Blockchain /ˈblɒktʃeɪn/: a digital ledger in which transactions made in bitcoin or another cryptocurrency are recorded chronologically and publicly
In 2008, while the rest of the world faced the biggest financial crisis in decades [29], a paper was circulated among a small group of cryptography enthusiasts [30]. In this paper, Satoshi Nakamoto [31] explained the concept of a cryptocurrency called Bitcoin1 and a solution to the long-standing problem of double spending (where digital tokens representing unique value can be spent more than once) [32]. For years, double spending has been one of the main barriers to the widespread adoption of digital money. In 2008, the domain name Bitcoin.org was registered, and at the start of 2009, the genesis block for bitcoin—that is, the first block in a blockchain—was created [30]. At that point in time, nobody foresaw the impact that Nakamoto’s [31] underlying technology would have on the world’s largest organisations, trusted intermediaries, and society at large [33].
Since Nakamoto’s paper, distributed ledger technology, also known as blockchain technology,2 has rapidly gained popularity. Although ledgers have been around for millennia, for the first time in history they can be updated across multiple organisations and computer networks simultaneously through the use of blockchain technology. This functionality significantly reduces the possibility of ‘gaming’ the system, that is, the distributed and decentralised nature of the blockchain ledgers prevents any single party from controlling, and therefore manipulating, the ledgers. The cryptography underlying blockchain ensures a ‘trustless’ system, thereby removing the need for intermediaries to manage risk. This is a true paradigm shift and it is why so many organisations are exploring Blockchain’s potential use to improve their tracking and audit systems.3 Although blockchain technology has only been around for less than a decade, businesses, government organisations, and consortia alike have significantly invested in this modern phenomenon, with a view to exploiting it for their financial or political gain [31]. Marc Andreessen, from the well-known venture capital firm Andreessen Horowitz, calls it as big an invention as the internet. Palychata [34], a research analyst from BNP Paribas, compares the creation of Blockchain to the invention of the steam or combustion engine, whereas The Economist predicts that it will be as important an innovation as the invention of Limited Liability Corporations [35].
The extent to which Blockchain is affecting our world is evidenced by the R3 Partnership’s investigation into how the distributed ledger technology affects players in the financial industry. The R3 Partnership is a consortium of 80 of the biggest financial institutions. The R3 Partnership described its December 2015 launch as the product of frustration among banks and other financial institutions with the multiple generations of disparate legacy systems that struggle to interoperate. In addition, six of the biggest global banks, led by Swiss bank UBS, have developed a ‘Utility Settlement Coin’ (USC) [36], which is the digital counterpart of each of the major currencies backed by central banks. Their objective is to develop a settlement system that processes transactions in (near) real-time, rather than days. The aim of the project is to enable global banks to conduct various transactions with each other using collateralised assets on a custom-built blockchain and to make financial markets more efficient [37]. A third example is Australia Post, which has released plans for developing a blockchain-based e-voting system for the state of Victoria, Australia [38]. The possibilities for the Blockchain are enormous and it seems that almost any industry that deals with some sort of transaction or tracking mechanisms can and will be disrupted by Blockchain. However, to understand how we should use Blockchain for social good, let’s first take a deep dive into the technology.
A blockchain is a shared and decentralised public or private ledger that describes a single version of the truth of ownership [39–41]. It is a distributed ledger that uses database technology to record and indefinitely maintain an ever-growing list of data records [42], which cannot be tampered with and are irreversible, verifiable, and traceable [33, 42, 43]. At first, these data records were bitcoin transactions, but applications have now moved to any type of online transaction across any industry. Blockchains can serve as a record keeper for societies, including registration of any type of document or property [44]. Data records are stored chronologically in blocks that are chained together cryptographically. Every node in the network has a copy of the block and, in order for a transaction to be added to a chain, there has to be a consensus among the nodes in the network.
The result is that peer-to-peer transactions become possible, without the need for a centralised certifying authority, such as a bank, which usually takes a small commission to carry out the work. The removal of third parties, and the ability of organisations and consumers to execute peer-to-peer transactions almost instantaneously, is a true paradigm shift. In essence, this is what makes Blockchain so important.
There are different types of blockchains and the type of blockchain selected determines how actors in the network interact with each other [33]. There are permissioned and permissionless blockchains, each with different characteristics, rules, and actors. Permissionless blockchains are public blockchains. The best-known example is the bitcoin blockchain. Trust within the system is created through game-theory incentives and cryptography [33]. This means that anyone interested in joining a particular permissionless blockchain can do so by simply connecting his or her computer to the decentralised network, downloading the application, and starting to process transactions. It is not necessary to have a previous relationship with the ledger and you do not need to be approved to join. If you want to start mining Bitcoin and supporting the Bitcoin network, simply go to https://bitcoin.org/en/full-node and get started. A public, permissionless Blockchain is not owned by anyone and everyone can contribute.
On the other hand, permissioned, or private, blockchains do not require these artificial incentives because all actors in the network are known to each other [33]. New actors have to be approved by existing participants in the network, which enables more flexibility and efficiency in validating transactions [33]. Private blockchains are generally used by organisations that like to keep a shared ledger for settlement of transactions [45], such as within the financial services industry. They are owned and operated by a group of organisations and transactions are visible only to members of the network [45]. A good example of a private Blockchain is the Blockchain Settlement System developed by UBS and five other major banks in 2016 [36]. This Blockchain enables the four participating banks to discernibly improve settlement times among them and no other party has access to the Blockchain or can contribute to it.
Private and public Blockchains are the two flavours that have been around and, for both options, the main feature is that, once a transaction is approved and on the Blockchain, it cannot be changed or edited. Some of the larger fintech institutions (including China’s first private and fully digital bank, WeBank) are considering layering their online banking on to combinations of public and private blockchain networks [46]. However, since 2016, a third option has been developed. Accenture has patented an ‘editable Blockchain’, the history of which can be adjusted by a central authority. This is a bit of a contradiction, because the power of the Blockchain is that data, once validated, cannot be altered. However, Accenture claims that this type of Blockchain would be for private permissioned Blockchains only—used, for example, by the banks, where a central authority can manage the network under agreed governance rules [47]. This type of Blockchain would offer a ‘safety button’ that could, in fact, make the Blockchain safer to use.
The type of blockchain that an organisation could opt for depends on the objective of the organisation and the type of transactions that need to be stored on a blockchain. Some transactions, such as financial transactions, should not be visible for the general public, whereas other transactions, such as ownership of (digital) goods and land titles, benefit more from a public blockchain [48]. Regardless of the type of blockchain, the data stored becomes immutable, verifiable, and traceable, due to four key components of Blockchain: cryptographic primitives, consensus mechanisms, transactions, and smart contracts. We address each of these components separately below.
Cryptography is a key component of any blockchain system. Among other things, it consists of two important features: the digital signature and the Hash Algorithm.
Digital signatures are based on public key cryptography, also known as asymmetric cryptography. Asymmetric cryptography means that two keys, a public and a private key, are mathematically related to each other. This relationship means that any data encrypted by one key (public key) can be decrypted only by the other (private key), and vice versa. It is impossible to encrypt data with a public key and use another public key to decrypt that data [49]. As a result, you can use a key pair to identify the owner of a certain digital asset. As the public key is publically available, any data encrypted with a related private key can be decrypted only by the corresponding public key. It works like a mailbox, where everyone has a key to deposit a letter to that mailbox, but only one person has the right key to open the mailbox and take the mail out of it.
