This is the third installment in the Blockchain for Grown-Ups series. In the first article, we took a critical look at the hype surrounding blockchain. In the second article, we went beyond the hype to look at the real possibilities for blockchain. In this third article, we discuss where the flurry of activity around blockchain is taking us—a blockchain multiverse.
A shared ledger only creates value if it has more than one user. An ecosystem of one is better off sticking with Postgres or Cassandra, but a distributed ledger creates value for the economic entities that share it and challenges existing power dynamics among those entities.
As a result, instead of One Blockchain To Rule Them All, we are seeing the formation of a blockchain multiverse. Every oligopoly, every asset class, every network will create its own instance, and perhaps even use incompatible implementations of blockchain—which will all limit interchangeability of value.
Regardless of the intent—to disrupt or entrench—the basic blockchain network patterns have already become clear. They are either private, public, or custodial models and they offer different trade-offs in terms of network trust and transaction volumes.
If the whole notion of transparency is too scary, then consider private blockchains. Private blockchains, also called “permissioned” blockchains, are closed networks that can only be accessed by known participants. If the entities behind the nodes have been investigated and certified before they can commit to the ledger, network participants have no doubts once they do commit, and have recourse if entities violate the trust.
Such an arduous process to join a private network limits exposure of valuable data and reduces the surface area of fraud risk, but it does so without transferring trust to the technology. However, if counterparties already trust each other, why bother with distributed ledger technology?
Sharing a ledger in a network of counterparties reduces the need to maintain disparate systems that hold a version of the truth. A private blockchain enables greater trade volumes in exchange for lower network trust. An example of a private network is R3CEV, where the world’s largest banks are working to create a private blockchain for trade settlement and in the process, attempting to eliminate costs associated with inter-bank settlements.
By reducing costs and requiring a “club membership” to play, private networks reinforce entrenched interests and positions of power. While disruptors can create alternative networks, their competitive advantage is primarily lower costs. If they attract enough trade volume—specifically, if they can siphon enough trade away from incumbents to be seen as a credible business threat—pricing pressures trigger a downward revenue spiral for upstarts and incumbents alike.
A battle for market-domination ensues, but only those with scale survive: institutions with pockets deep enough to buy rapid, sustained growth.
If you don’t trust anyone, you need to open your books up to everyone. This is the paradox of the public blockchain. A public blockchain is open to everyone, and anyone can stand up a node and directly participate in trade.
Bitcoin and the public Ethereum network are two examples of public blockchains. The promise of a public blockchain is true peer-to-peer transactions without intermediaries: trust isn’t provided by third parties, but on the economics of non-infinite computing resources performing advanced mathematics to amend a merkle tree in a global peer-to-peer network. This creates a technical means of providing trust at the expense of large trading volumes—keeping your tin-foil hat on your head.
By bringing accessibility and unfudgable irrefutability to markets whose dominant players prefer the protection of institutionalized barriers to entry and control of information, a public blockchain challenges established power dynamics. There are also questions of sovereignty and geopolitical power balances that come into play with public blockchains.
A globally accessible distributed ledger, comprehensive of all assets and events that anybody could ever want to record on it, creates unfettered recording of information and movement of capital. It would require the EU to eat its safe harbor laws, Venezuela to give up the right to impose controls on capital flight, and the US to accept that China can be a dominant power behind global trade technology. No need to hold your breath in anticipation of nation states withering.
Some will be scared by a completely open network, while others will never trust a private one. A third model is an open network where some nodes (or more accurately, the entities that operate them) are more “special” than others.
This is a custodial model of a blockchain where some nodes act as “representatives” of many other nodes, striking a balance in how trust is achieved and the ability to support larger transaction volumes.This requires incorruptible “neutral” parties who have no interest in the assets and events recorded to the ledger per se, but do have an interest in their implications. These neutral parties would run full nodes, while trading participants run “Lite Clients”. Estonia’s e-residency and e-voting initiatives are examples of custodial network relationships.
Meet the New Boss, Same as the Old Boss
The parties operating full nodes in a custodial blockchain network will look a lot like the institutions with that power today, such as governments, regulators, tax agencies, central banks, and industry consortia. They can also behave in the same way as their traditional marketplace counterparts.
Institutional players in existing markets make, break, and rewrite the rules of trade to protect their interests. The decision by members of the Ethereum network to roll back the ledger show us that equivalent institutions in custodial blockchains are no different. For blockchain to fulfill its aspirations, the wants of a single participant cannot be elevated above those of all others, even if they are the victim of a self-inflicted smart contract of inadequate design, buyer of first resort in what turns out to be a market rout, or an infrastructure provider with exploitable loopholes. The moment they are, doubts about blockchain shift from technological relevance to commercial relevance.
Today, there is a commercial battle for which network—Bitcoin, Ethereum, Eris, Ripple, and so on—will become the One Public Blockchain To Rule Them All. What these networks need are higher transaction volumes; increasingly, blockchain providers are advocating private blockchain terrariums.
What this fragmented approach will result in is locally optimized, but highly fragmented, solutions. Conway’s Law stipulates that “organizations which design systems…are constrained to produce designs which are copies of the communication structures of these organizations.” Like the late 1980s when companies large and small were building a Local Area Networks with token rings, Ethernet or ARCNet; Novell NetWare, Banyan Vines or Xerox Network Services; IPX/SPX, Nortel, and proprietary TCP/IP stacks, we are proliferating blockchains for specific uses with specific technical capabilities and questionable interoperability.
Intermediaries will emerge to provide the equivalents of dial-up modems, network bridges and tunnels. Redundant implementations of the same idea will clutter the landscape and compete for market share. The intermediaries in the blockchain multiverse will form a patchwork network-of-networks: linking private ledgers together, charging tolls for crossing ledgers, and consolidating only when it becomes viable for one to eclipse many others.
The race to be the dominant blockchain technology is a slow one indeed. Application of blockchain technology lags the hype surrounding it by a wide margin. High volumes of trade on blockchain ledgers are still in the future, so ecosystems have yet to emerge and inspire—or force—incumbents to act.
Governments and regulators have done little more than acknowledge the technology and its possibilities. Incumbents have the luxury of buying call options on the success of the technology by engaging in minor amounts of collaboration, dabbling as clients of venture capital-supported upstarts, and waiting for a winner to emerge.
The commercial success of any distributed ledger application will have more to do with the commercial savvy of those behind the application, not the specific blockchain technology that it’s built upon. In the end, the path is clear.
The winning strategy in the blockchain multiverse? Experiments and targeted investments, not worrying about the multiverse.