Blockchain versus cryptocurrencies: looking beyond this simplification

29th Oct 2018
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The past 18 months have been an era of extremity for blockchain. The acceleration of mainstream coverage and sheer capital inflow has catapulted blockchain and cryptocurrency from obscure crypto-anarchist mailing lists to viral status. Indeed, despite the alarming proliferation of Initial Coin Offerings (ICOs) with questionable governance, the practice of crowdfunding ventures by issuing tokens on the Ethereum blockchain continued to rise, collecting over $11.69 billion in funding throughout the first half of 2018.

Blockchain and crypto assets have been, in some ways, the perfect storm: early-stage foundational technology that has unwittingly become a vehicle for unregulated retail speculation. Yet, in the past six months, total crypto asset market cap has fallen nearly 80 percent, flushing out a large portion of non-delivering token projects, quieting investment hype, and giving real technologists a bit of room to breathe.

Let’s interrogate a common theme we encounter in the Indian market: ‘we support blockchain, not cryptocurrencies’. Whether it be regulatory bodies, industrial conglomerates or existing technology companies, many are keen to embrace “blockchain” without any native unit of value. Governments, in particular, alarmed by the pseudonymous and censorship-resistance nature of cryptocurrencies, and eager to monitor and control foreign exchange inflows and outflows, have taken pains to embrace blockchain while denouncing ‘cryptocurrencies.’ We would like to show why this line of thought should be evaluated carefully, how it could fundamentally overlook a key feature and value proposition of blockchain itself, and how the government’s (very reasonable) concerns may still be addressed within a blockchain and crypto assets world.

Crypto assets, not cryptocurrencies

In this article, we will be careful to use the term “crypto assets” versus “cryptocurrencies.” Only a limited subset of all cryptographic units of value can be categorised as currency assets (e.g. Bitcoin, Monero, Litecoin); that is, they are designed and used as mediums of exchange, stores of value and units of account, much like traditional currencies. Yet, with the advent of Ethereum and general-purpose blockchains, there now exists many other crypto assets that are designed for non-currency usage including, but not limited to, tokens that represent access and participation in a decentralised application/ecosystem, tokens as a representative right to a dividend of an underlying asset’s cash flow, tokens as a right to vote for updates to a blockchain protocol, etc. Indeed, deeming all native units of value on a blockchain network to be a ‘cryptocurrency’ is dangerous and misleading. Thus we revert to ‘crypto assets’.

Blockchains are powerful because they are more than just databases.

In order to understand why the “blockchain without cryptocurrencies” perspective may be at best an oversimplification of the underlying technology and, at worst, an outright misunderstanding of it, it is imperative to understand the technical origins of blockchains and crypto assets. Bitcoin was the first large-scale implementation of blockchain technology – yet Bitcoin itself drew from numerous previous technologies. Such precursors include David Chaum’s E-Cash (private and untraceable electronic cash enabled by cryptographic blind signatures), Adam Beck’s Hash Cash (cryptographic ‘proof-of-work’ as a method to prevent spam and denial of service attacks), Wei Dai’s B-money (a proposal for distributed electronic cash using Hash Cash’s POW), and numerous theoretical results in distributed consensus and databases. The key motivating, unsolved problem was the following: how can you create an anonymous electronic cash system that is at once “decentralised” (i.e. the ‘ledger’ of transactions and account balances is not secured or kept by any one central server) while protected against the double-spend attack (users cannot spend the same funds twice across the distributed network)?

Bitcoin is powerful because it solves an age-old distributed consensus problem in practice (albeit not in theory): how can a bunch of anonymous, unrelated and distributed computers reach consensus, i.e. agree, on one history of transactions? While there are many other components to Bitcoin, the two most important to understand for our purposes are the following: the database layer and the incentive layer.

The database layer of Bitcoin is the “blockchain”: transactions are batched and stored in time-stamped “blocks” that are “chained” together by hash functions. The “blockchain” is what gives the Bitcoin ledger its immutable, fraud-resistance quality—if a computer tried to alter transactions on its own ledger, its blockchain would not match with any of its distributed peers. Blockchain, in this sense, is an interesting distributed database, though by no means the only one of its kind. Further, because of its highly replicated nature (all nodes/computers in a blockchain network must download the full history of the ledger), blockchains are computationally intensive and inefficient when compared to other distributed databases.