Public Key Infrastructure has now been widely deployed. Almost anything online uses the Public Key Infrastructure, from sending emails to visiting websites (a website is encrypted using the Public Key Infrastructure if it has an SSL certificate and the website shows https). It means that we can be certain that the data that is sent between you and the server is not interrupted. Public Private Key Infrastructure is also used to ensure authenticity of a certain document, which is done using the Hash Algorithm.
Each block of data on a blockchain receives a hash ID, as a database key, calculated by a Secure Hash Algorithm. A block’s hash is fixed. In other words, the hash ID allocated to the block never changes. Hash algorithms are used in a variety of components of blockchain technology, one of them being the hash ID, which is a unique string of 64 numbers and letters linked to data in each block. The US National Security Agency (NSA) has designed a second generation of cryptographic Hash Functions called Secure Hash Algorithms 2. It includes SHA-256, a highly efficient Secure Hash Algorithm that creates a unique hash ID for every piece of data. Hash Algorithms create the exact same hash if the data is exactly the same [50]. Altering only one bit in the data will result in a completely new hash ID. The hash ID of a block that is added to a blockchain is the starting data for the next block, and as such the blocks are chained together. This means that if data in a block is changed, it will change the hash of that block, which in turn will change the hash in the subsequent block, etc. To tamper with the data, the blocks would have to be revalidated by consensus. This will not happen because the other nodes in the network do not have an incentive to work on ‘old’ blocks in the chain. Besides that, a blockchain keeps on growing, so it requires considerable computing power to revalidate old blocks, which simply makes it not worthwhile [51]. The hash makes data on a blockchain immutable and that it has not been changed over time verifiable.
Consensus decision-making has been used by humans for many years [52]. Although it began as a concept applied to politics and societies, it has become an important part of computer science [53]. Consensus algorithms ensure that connected machines are able to collaborate independently without the need to trust each other and can continue working even if some members of the network fail [53, 54]. There are a multitude of consensus algorithms that take different approaches to authenticating and validating values and transactions on a blockchain. Consensus mechanisms are key to any blockchain; due to the consensus algorithm, there is no longer the need to trust the other party and, as a result, decisions can be created, implemented, and evaluated without the need for a central authority [44, 54, 55]. The result is intermediary-free transactions, whether they be human to human, human to machine, or machine to machine [44].
Consensus is vital to blockchains, because there is no trusted central authority. Actors in the network have to agree on the rules that govern the blockchain, and how these rules must be applied, before a blockchain is deployed. The nodes in the network execute an agreed-upon algorithm and a predefined majority must agree on the outcome. Consensus algorithms use cryptography to validate transactions (and thus decisions) and at the moment,4 the two most common consensus algorithms are Proof of Work (PoW) and the Practical Byzantine Fault Tolerance (PBFT), although new consensus algorithms are being developed constantly [56]. PoW is commonly used in permissionless blockchains, whereas PBFT is used in permissioned blockchains. In addition, Proof of Stake (PoS) is another consensus mechanism that is currently being developed. It is highly experimental, used only in a few altcoins, and not yet mature. Although Ethereum is looking into switching to PoS and the EOS Blockchain will use a delegated Proof of Stake consensus mechanism.
A consensus algorithm solves the long-standing problem of double spending related to digital currencies. Double spending refers to actors who want to cheat the system by spending the same digital token more than once. With fiat money, this problem is solved through the usage of a central authority (that is, a bank). In a decentralised system, without a central authority, it can be solved by consensus. To understand the issue, Lamport and Shostak [57] proposed The Byzantine Generals’ Problem, a thought experiment about a group of generals who are each commanding a different part of the Byzantine army and need to agree upon a plan to attack and conquer an enemy city. The generals can communicate only via messenger, but the problem is that at least one general is a traitor. The question is how many traitors can the army have and still function as one force? Every consensus algorithm is a Byzantine Generals’ Problem solution and the first algorithm that came up with a solution was the PBFT algorithm [58]. Since then, many PBFT algorithms have been developed, before Bitcoin was introduced. PBFT algorithms can be applied in a decentralised, permissioned network, meaning that a central aspect to PBFT algorithms is that a membership is required, which has to be approved by a centralised authority. The PoW algorithm solved this problem [31, 54]. This consensus algorithm operates in a decentralised network, without a central authority, but it assumes that most of the actors are ‘honest’ actors and reduces the risk of dishonest actors.
The PoW algorithm solved the requirement for a centralised authority. The technical innovation of a PoW is that it does not require membership. For this reason, a central authority is no longer required. The PoW algorithm is, therefore, used in public or permissionless blockchains, where actors do not have to know or trust each other. As such, it is used in the bitcoin blockchain, which is a public blockchain. This consensus algorithm requires participating actors to solve a difficult computational problem to validate the blocks. The validation is done using cryptography, which means that the actor has to find the solution of an inequality, which requires considerable computing power (and energy). When a solution is presented, it is immediately clear that it is correct. This can be compared with a crossword puzzle, which can be difficult to solve, but once completed you immediately know that it is done correctly. The moment an actor has solved the equation, the solution is presented to the whole network and the actor receives bitcoins as a reward (in the case of the bitcoin blockchain).
Proof of Stake (PoS) is another common consensus algorithm that takes a different approach. Within PoS, as within PoW, validators are selected randomly, but, where validators within PoW have a larger chance of being selected if they have more computing power, within PoS the amount of money (that is, the number of tokens or the amount of cryptocurrency) that a member holds determines the likelihood of being selected [59]. Once a block has been produced, a transaction fee is paid to that validator and signers commit the block to the blockchain. These signers can all be nodes in the network or a randomly selected group of nodes that do the signing for the complete network. To ‘incentivise’ nodes to hold a larger stake, the more stake a node has in the network, the less complex the puzzles the node has to solve. As a result, nodes that already have a large stake can easily become larger. PoS still requires a consensus agreement on the current state of the network, but the more crypto-coins an actor owns, the higher the stake in the success of a blockchain. As a result, PoS requires far fewer computer processing unit computations and therefore is more energy efficient [60]. The assumption underlying PoS is simple: if an actor has a higher stake in the system, they have a higher incentive to ensure that the network is secure and correct because of the pain felt when the price and reputation of the cryptocurrency are damaged, due to attacks. It is expected that the Ethereum network will implement a PoS consensus mechanism in 2018.
A consensus mechanism implements a timestamp service [31], which ensures that every block that is added to a blockchain is timestamped to prove temporal relationships between different events [31, 61]. The timestamp basically confirms that a certain transaction occurred on the blockchain at a certain time. If an actor tries to cheat the system and offer the same transaction again, nodes will check the transaction against the timestamp and, if the transaction is found in a previous block, the nodes in the network will come to a consensus that the transaction is invalid. In addition, the timestamp feature, in combination with the hash, enables users to prove at any given moment that a certain document was owned by a particular user at a certain moment in time and that since then the document has not been altered [44] (that is, it makes the data fully traceable).
