On Crypto

I can’t tell you how many times I’ve heard that “bitcoin is a bubble, but blockchain is interesting” over the last few months. With everybody from Kodak to Long Island Iced Tea cashing in on the hype, it’s hard not to be cynical about blockchain as a technology. Resisting that urge, I’ve spent some time over the past few months thinking about when, if ever, blockchain might make sense. It’s true that blockchain has some attractive attributes, including anonymity, immutability, and fault tolerance. It also has some very real drawbacks: low throughput, wasted energy, and high transaction costs are among the most discussed. My high-level conclusion has been that unless you have a realistic fear of either massive DDOS attacks or censorship, there is little reason to use a public blockchain. As for private blockchains, I’ll just say that many businesses would benefit from a thoughtful implementation of public key cryptography, but that the extent to which any firm can benefit from blockchain is more dependent on how poor their existing IT infrastructure is than on the technical merits of blockchain.

Chris Dixon, general partner at a16z’s crypto fund, makes the case in favor of decentralization in his excellent blog post here. While I like his arguments, I disagree with this part:

The question of whether decentralized or centralized systems will win the next era of the internet reduces to who will build the most compelling products, which in turn reduces to who will get more high quality developers and entrepreneurs on their side.

This argument is at the heart of the case in favor of decentralization, but it ignores some key economic realities. Every token system needs to rely on some scarce resource, typically computing power and electricity. If that resource is subject to economies of scale (as in proof-of-work systems) then it seems virtually certain that a few dominant players will emerge. If the resource is the token itself (as in proof-of-stake systems), then access to capital becomes the determining factor (especially early in the lifecycle of these tokens). Again, dominant players emerge.

On a less technical note, I am intrigued by the emergence of crypto-anarchism as a social movement. In its most extreme form, this theory proclaims that technology—specifically blockchain, cryptocurrencies, and cryptography—can free us from the tyranny of corporations, governments, and the Illuminati. The crypto-anarchist is easily identified by his repeated pronouncements that “the code is the law” and “information wants to be free.”

This religious fervor for absolutely trustless systems is an exercise in navel gazing. Its most zealous adherents are building systems that are theoretically perfect and practically useless. We exist in the physical world, outside the bounds of the beautifully polished systems that they have created. It’s all well and good that I have a token entitling me to a 1/1,000th ownership stake of a Monet, but when the current holder runs off and sells it in Macau I’m going to have to go to Interpol to try and get my cut.1 Governments, laws, and civil society are necessary constructs. They will be altered by technology, but they will not be replaced by it.

I don’t mean to say that blockchain is useless. On the contrary, I believe that blockchain could create value in three ways:

First, blockchain is driving standardization. This is not an inherent property, nor is it unique to blockchain—rather, it is a function of the hype that has been generated by it. You will never get a group of CEOs to adopt a common SQL schema based on Merkle trees, but they are more than happy to embrace the blockchain (and the subsequent pop in their share prices).

Second, the emergence of cryptocurrencies has created a massive economic incentive to study cryptography and decentralized systems. Until recently, these have been relatively niche specialties. Over the long run, increased interest and resources devoted to these fields could create substantial value for our society.

Third, decentralization and smart contracts can be much more compelling offerings in emerging nations. In the United States, we have a robust legal system that obviates many of the purported benefits of these systems. Large swaths of the world’s population do not enjoy this luxury. In these circumstances, the cost/benefit calculus of blockchain adoption may be radically different.

Blockchain and cryptocurrencies are a fascinating area of study. As an engineer I can appreciate the technical beauty of these systems. As an investor, I remain deeply skeptical of the value that they create. In the words of Fox Mulder, “I want to believe.” I simply can’t yet.

1 Securitization of physical assets on the blockchain is actually an interesting and active area of development, but it will never be trustless.

Written on August 5, 2018