What makes Bitcoin so powerful is that it marries a “blockchain” distributed database with a carefully designed incentive system. For instance, nodes that expend computational power (i.e. spend money, on hardware and electricity) to add blocks, validate transactions and store the full blockchain are rewarded in BTC, a native unit of value on the Bitcoin blockchain. BTC has exchange value: you can use BTC to buy goods, transfer to other accounts, or convert to other currencies like rupees or dollars. Only BTC rewards on the “true” chain – the Bitcoin blockchain with the longest history and over 51 percent of nodes agreeing with its history – can be redeemed for exchange value.

By bootstrapping the network with BTC and a carefully designed incentive system for participating nodes, the Bitcoin network’s practical security as a decentralised network increases dramatically: given a large set of self-interested miners, one or a few malicious miners would find it very difficult to convince the majority to mine to publish a fake history of transactions. This is because without majority consensus, the rewards published on the ‘fake chain’ would be worthless. Thus, miners collaborating with a minority malicious actor would simply be expending capital without collecting any rewards, an economically irrational action. Even in the extreme example, a malicious miner who successfully compromises the Bitcoin network would also be destroying its own economic rewards, as the price of Bitcoins would likely drop precipitously if the Bitcoin network itself were compromised (just as national currencies are devalued by global markets if the issuing central bank is shown to be corrupt, faulty or in distress). All the malicious miner’s rewards from the Bitcoin network would be irreversibly destroyed. Indeed, Bitcoin’s design leverages assumptions about rational, economic self-interest to coordinate securing the integrity and consensus on its decentralised ledger.

This is a vast oversimplification, and we suggest that any readers who are interested check out the original Bitcoin white paper as well as Princeton’s in-depth Coursera curriculum on Bitcoin’s design. Yet the key takeaway is that Bitcoin’s genius lies in combining a unique database with real-world economic incentives.

Blockchain without any native store of value would essentially be keeping the database without the economic incentives, which, as demonstrated above, actually plays an enormous role in the unique value proposition of decentralised blockchain networks.

The danger of overlooking the role of economic incentives in blockchains

Blockchain without cryptocurrencies is just a distributed database, and not necessarily an optimal one. Combining cryptography, distributed systems and economic incentives is the true intersection point of powerful blockchain networks: and it is this intersection that promises the most innovation in the future to come. Public blockchains with native stores of value (crypto assets) are what can redesign the future of application development, organisation design and governance.

As blockchain use cases have expanded past currency/value transfer with the advent of general-purpose blockchain networks (Ethereum, Dfinity, EOS), we are seeing a wealth of awesome technologists challenging the limits of Bitcoin’s original design. At the cryptography layer, database layer and economic incentive layer, numerous interesting models are emerging to attempt to create more powerful and generalisable blockchain networks. In future articles, we would like to explore some of these emergent trends.

For entities that are rightfully concerned about the dangers of unregulated crypto assets, we suggest careful categorisation of various crypto assets (utilities, securities, currencies/commodities, governance/voting) and active regulation of exchanges, which are the centralised point of conversion between crypto assets and other assets. Once these entities fall under regulation, and once governments become aware of various identification, analysis and tracking methods available for public blockchain networks, they may be less eager to separate “blockchain” and “crypto assets” in one fell swoop.

“Blockchain without cryptocurrencies” or “blockchain without crypto assets” is a position that we can understand but feel strong reservations about. The importance of constructed incentives in blockchain networks are central to the technology itself. Such incentives often require native units of value, primarily at the base protocol layer. We must be careful not to aim for a world of “blockchain without cryptocurrencies”, and with this misunderstanding, overlook or hinder the true development of this foundational technology.

We believe that times like these are best for education and real technological development. The aim of the series is to start with general education, and delve deeper and deeper into real technical developments in the blockchain space. We aim to tackle some common misconceptions about blockchain to start a real conversation about blockchain: its history, its current developments, and its future potential.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)

 

 

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