Intermediary-free transactions [44] are key to Blockchain because they remove the need for trusted centralised third parties, who generally take a commission for verifying transactions. Taking out the middlemen (that is, the intermediaries) will completely change how actors interact with each other and how decisions are developed, implemented, and evaluated [60]. Bitcoin transactions are still the most common transactions that are recorded on a blockchain. However, other financial transactions related to any other currency, financial contracts, or hard and soft assets can also be recorded on a blockchain [44]. In fact, any type of transaction, whether related to digital or physical goods, can be recorded on a blockchain. This includes land registrations [62], tracking of goods throughout a supply chain [48], Internet of Things devices exchanging transactions [63], identity, reputation, natural resources [64], as well as peer-to-peer exchanges such as taxi rides or home sharing [65]. The list is endless and a complete overview can be viewed at the website of Ledra Capital, which is collecting the wide range of potential uses of the Blockchain on an ongoing basis [66]. In 2016, for the first time, a transaction took place between two organisations across the globe that was paid for using the blockchain and smart contracts [67]. The Commonwealth Bank of Australia and Wells Fargo from the USA used blockchain in, what was hailed as, the world’s first global trade transaction between independent banks for a shipment of cotton from Texas to Qingdao in China. Further, in December 2017, Dutch agriculture trading house Louis Dreyfus Co. collaborated with Dutch banks ING and ABN Amro, and French bank Société Générale SA to sell a cargo of US soybeans to China using a blockchain platform. They digitised documents, were able to match data in real-time, prevented duplication, and handled the entire transaction in half the time it normally took [68].
Ownership of physical products can also be transferred and stored on a blockchain when owners sell their assets (such as art) by transferring a private key attached to that asset [44]. When this is done automatically using smart contracts, it is called smart property [44]. Smart contracts are a special branch of transactions that can be stored on a blockchain, using, for example, the Ethereum Blockchain [69]. Smart contracts, it is proposed, will have a major effect on organisational design and decision-making [44, 65, 69].
The term ‘smart contract’ was first coined by Szabo [70] as ‘a computerised protocol that executes the terms of a contract’. It can be seen as a traditional agreement that is automatically defined and executed by code, leaving no room for discretion [44]. Smart contracts are analogous to scripts for processing transactions and/or decisions. They run on a blockchain and are considered ‘the killer application for the cryptocurrency world’ [71]. With the arrival of smart contracts deployed on a blockchain, the concept of what defines an organisation and how organisations can achieve competitive advantage will change drastically.
Smart contracts can be seen as If This Then That statements compiled into bitcode (although a lot more complicated). They are software programs that will execute certain transactions or decisions, which were agreed upon by two or more actors [72]. They are created by choosing events or preconditions, and by providing what needs to happen when those preconditions are met. The protocol is then recorded on a blockchain and, once deployed on the blockchain, these scripts can no longer be altered and will always execute once the preconditions are met [73].
Smart contracts have three distinctive characteristics: they are autonomous (after deployment on a blockchain they can no longer be altered); they are self-sufficient (they can accumulate and spend value over time); and they are decentralised (they are distributed across multiple nodes within a network) [39, 44]. Once a smart contract is on a blockchain, it is final and cannot be changed (that is, they become immutable, verifiable, and traceable). However, certain parameters can be altered only if the original code allows for this. Therefore, it is vital for organisations to ensure that the code is 100% correct and that no bugs or errors remain in the smart contract when it is recorded on the blockchain. Mistakes can be extremely costly, as we have seen with The DAO Hack which lost US$50 million due to a mistake in the smart contract [74]. The only way to fix a bug in a deployed smart contract is through a ‘hard fork’ on the blockchain, which is exactly what happened with The DAO. Nevertheless, do not expect blockchains to create a hard fork every time an organisation deploys a faulty smart contract.
Smart contracts not only have a potential impact on contract law but also, more broadly, on social contracts within society and organisations. This is because smart contracts are automatically and autonomously executed, thereby taking out the need for human judgement and minimising the need for trust [44]. In addition, smart contracts remove the need for developing, implementing, or evaluating decisions by management or employees—when multiple smart contracts are combined, together with artificial intelligence and big data analytics, it becomes possible to automate decision-making capabilities [44, 69]. This will result in a ‘fundamentally new paradigm for organising activity’ [44], automating (strategic) decision-making, and corporate and data governance, and creating new organisational designs [33] that are completely run by computer code, so-called Decentralised Autonomous Organisations (DAOs) [69].
Smart contracts may seem revolutionary, but they are nothing new and have been around for a long time. As explained by Vitalik Buterin, founder of Ethereum, smart contracts are already in place in most modern office buildings. For example, access cards that determine whether you are allowed entry to a certain area are predefined by a piece of code and linked to a database [75]. The example of the access card shows that smart contracts have already been around for a long time. The only difference now is that, when they are deployed on the blockchain, they remain accessible indefinitely and will carry out their predefined tasks whenever certain conditions are met. Smart contracts offer tremendous opportunities for organisations, but it is vital that they are deployed on the blockchain only when they are correct. In the coming years, we will probably see a wide variety of applications using smart contracts that will change how we work, how we do business, and how we run our daily lives. It will be interesting to see how this will increasingly take away the middlemen, managers, and employees.
When managers or employees are no longer required to run an organisation, it will significantly change organisation design and how actors within the organisational network interact with each other [44]. Even if an organisation does not move to a completely DAO design, the usage of blockchain and smart contracts will affect how actors interact with each other [76] and change decision-making capabilities. Blockchain reduces opportunism within networks, due to the trustless system based on cryptography [55], and automates decision-making. In addition, organisations become more intensely connected with each other, because they share the same database across time and space, thereby increasing the actors, and interactions, within the network.
Organisations adopting blockchain technologies can be viewed as Human–Machine Networks (HMNs), where combinations of humans and machines interact with each other to produce synergistic effects [77]. Depending on the level of blockchain integration within the organisation, it could affect strategic decision-making capabilities. The more an organisation moves towards a DAO design, the more efficient and autonomous it will become. Ultimately, organisations can operate completely independently using a blockchain, smart contracts, and big data analytics, and a DAO will not have any management or employees [69]. The interactions between actors will be guided purely by autonomous software algorithms [39, 44, 62], increasing the need for careful deployment of smart contracts on a blockchain by shareholders of the DAO. The immutable, verifiable, and traceable characteristics of blockchains mean that steps would need to be taken to avoid the considerable damage that would ensue if smart contracts were deployed with bugs [73]. Incorrect smart contracts are, however, not the only challenge facing organisations wanting to move to a blockchain. The Blockchain is still a nascent technology and many (technical) challenges remain that need to be solved before wide-scale adoption becomes possible.
2.6 Changing organisation design
Although Blockchain is the underlying technology of Bitcoin, cryptocurrencies are not the only possible application. Any transaction can be recorded on a blockchain [39]. Smart contracts can enable a wide variety of applications, not just those related to financial markets and/or ‘self-enforcing autonomous governance applications’ [73]. The possibilities of Blockchain are, therefore, almost endless for organisations to create new, distributed products and services that will result in efficiency gains in existing organisational structures [33]. Such Blockchain-enabled products and services are commonly referred to as Decentralised Applications, or DApps. A DApp has at least two distinctive features [44]: (1) any changes to the protocol of the DApp have to be approved by consensus; and (2) the application has to use a cryptographic token, or cryptocurrency, which is generated according to a set algorithm. There are already quite a few examples of DApps, of which Bitcoin is of course the best known. An extensive list of all known DApps at the moment is available at dapps.ethercasts.com.
The development of such decentralised products and services will change organisation design. Blockchain does not require a centralised authority for maintenance, because the database is stored on millions of decentralised computers, and its decentralised infrastructure ensures that a single case of mismanagement, resulting in a point of failure, does not affect the entire network [45]. In addition, due to the trustless system based on cryptography, the usage of Blockchain and smart contracts will enable an organisation to control and reduce opportunism, while automating decision-making. This will, in turn, have a direct impact on organisation design [55] and any legal, regulatory, IT, and accounting frameworks [72]. Blockchain removes the need for trust in the absence of a centralised governing body. It therefore follows that any organisation developing DApps should still have a strong focus on data governance. After all, only data authenticity can be ensured; reliability and accuracy cannot. With Blockchain, it becomes possible to embed data governance directly within the network, bringing the code to the data [45]. Laws and regulations can be programmed into a blockchain itself, so that they are enforced automatically, which makes governance easier [78]. Hence, the ledger can act as legal evidence for data and increase the importance of data ownership, data transparency, and auditability. The resulting effect on organisation design could eventually result in the establishment of DAOs.
