Blocks for the Blockchain

Blockchain, the terminus is all over the place. Hence the (over) use of the word is increasingly creating block-pain for the educated listener. But what is all the excitement really about and how to differentiate marketing lingua from solid technology?

The idea of Blockchain can best be compared to the revolutionary concept of data packages in transport protocols. Slicing data into little pieces that can be transferred independently generated the foundation of scalable and decentral networks that ultimately enabled the Internet. Still it took decades for this to happen and until sufficient software (killer applications like usenet, email or web) and hardware (router, network infrastructure) had been build to support such networks.

20 years ago the concept of cryptographically linked blocks has first been described and 10 years ago blockchain has been coined by the Bitcoin white paper. Use as cryptocurrency has flourished since - with the usual up and downs typical to early and volatile markets. But, aside from the use as a currency (and indeed the blockchain has a lot of characteristics that makes it well suited for that purpose) a lot of new blockchains and concepts have been invented and smart people are working on new kind of infrastructures and services.

However, with the strong promise there is the risk of overengineering. Every problem starts to looks like a nail if you have a (blockchain) hammer. Hence I am often confronted with situations that try to force the use of a blockchain, although other protocols and architectures might be a much better fit. I therefore asked myself what are the core characteristics of blockchain and in what kind of situations and for what class of problems does it make sense to use and when not?

Let’s start with the characteristics. A blockchain is essentially a distributed ledger. The data is stored in blocks (similar to packages in transportation protocols) and these blocks are hard linked together in a chain (by cryptography). Everybody in the network can read and write into that database, as long as they follow the agreed protocol (for instance that the longest chain is always the valid chain). The participants even do not need to know or trust the other parties in the network, as the protocol ensures that the rules are enforced.

Hence one can ask several questions to determine if a blockchain is a suitable architectural choice. At least all of the following questions should be confirmed:

  • Do I need a (infinite) history and preservation of data?
  • Do multiple parties need to write data?
  • Are writers not known or trusted?
  • Is there no common or trusted 3rd party or authority?

A NO to any of these questions is a good indication that blockchain might not be the way to go. Indeed a lot of business models are centered just around replacing the common (trusted) 3rd party or broker. At first this might look like a great idea, but also the use of blockchain comes at a cost (e.g. in the form of processing costs or transaction fees) and usually centralized architectures are more efficient.

Based on its unique characteristics I believe blockchain technology can create the most value in situations where it is important to store and preserve data, generated by a lot of participants (that are unknown to each other) and who don’t have or want a central authority. Recording and exchange of value (currency) certainly checks these boxes, but also applications in machine-to-machine (internet of things) settings and ways to record and preserve our knowledge, identities or claims are promising fields. Just imagine a blockchain based Wikipedia or patent system.

I believe we are still early in the game and will see a lot of exciting applications in the future. From the developments I have seen so far a couple of learnings can be derived:

  • Using Blockchain does not imply the need of a crypto currency, classical means of payment make a lot of sense regarding acceptance and adaption
  • Initial coin offering (ICO) are a (partly unregulated) way to raise funds, but most Blockchain project should not be funded that way
  • It’s usually better to first build a network before introducing a blockchain. The distributed nature usually requires a critical mass of players and use of the blockchain in order to create value. Concentration and centrality are natural enemies of this architectural choice
  • If a token economy is needed, it needs to create very clear value for every stakeholder involved
  • The tax system is partly broken in the digital space, as any transfer of value usually implies value added taxes. However this is currently not the case for the transfer of data, information and virtual assets, even though value can be clearly attached. Thus there is the risk that once legislation picks-up, a lot of business models will not work any more, if their main benefit does not arise from increased efficiency or security but from the avoidance of taxes

Like any new technology, this is a work-in-progress, let me know what you think @peterlasinger.

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