full control, which will remove the fear of potential users and drive the Internet of Things into mainstream. Not only we think so, also companies like Samsung and IBM see this, and are experimenting with Ethereum technology to create prototypes of Internet of Things related devices.
The current state of the blockchain revolution
While the potential upside of bitcoin technology seems huge, usage of blockchain technology is currently limited to that of a few insiders. Given the developments described above, our vision is that companies as well as consumers in developed and underdeveloped countries will drive adoption and that blockchain technology will become mainstream as a result, like what happened with the Internet.
We are not alone in this vision. A growing number of leaders in the tech industry share this believe. One of the most prominent tech investors, Marc Andreessen, compares the impact of the invention of blockchain technology to that of the invention of personal computers in 1975 and the Internet in 1993. And he is putting his money where his mouth is.
Not only Andreessen does. Over 800 million dollar has been invested by venture capitalists in blockchain related startups until july 2015, of which more than half in the last 6 months. Those figures are comparable to the amount of venture capital investment in Internet related businesses in 1995 and 1996, according to this report by Coindesk.
Image source: Coindesk - State of Bitcoin Q2 2015
And even though banks might have most to worry of the blockchain revolution, a quickly rising number of them, among which Barclays and Goldman Sachs, realize they have to adapt and are now looking into how blockchain technology might be incorporated in their businesses.
So the potential future impact of blockchain technology is enormous. If we look at current usage of blockchain technology in our everyday life, it is comparable to that of Internet usage in 1993: only a few insiders know how to use it, but it is gaining momentum fast. To us, that looks like the ideal time to be one of those insiders and invest in this technology.