A DAO is a combination of smart contracts linked together, possibly connected to Internet of Things devices, big data analytics, and artificial intelligence. It is run by immutable code under the sole control of a set of irreversible business rules [39]. A DAO will have different actors from today’s organisations; it will require extensive data governance processes that ensure data reliability and accuracy, and it will result in a fundamentally new organisational structure [44, 79–81]. A DAO is a self-organising framework that uses automated decision-making based on consensus in which actors interact with each other without the need to trust each other. Within a DAO there is no traditional organisational hierarchy because hierarchy is determined by ownership (that is, how trusted an actor is as well as the merits earned by that actor as a result of behaviour). This change in organisational structure affects the balance of power. In traditional organisations, power is distributed either by hierarchy or by knowledge, and often these are related; the higher up the hierarchy, the more information you have and the more power you have within the organisation [82]. Within a DAO, this works differently. Power is determined by the number of tokens an actor owns, an actor’s trust level, and their achieved merits. This will shift the power balance within an organisation from a hierarchical structure to a distributed structure, thereby affecting the governance structure [83].
In its simplest form, a DAO is just immutable computer code: one or more smart contracts linked together and deployed on a blockchain, encouraging actors to self-organise. The code defines governance within the DAO, because governance is the rules that are implemented within the smart contracts. With the functionality of blockchain technology, a DAO can be seen as a self-organising structure that uses consensus mechanisms to make automated decisions, without the need for trust. As a result, within a DAO, there is no traditional hierarchy (because there are no employees or managers), no traditional governance (because the code is the governance as the rules are embedded within the smart contracts), and it is not possible to email or call a DAO, except for interacting with chat bots (because the entire organisation operates automatically, without the need for people being involved). DAOs can, however, operate as traditional organisations, although they do this autonomously; they can order products and services, have customers and suppliers, and make profits or losses. It has the same activities as a traditional organisation; it needs to make money, it has costs, it has customers, shareholders, and even employees (although these are independent contractors), it offers a product or service, and it is subjected to regulatory requirements (although being a distributed company this becomes a lot more difficult since regulatory requirements could be contradictory across jurisdictions). Therefore, governance is important when developing a DAO and a governance structure should be incorporated within the DAO (within the code). In addition, one should ensure that the code of the DAO works and continues to function correctly for an indefinite amount of time because, once deployed on a blockchain, it becomes irreversible. Lack of governance or quality assurance can have major consequences, as was shown in The DAO Hack in 2016 [84]. Therefore, in summary, actors who want to establish a DAO have to ensure that the right governance structure is implemented within the code and that the code works correctly to guarantee that the DAO can operate properly once deployed.
So far, we have not yet seen any true, and successful, DAOs. The first attempt of a DAO, ‘The DAO’, was stopped after a bug in a smart contract enabled a hacker to siphon away US$50 million. However, there have been several other attempts to create a DAO of which DAX and Digix are the most well known. Digix is an asset-tokenisation platform built on Ethereum. They leverage the blockchain’s immutability, transparency, and auditability by applying it to precious physical assets such as gold (on a separate note, Digix raised US$5.5 million in just 12 hours with their Initial Coin Offer—or ICO—in 2016 [85]). Dash is an open-source, peer-to-peer cryptocurrency that offers instant and private transactions. Some people would also classify bitcoin as a DAO, although this classification is a point of contention.
To gain a better understanding of how a true DAO would look like for society, let’s look at a futuristic example of how a DAO could operate in the real world several years from now:
Imagine a self-driving taxi company in the not-too-distant future. Consumers can call the taxis using an App, similar to the Uber App. Once the taxi has been ordered, it automatically picks up the passenger and drives him or her to the requested destination. The car automatically takes the best route, avoiding traffic and detours. Once the passenger leaves the taxi, the money is automatically transferred using a smart contract. The money that is received with the service is used to automatically service the cars if needed. Once a car notices that service is required, it automatically books an appointment with a car service station. The repairman automatically and immediately receives a report on what needs to be done and if any parts need to be ordered. After years of great service, the car notices that it has reached the end of its life and automatically drives itself to the car-recycling company. Some time before that, smart contracts ordered a new self-driving car, based on the demand it sees in the market. The moment the old car is recycled, the new car leaves the factory and picks up the first passenger. No manager, no employee will be involved in the entire process. Big data analytics is used to automatically improve the service, understand the customers, and monitor the cars.5
Although it will be a while, probably a decade or so, before such a DAO exists, it is just a matter of time. The process of completely automating a company using smart contracts, big data analytics, artificial intelligence, machine learning, and the Internet of Things not only can be done within the taxi branch, it could also be achieved in retail, banking, manufacturing, or even the hospitality industry [86]. Obviously, governance will always remain important and there are quite a few challenges to be solved. After all, within a DAO, multiple actors, human and non-human, have to cooperate interdependently. Within such systems, mathematical models of conflict and collaboration can incentivise actors to act in the best interest for the system as a whole. DAOs are an exciting opportunity to redesign our society and how we do business, and to create more efficient organisations that offer better products and services for lower prices.
2.7 ICOs—every company its own central bank
An important aspect of a DApp or DAO is the cryptocurrency, sometimes referred to as the cryptocoin or token. For years, start-ups have been looking for investors to invest in their venture to build the next Facebook or Google. However, money is expensive and any start-up that raises money has to give a share of the company to the investors. The earlier an investor joins, the higher the risk, and the more expensive it becomes for the entrepreneur. That has been the paradigm for the past decades. Not anymore. Since the rise of the Blockchain, times are changing. The latest method to raise funds for a new start-up has become the Initial Coin Offer, or ICO (also known as a Token-Generation Event).
An ICO is increasingly being used by Blockchain start-ups to raise money by distributing a percentage of the initial coin supply [87]. Basically, with an ICO a start-up plays the role of a bank; it digitally creates money out of nothing and sells that to ‘investors’. The tokens, or cryptocoins, which are sold during the crowd sale will be used on the platform to pay for transactions and distribute value across the stakeholders. ‘Investors’ who purchase these coins during the ICO do not get a share in the start-up, but they hope that the price of the coin will rise and as such they can get a (substantial) return on their investment.
Some ICOs can be very successful. For example, the ICO of Filecoin, a blockchain data storage network, raised US$257 million in their ICO in September 2017. Filecoin raised the record-breaking amount in less than a month. However, one of the earlier ICOs was that of Ethereum. In 2014, Ethereum raised US$18.4 million via the ICO of their cryptocoin Ether (ETH). At the time of the ICO, 1 Ether was worth ≈ US$0.31 (2000 ETH for 1 BTC) and, at the moment of writing this book, 1 Ether has increased in value from US$11.27 to US$1228 and consequently dropped in value to US$600.6 Two other very successful ICOs have been Bancor, which raised US$153 million in five hours, and Block, which raised US$185 million in five days. At the end of 2017, the secure messaging app Telegram announced their ICO to enable them to develop a decentralised ecosystem. In March 2018, they had already secured US$1.7 billion in funding through their private token sale and, by the time you read this, it will be known how much they eventually raised. Of course, these fundraising activities also raise questions about purpose, trust, and governance. Notoriously, some ICOs and exchanges have operated Ponzi Schemes and other scams. Wherever there is money to be made, fraud and deceit are likely to follow. Some examples of these are discussed later in this book.
The coins that are sold during an ICO are often used to fund the development of the platform that is built. In many cases, a platform has not even been built yet and the founder(s) of the start-ups only have an idea or whitepaper that explains the objective of the platform. As a result, ICOs are extremely high risk and, because they often take place outside the realm of government regulators, there is no safeguard or guarantee at all for those who invest [88].
Start-ups that want to do an ICO should take it very seriously and ensure that the ICO complies with all relevant regulations. Often, start-ups naively think that, because they are incorporated outside of the USA, they do not have to take into account the SEC (Security and Exchange Commission) requirements [89]. However, failure to comply with the SEC is illegal and could affect the founders of the start-up.
Nevertheless, currently an ICO is a very popular way to raise millions. In the past months, there have been ICOs that raised millions of dollars in days, hours, or even minutes. Some of the most successful ICOs are: the DAO (raising US$160 million in three weeks, and subsequently losing US$50 million in the DAO Hack) [90], Bancor (raising US$153 million in three hours), Block.one (raising US$185 million), Sirin Labs (raising US$157 million in December 2017 to build a blockchain-based smartphone), Polkadot (raising US$145 million in October 2017 to allow people to use multiple blockchains at the same time), and Status (raising US$107 million in June 2017 to offer an interface that makes it easier to use Ethereum). These massive ICOs are a long way from earlier ICOs, which were deemed very successful at the time. For example, in 2016, Lisk raised US$5.7 million in four weeks whereas Synereo managed to raise US$4.7 million in four weeks, and SingularDTV raised US$7.5 million in just 17 minutes. Back in 2015, Augur raised US$5.2 million, of which the first 2000 BTC in only 12 hours. By the time you read this, these numbers will pale against more recent trends and records. A list of ongoing ICOs can be found at www.smithandcrown.com/icos/ or https://tokenmarket.net/ico-calendar
However, it is not all good news. There have been a few scams with ICOs. Quite a few ICOs are more like Ponzi Schemes and try to lure people in with the promise of high returns. OneCoin was one of the largest digital currency scams exposed recently as a Ponzi Scheme [91]. Another scam was GAWMiners, which raised US$19 million in their ICO based on nothing but lies [92]. If there is no working beta, or worse if there is only limited documentation and/or it is unclear who the developers are and what their background is, participating in an ICO is extremely risky and consumers can be scammed out of their money. Even if everything seems fine, as was the case with the massive ICO of Tezos, which raised US$232 million in July 2017, things can quickly turn bad. In December 2017, a class-action complaint was filed on the basis that Tezos allegedly violated US securities laws and committed investor fraud.
After an SEC investigation into The DAO Hack, the SEC ruled that some coins for sale are actually securities and that investors should be careful in deciding whether to invest in them. It is likely that the SEC will announce more guidelines in the future [93]. China went a step further and completely banned ICOs in 2017; this was a result of the Chinese community voicing concern that some ICOs are financial scams and pyramid schemes [94].
The scams organised by maleficent ‘entrepreneurs’ are one way that investors can lose their money when taking part in an ICO. Unfortunately, there are many more types of cryptocurrency scams. The most common is the so-called Pump-and-Dump schemes, where members of private groups on, for example, the messaging app Telegram, decide to promote a coin they own so they can sell it at a higher price. Within the stock market, such practices are illegal, but the crypto-market is still unregulated in many jurisdictions. Such behaviour can result in volatile fluctuations and ordinary investors suffering hefty losses. Criminals also try to steal money by copying websites of popular ICOs and trying to direct people to the wrong website. When people then transfer money to a given address, they never receive any tokens in return. In addition, there have been examples of fake exchanges, Ponzi schemes, fake wallets, and phishing attempts.
As a result of these scams, there has been a crackdown on cryptocurrencies by various countries including China and South Korea in 2017 and 2018. Of course, this caused mayhem among cryptocurrencies, with some coins losing almost 50% of their value in a few hours and Bitcoin dropping 25%. Many government bodies and regulators are trying to understand cryptocurrencies and developing regulations for them. However, the outright banning of cryptocurrencies, crypto-exchanges, and ICOs is not the solution. Instead, what we need are global regulations focused on exchanges complying with Know Your Customer-Anti Money Laundering (KYC-AML) regulations and ICOs complying with regulations similar to Initial Public Offerings (IPOs). Only then will we get a more educated and regulated market that does not limit innovation and benefits all.
As is the case with any new technical innovation, especially in the IT space, regulators always lag behind new markets and disruption to old systems. By the time laws and regulations have been implemented, they are often no longer relevant to the digital space. As soon as new regulations are announced, the community moves ahead and develops new solutions. In addition, as much as governments cannot prevent hacking, spam, or phishing, they will not be able to prevent hacks and robberies in the cryptocurrency market. Furthermore, as cryptocurrencies are inherently decentralised, virtual, and borderless, attempts to regulate such a phenomenon in one part of the network will not work. As Joachim Wuermeling of the Bundesbank stated, at the start of 2018, the only way to regulate a decentralised phenomenon is through global agreements:
Effective regulation of virtual currencies would therefore only be achievable through the greatest possible international cooperation because the regulatory power of nation-states is obviously limited.7
The problem with global regulations is that they take time and a lot of countries have different motivations to ban or regulate cryptocurrencies. Nevertheless, there are two areas that regulators can focus on in attempting global regulations: crypto-exchanges and ICOs.
Regulations can force crypto-exchanges to comply with KYC-AML obligations to prevent cryptocurrency being traded by people who are not allowed to do so (although due to the inherent decentralised nature of it, they can never prevent users from making transactions outside exchanges). Regulations can also enforce exchanges to take the right security measures. Unfortunately, it is impossible to completely prevent hacks or digital robberies.
In addition, regulators should focus on the ICO. A more streamlined process around ICOs can definitely prevent scams and Ponzi Schemes. Similar to existing IPO regulations, ICOs should comply with certain regulations to protect investors and keep promoters accountable. However, regulations should not prohibit ICOs completely, because they are truly an innovation with tremendous potential. Therefore, similar to the General Data Protection Regulation (GDPR) compliance developed by the European Union (EU), a global standard should be developed for ICOs. These regulations could include requirements such as:
• Disclosing financial, accounting, tax, and other business information before an ICO;
• Implementing escrow functionality with smart contracts to ensure that funds are released only on reaching certain milestones. If those milestones are not met, funds will be returned automatically;
• Having a board of advisers that are involved with the company, instead of having stock photos as advisers or even stealing other people’s identity;
• Having a prospectus that informs potential investors of the risks involved with the ICO.
Apart from regulations, another area that governments and regulators should focus on is educating citizens about the risks involved when dealing with cryptocurrencies and helping consumers understand how they should deal with them. By 2017, Russia had already announced a programme to educate its citizens on cryptocurrencies and the dangers associated with investing in them. More countries should follow to help citizens understand what this new phenomenon is and what risks involved are.
Nevertheless, it seems that ICOs are here to stay. Start-ups have discovered this lucrative way of raising money and are acting as their own central bank, although it is very likely that regulators will attempt to regulate the ICO and impose restrictions or rules on doing an ICO. Cryptocurrencies will fundamentally change how we perform transactions online and as such how we use and build new products and services. They will have a big impact on Blockchain for social good and could hold the key to solving some of the Wicked Problems, but more on that in the following chapters.
This section considers some of the organisations that are developing the new technology for Blockchain. Of course, this is not an exhaustive list of the technology that is already available. The number of companies developing new tools and solutions is constantly expanding and here we provide three examples of different types of blockchain start-ups. The companies mentioned below are only for the purposes of illustrating what is already out there.
Ethereum aims to reinvent the internet and has been around for a few years now. It is a decentralised platform to develop DApps that run through smart contracts. These smart contracts are small software programs that execute a task, a sort of If This Then That statement (but a lot more complex). They run on a custom-built blockchain and as such there is no chance of fraud, censorship, or third-party interference. Ethereum has developed an enormously powerful, shared, global infrastructure, the Ethereum Virtual Machine, which can execute code of arbitrary algorithmic complexity. They are continuously expanding the infrastructure and building new solutions for the distributed web.
Ripple is a Blockchain start-up focused on the financial services industry. They claim that they are not using blockchain, but rather use Distributed Ledger Technology. They have developed a Distributed Ledger Technology to enable banks around the world to send real-time international payments, without the need for a centralised authority. It is in reality a payment network to instantly transfer any type of currency across the globe. They have developed a distributed global network that hosts payment nodes to transfer value around the world. Banks can monitor and coordinate the transfer of funds across distributed ledgers, with minimal risks and delays, contrary to the amount of time it takes today to settle international transactions (which can be up to a week).
IOTA is a completely different cryptocurrency from the above because it does not use a blockchain, but rather uses a Directed Acyclic Graph called Tangle. It is developed especially for Industry 4.0 where connected devices have to be able to perform micro- or nano-transactions with each other. As such, it offers the following characteristics:
• Infinite scalability as it does not use blocks or miners. Instead, every party that wants to perform a transaction has to validate two transactions;
• No transaction fees, thereby enabling nano-transactions among connected devices;
• Proof of Work consensus mechanism that requires minimum computing power and can be performed by connected devices;
• Completely decentralised, in contrast to the semi-decentralised networks such as Bitcoin.
In 2016, the amount of investment in Blockchain start-ups crossed the US$1 billion mark for the first time and in the first quarter of 2018, ICO funding exceeded US$ 6 billion, as such it is impossible to give a complete overview of Blockchain start-ups [95]. However, we set out below, in no particular order, a list of some more interesting start-ups working in the decentralised and distributed space. By the time you read this book, it is likely that some of these start-ups may no longer exist:
Everledger: a permanent ledger for diamond certification and related transaction history.
Cardano: a smart contract platform that seeks to deliver more advanced features than any protocol previously developed.
Stellar: a platform that connects banks, payments systems, and people. Moves money quickly, reliably, and at almost no cost.
NEO: a competitor to Ethereum, NEO is developing an open network for a smart economy.
Coinbase: a platform to buy and sell bitcoin and ether.
Lisk: a platform that enables the development and publishing of blockchain applications with your own sidechains.
Blockstream: offers software and hardware solutions using the Blockchain.
tØ: a blockchain-based trading platform.
OpenBazaar: a decentralised marketplace.
BitFury: one of the biggest bitcoin mining infrastructure providers.
Augur: a decentralised prediction market built on the Ethereum blockchain.
Neureal: open source and decentralised artificial intelligence.
Maidsafe: a distributed platform that enables the creation of fast and secure applications.
IPFS: a peer-to-peer distributed file system that aims to replace http.
Imagjn: developing a reputation protocol to enable collaboration among individuals, organisations, and things.
EOS: a smart contract platform for DApps that raised over $4 billion in their token sale.
Of course, there are many more Blockchain start-ups establishing their roots in this market every day.
2.9 Blockchain challenges to overcome
Blockchain follows the same path as many disruptive technologies that could have a major impact on the world. As such, it still faces some challenges, which will require time before they will be overcome.
With the attention moving away from Bitcoin and towards the enormous potential of Blockchain, it may seem that Blockchain will solve many of the world’s problems, but it is still a very young technology. Below is an overview.
Scalability is a major issue for blockchains, at least for public blockchains. The most popular blockchain, the Bitcoin blockchain, is by now 170 Gigabytes8 and is growing steadily at 1 MB per block every ten minutes. The idea of Blockchain is that every node in the distributed web has a complete copy of the blockchain. So, if you wish to start validating transactions on the Bitcoin blockchain, you first have to download the entire blockchain.
A potential solution to the issue of scalability could be ‘blockchain pruning’. This basically means that nodes in the network use only a verified representation of the blockchain that contains the last few hundred blocks. The entire blockchain would still be available, but only on a few nodes. At the time of writing, there is a lot of discussion in the Bitcoin community regarding whether the size of the block should be increased to 2 or 4 MB. It is likely that scalability will remain an issue as the popularity of Bitcoin increases. In 2017, this scalability challenge resulted in a division among bitcoin miners. As a result, some miners decided to hard fork and create a new cryptocurrency, Bitcoin Cash, which enables up to 8-MB blocks. The size of the Bitcoin Cash Blockchain has since grown to 159 GB.9
Scalability is less of an issue for private blockchains, such as Hyperledger, because they contain only nodes that have a direct interest in processing transactions. Although private blockchains are more expensive than a single centralised database, if you add up the costs involved in all those centralised databases replaced by the blockchain, it is still a lot cheaper.
2.9.2 Transaction speed and costs
Transaction speed and costs are also a major issue for some blockchains (although not all). IOTA’s distributed ledger (Tangle) is infinitely scalable at zero costs. However, the bitcoin blockchain does face significant transaction and cost challenges and, as it is the most-developed blockchain, we focus on the bitcoin blockchain. When Bitcoin was launched, everyone was excited about the almost negligible transaction costs. Sending money almost instantaneously across the globe was almost free of charge; this created a completely new world that bypassed the need for banks when it came to transferring money across the globe. However, things have changed. On 21 December 2017, the average transaction fee reached its highest level of US$54.90 per transaction.
Obviously, if you wish to perform a small transaction, let’s say buying a coffee with bitcoin, this becomes impossible. If you use bitcoin to transfer large sums of money across the globe, hundreds of thousands or millions of dollars, such a fee is relatively cheap compared with what you would have to pay a bank. However, for a cryptocurrency to be widely accepted and potentially replace fiat currency, it should be usable by everyone for every type of transaction.
The cause for the high transaction fees lies in the fact that the sizes of the blocks are currently limited to 1 MB per block and almost each block is completely filled. For example, on May 4, 2018, the average block size10 was 974 kB, which means that every block is filled up with transactions. Bitcoin was created in such a way that miners who validate transactions have to use a tremendous amount of computing power (that is, energy). If there is an increasing demand for transactions to be validated, miners will prioritise transactions that pay a higher fee. Economics 101 dictates that, if the demand increases, but supply remains the same (number of transactions that can be validated per block), the price increases.
Another reason for the increased transaction fee is the newly created cryptocurrency Bitcoin Cash that split off from Bitcoin on 1 August 2017. Bitcoin and Bitcoin Cash are very similar cryptocurrencies, which means that miners can easily switch from Bitcoin to Bitcoin Cash, if it becomes more profitable to mine Bitcoin Cash (the rationale behind this has to do with how the Bitcoin and Bitcoin Cash protocols have been developed; if there are fewer miners, the mining difficulty goes down, and the possibility to make more money increases). Fewer miners on the Bitcoin network means less supply, which means an increased transaction fee.
Of course, the Bitcoin community is aware of this and is attempting to implement solutions to increase the size of the blocks, thereby increasing supply and lowering transaction fees. There is an ongoing debate in the Bitcoin community related to block size, with multiple arguments in favour of and opposed to an increase in size. The reality is that, without a solution to this problem, the number of transactions per second remains limited, and the transaction fees will continue to increase. Or, as Vitalik Buterin [96], founder of Ethereum, said: ‘If [the niche of digital gold] is what Bitcoin users want, then they should keep the limit, and perhaps even decrease it. But if Bitcoin users want to be a payment system, then up it must go.’
2.9.3 Negative image due to security concerns
Clearly, the decentralised approach that blockchain offers has some advantages. It becomes a lot more difficult to hack and/or censor data, and the usage of the Hashcash Algorithm ensures that it is impossible to retrieve the hashed content. The Bitcoin blockchain itself has not yet been hacked, despite the fact that it has been around for almost a decade. However, many of the services surrounding it have. The DAO was hacked and subsequently almost lost US$50 million [90]. This was preventable only thanks to a ‘hard fork’. Mt Gox, the (at the time) world’s largest bitcoin exchange, was hacked and as a result US$460 million disappeared [97]. Further, Bitfinex, a Hong Kong-based bitcoin exchange platform, lost US$70 million [98]. More recently, in January 2018, the Japanese exchange Coincheck was hacked, resulting in a loss of US$660 million in NEM tokens. These hacks do not help the image of bitcoin and other cryptocurrencies. Although bitcoin is only one application of Blockchain, these hacks distract the general public from its true value. People might not feel comfortable with these security concerns surrounding blockchains.
2.9.4 Energy consumption and costs
Validating transactions requires computers to solve complicated puzzles. This, in turn, requires a tremendous amount of computing power and is very expensive. Bitcoin is a particularly unsustainable coin in terms of its energy consumption. The Proof of Work consensus mechanism requires tremendous amounts of computing power. According to VICE, in 2015 a single Bitcoin transaction used roughly enough electricity to power 1.57 American households for a day [99]. This results in an estimated annual energy consumption of approximately 16 terawatt-hours.
CERN (the European Organization for Nuclear Research) uses approximately 1.3 terawatt-hours per year to power the Large Hadron Collider [100], an amount equal to the annual energy consumption of Iceland. This is almost 30,000 times the energy consumption of VISA [101] (which processed 82.3 billion transactions in 2016 [102], compared with the approximately 100 million Bitcoin transactions in 2017). With the potential increase in block size, the amount of energy required to solve the puzzles would continue to increase. In addition, given that most of the mining pools are in China, most of this energy consumption is driven by unsustainable coal-powered energy plants. Although it is possible that miners may switch to clean energy, there is still the problem that the mining of bitcoin is literally a waste of energy [103], because the complex computer calculations as part of the Proof of Work consensus protocol have no value at all. No world problems are being solved by the calculations, except to show that the calculations have been done. In an ideal world, we would see the development of a consensus algorithm that actually contributes to the public interest, similar to what was done with reCAPTCHA, which was used for training neural networks.
In times of climate change, the energy consumption of Bitcoin is a serious problem. Of course, different consensus mechanisms, such as Proof of Stake, do solve these issues, but many blockchains, including the Bitcoin blockchain, continue to use Proof of Work. Unless Bitcoin switches to a different consensus protocol, the energy consumption of Bitcoin will rapidly become unsustainable.
Blockchain technology remains nascent and as a result not many developers have mastered working with blockchain-related technologies. Already, there are hundreds of Blockchain start-ups that all want fish from the same talent lake. As a result, it becomes increasingly difficult for organisations that want to move to the distributed web to attract the right talent. As was the case with big data a few years ago, it will take time before universities catch up and start developing the right courses for the distributed web. This delay in training the right graduates may slow down the development of new applications.
2.10 A word about doubt and criticism attendant upon blockchain adoption
In 2017, the Australian Government’s data research and engineering centre— Data61—produced two reports detailing the long-term scenarios and immediate technical applications for blockchain technology11. The Data61 reports describe some of the possible opportunities for the use of Blockchain in Australia, including monitoring the outbreak of pests or animal and plant diseases, conducting border surveillance, tracking intellectual property, and establishing identity systems that provide greater certainty over entitlements, benefits, and tax obligations. The reports also provide some well-researched insight into why some of the major blockchain projects that were launched in 2015 and 2016 stalled. It is useful to consider here the problems facing blockchain-based solutions, because these issues have garnered media attention and resulted in some negative sentiment surrounding blockchain’s promise as a solution to some of the fundamental problems facing our globalised world.
Since 2015, banks, regulators, tech giants, and start-ups from across the world have raised billions of dollars to explore the potential of Blockchain. But, so far, the only really successful, ‘scale-able’ use of Blockchain remains cryptocurrencies. The problems that have hampered attempts to apply the Blockchain’s capabilities to other applications are all risk based, and fall into three broad categories: privacy and fraud.
When it comes to blockchains and privacy, it is important to begin with a distinction between private and public ledgers. Public ledgers do not afford privacy. Privacy inside the Bitcoin system has proved to be highly porous and heuristic, with nothing even close to approaching high guarantees. This is because transactions are globally published and are not encrypted in most applications. If this data is personal data, for example ‘medical or financial data’, this brings the regulatory and legal issues into the light, particularly in Germany, which has some of the strictest privacy regulations. Even if there is an attempt to encrypt and hide personal information, it is still possible to glean statistical or meta-data. One solution is to store only encrypted data on a blockchain, but this leads to another problem: if the key to decrypt specific information is lost, the data may not be recovered accurately. Furthermore, if a key is stolen and published, all the data is forever decrypted in the blockchain because the data cannot be altered. For more information on Public Key Infrastructure, see Chapter 3.
In a speech delivered to the Africa Blockchain Conference in March 2017, Andreas Antonopoulos warned that many recent ‘blockchain’ projects are fraudulent attempts to raise capital under the guise of innovation and disruptive technologies. The use of blockchain in financial transactions also poses problems for compliance with anti-money-laundering legislation, which requires that anyone providing financial services (for example) must satisfy themselves as to the identity of their client or customer. At this time, a problem with smart contracts and cryptocurrencies is that they are susceptible to manipulation. This was a key reason for the US Security and Exchange Commission’s refusal in March 2017 to approve the registration of the Winklevoss Bitcoin Asset Trust.
These shortcomings may explain why a number of high-profile blockchain projects stalled in 2015, 2016, and even 2017. For example, in mid-2017 the Bank of Canada announced that its blockchain project, Jasper, was not yet fit to handle settlements. Citing transparency and privacy issues, the bank found that the benefits of using blockchain did not outweigh the risks [104].
Risk was not the only reason that blockchain projects stalled. In February 2017, the R3CEV consortium of banks and technologists announced, after more than 18 months of investment, innovation, and testing, that they would not be using blockchain for their project because they did not need it. This decision does not amount to an attack on the Blockchain’s promise or reputation. It is simply a practical decision based on the fundamental question of whether or not an application is fit for purpose.
Finding a solution to the real risks and challenges facing the Blockchain is a priority for developers, investors, and promoters who want to attract the number of users needed to make running a network reliable and profitable.
At the Third Global Blockchain Summit held in Shanghai in September 2017, Vitalik Buterin acknowledged these problems and offered a road map for the Ethereum Project’s proposed solutions. In his presentation to an audience of 1200 government, industry, and academic experts, he suggested that security and privacy issues can be readily addressed by creating user accounts (for networks managed by central authorities), or via zero knowledge proofs known as SNARKS and STARKS which may resolve issues for public networks.
A SNARK is a succinct non-interactive argument of knowledge that enables the extraction of verification so that it can be published to the network as an additional proof. Meanwhile, STARKs are scalable transparent arguments of knowledge. This zero knowledge proof improves the verification process by providing a statistically (probabilistically) checkable proof. These measures will improve the mathematically defensible verification of each block in the chain.
In order to resolve the problems arising from the demand for security and scalability, the Ethereum developers have looked to Sharding as a possible solution. A blockchain cannot process more transactions than a single node can. In large part, this is why Bitcoin is limited to three to seven transactions per second and why Ethereum can only manage seven to fifteen transactions per second. The promise from Ethereum is that Sharding will change the way that the Blockchain can be validated. Referred to as Sharding, a small subset of network nodes will validate every single transaction. This means that the Ethereum blockchain will remain secure while also allowing for better scaling. There are also completely new solutions in production, such as the internet of things Blockchain start-up IOTA which offers a new version of blockchain, called ‘the Tangle’, offering infinite scalability.
There are still issues that remain unresolved and questions that remain unanswered. For example, the timeframe for the implementation of these innovations remains unclear and their performance has yet to be tested. Importantly, technologists are as invested as users in the way forward. This moment is reminiscent of the routing security problems that dogged the development of the internet in 1989, when it was little understood, hard to explain, and described amusingly in terms of surfing and super-highways.
Ultimately, blockchain technology can help to improve defensive cybersecurity strategies, especially in terms of identity and access. Solutions are being explored and they promise to provide greater security and privacy than yet experienced on the internet. Cybersecurity threats emerge every day, whereas older threats still linger around and wait to be exploited once again. Blockchain technology will not be the holy grail of cybersecurity, but it is a powerful tool that can help to harden systems.
2.11 A decentralised and distributed society
In recent years, technology has drastically changed many elements of how we do business and lead our lives. Unfortunately, our economic, legal, and political systems have not kept up with the changes [105]. As a result, our administrative controls have also not kept up and our economic, legal, and political systems still operate in a bureaucratic way. Hence, these systems are often ineffective, lack transparency, and are open to fraudulent actions. Blockchain technology can change this and the opportunities of a decentralised and distributed society are enormous. Marco Lansiti and Karim Lakhani, both professors at Harvard Business School, view Blockchain not as a ‘revolutionary technology but a foundational technology, which has the potential to create new foundations for our economic and social systems’ [105]. Building new foundations for our economic, legal, and political systems takes time (possibly decades), and will present many different challenges. However, once we make it to the other end of this transition, it will result in better, more transparent, and fairer economic, legal, and political systems.
A decentralised and distributed peer-to-peer world will offer many benefits, which our economic and social systems are currently lacking. The cost of doing business will be reduced by removing intermediaries, (smart) contracts will be executed automatically based on predefined conditions, society will be reshaped, and we will need to rely less on intermediaries, whether these are governmental or for-profit organisations. Of course, organisations that want to move to Blockchain will also reap all the benefits of this technology; it will help them reduce costs, reduce fraud, offer better services, become more transparent, and all in all, become a better company. However, this book is not about how companies can use the Blockchain. If you are interested in how your company can become more profitable using Blockchain, we recommend you put aside this book and read one of the many, often very-well-written, books on Blockchain for businesses. In Chapter 10, we do provide a roadmap for organisations how to implement blockchain technology within their business. This book is all about solving the many Wicked Problems our society faces, because of the economic, legal, and political systems that have lagged behind. Our objective is to explain how Blockchain can help these systems catch up and we sincerely believe that, if governments and organisations focus on Blockchain for Social Good, we can create a better world for all. Therefore, we focus on those problems that affect our society negatively, and for each of these problems we discuss the identity and nature of the problem. What is the scope and impact of the problem and why should we actually care? What attempts have been made to solve the problem so far and how can Blockchain solve the problem? How can a decentralised and distributed approach offer new insights for solving the Wicked Problem? We dive into some of the best practices that are already out there, as well as the barriers and possible solutions to those barriers. The seven Wicked Problems that we discuss in this book are:
• Identity;
• Poverty;
• Climate change;
• Corruption, tax evasion, and money laundering;
• Fair Trade;
• Voting fraud and disenfranchisement; and
• Censorship.
If we can solve the above Wicked Problems, using a decentralised and distributed solution, we will create a peer-to-peer world that offers many advantages to our current system. Although the technological developments will take up at least a decade or more, once we have created a decentralised and distributed society based on peer-to-peer collaboration, we will have created a better world.
Blockchain is the Distributed Ledger Technology that ensures that data and contracts are stored in transparent and shared databases, and protects data from removal, corruption, or modification using a consensus mechanism and cryptography. The Hash Algorithm ensures that we can always control whether a document, ownership, or transaction has been altered. The immutability of records on a blockchain ensures that we can always go back to the origin of a transaction, to control or monitor who has been involved in that transaction across time and space. Apart from transactions, a blockchain can also store smart contracts, so-called If This Then That statements, albeit a lot more complex. These contracts are written in code, understandable across jurisdictions, and ensure that a certain action will automatically take place once certain pre-set conditions have been met. When you start combining one or multiple smart contracts with technologies such as big data analytics and artificial intelligence, it becomes possible to create DApps or even DAOs. A DAO is an organisation without management or employees, run completely by code, where (data) governance is enforced in the code. In this way, existing paradigms of how we should run an organisation are changed completely.
The Blockchain, and with it the hundreds of DApps that have already been developed, offer a glimpse of what the future holds. Blockchain is still in its early development and a lot of development work has still to be done. However, decentralised applications that are run by smart contracts, without the need for a centralised governing power that generally takes a large commission, offer tremendous advantages. They are cheaper and more efficient to run, more difficult to control by governments or centralised organisations, and more secure and transparent than existing applications. It is these technologies and applications (Blockchain, smart contracts, DApps, and even DAOs) that could contribute to solving Wicked Problems.
Notes
1 This book follows industry practices in the writing of Bitcoin vs bitcoin. When written as Bitcoin, it relates to the technology, and, when written as bitcoin, it relates to the cryptocurrency.
2 Blockchain is only one form of a distributed ledger technology. There are more versions of distributed ledgers, for example the Tangle developed by IOTA. However, in this book we focus on the distributed ledger technology called Blockchain and, for the sake of the argument, include other variations of distributed ledger technologies under Blockchain (although technically these variations of course differ, sometimes even significantly).
3 This book follows industry practices in the writing of Blockchain vs. blockchain. Blockchain refers to the technology/trend as a whole, whereas blockchain means one or more blockchain(s)—a distributed ledger database.
4 It should be noted that the technological developments around Blockchain are so rapid that, by the time you read this, this could be outdated.
5 This example was originally created by Vitalik Buterin, founder of Ethereum and has been adapted for this book.
6 Price as of the beginning of February 2018—https://blockchain.info/charts/blocks-size.
7 www.reuters.com/article/us-bitcoin-regulations-germany/any-rule-on-bitcoin-must-be-global-germanys-central-bank-says-idUSKBN1F420E.
8 As per March 2018—https://blockchain.info/charts/blocks-size/.
9 https://bitinfocharts.com/bitcoin%20cash/—as at March 2018.
10 https://blockchain.info/charts/avg-block-size.
11 See ‘Distributed Ledgers’ (2017) and ‘Risks and Opportunities for Systems using Blockchain and Smart Contracts’ (2017), which can both be found here—www.data61.csiro.au/en/our-work/safety-and-security/secure-systems-and-platforms/blockchain.