The New Internet. Digital Gold. The Fourth Industrial Revolution. The next Visa. The new Tulip Bubble.
There have been so many ham-fisted attempts at describing blockchains and what they can do, it might be easier to list the analogies that have not been tried. At least the 98 year old Charlie Munger struck an original chord when he called them ‘rat poison squared’.
I submit to you that a better characterisation is this one: a decentralised, world computer. A computer that no one can single-handedly stop or alter, and runs on thousands of machines concurrently. That everyone can use without anyone’s permission. And whose calculations and memory are visible in real-time by anyone who cares to inspect them.
In this sense blockchains are simply the next version of the box that computers come in. What your IT department and weekend tinkerers might call the computer’s form factor. After the hulking IBM mainframe computers, the original form factor which dates back to the 1950s. After the desktop personal computer. After the laptop. When the next version of the box arrives, it’s usually not immediately obvious what it’s going to be uniquely good at and what novel applications it will unlock.
The last major version of the box, the smartphone, arrived in circa 2007 with the launch of the first Apple iPhone. Here was a computer that could fit in your pocket, make phone calls, and connect to various wireless networks. To the naysayers it was a ‘solution in search of a problem’. And in 2007 it indeed wasn’t obvious what it was for. The answer appeared quickly. It turned out that what the smartphone was for included hailing cabs (Uber - founded in 2009), messaging anyone in the world for free (Whatsapp - 2009), and taking pictures of your brunch food and sharing them on the internet with complete strangers (Instragram - 2010).
Steve Job’s unveiling of the iPhone at the 2007 MacWorld Expo makes no mention of any of this. ‘An iPod, a phone and internet communicator’ is the best he could come up with at the time. Only in hindsight is it obvious what the next version of the computer is for.
So how is a blockchain a decentralised, world computer? Well, at the risk of surprising you, a blockchain can be viewed as a set of blocks, connected together in a chain. Users of the computer pay in tokens to send a set of commands, or transactions, that cause changes to the computer’s internal memory or state. Miners or validators compete to bundle these transactions into a block which doesn’t break any rules, like spending the same token twice, and are paid in transaction fees and freshly issued tokens. Every block is then encrypted and chained to the previous one. And on and on.
An idealised blockchain:
How exactly it works is less important than what it can do. I gather you’re probably a user of electricity. Yet if you’re anything like me you can only go so far in explaining exactly how those electrons and magnets power your toothbrush. Which is fine. The properties of that technology, a clean, silent, instant source of energy, and its capabilities are totally obvious to you.
In the same way, the cryptography and game theory at the heart of these blockchains is fiendishly complicated. But we can get away with a partial understanding of these if we keep in mind the properties that they enable: a decentralised, censorship-resistant permissionless world computer.
What follows is a brief discussion of three example applications of the decentralised world computer. A mature one which has found product-market fit and legitimised the entire universe of digital assets (Bitcoin). A second application which is feature-complete and ‘just works’, but still needs to impact the real world (Decentralised Finance and Payments). And a third one which is nascent but promises to touch billions of users (‘Web3’).
BITCOIN: the value of censorship-resistance
I won’t dwell on the Bitcoin network for long. It’s the cryptocurrency you are no doubt the most familiar with. But it best demonstrates some possibilities of the world computer.
Firstly, the Bitcoin network represents an unalloyed success technologically. As you know it’s a computer with limited functionality: the capital B Bitcoin network just maintains a ledger or database of who owns how many units of the small b bitcoin cryptocurrency. Technologically though, it is the giant on which all other blockchains and digital assets stand: Since its genesis block in 2009, 13 years ago, here is a decentralised computer that thousands of miners have together kept running, with minimal coordination, out of sheer self-interest and good incentive design.
It’s the poster child for that first feature of the world computer: censorship resistance. No one can stop it. As you know in May-2021 China, where most Bitcoin miners were based, banned all mining or holding of the cryptocurrency, from one day to the next. The most powerful authoritarian state the world has ever seen wielded its biggest baseball bat in an attempt to shut the network down. As miners across the country were the subject of police raids, the total hash rate, or total mining power that competes to produce blocks and secure the blockchain, dropped by almost half over a 6 week period:
Bitcoin hashrate evolution:
Thanks to its robust mechanism design, the Bitcoin network, like a protean living organism, just adapted and sailed through the challenge. An adjustment to the ‘Difficulty Rate’ of the Bitcoin mining algorithm occurs every 2,048 blocks (roughly two weeks) to ensure that a fresh block is produced every 10 minutes, no more, no less. So in the few weeks it took for all that mining hardware to redomicile to Kazakhstan, Norway or Texas, the Difficulty Rate went down, the remaining miners continued to secure the network, and onwards and upwards from there.
Secondly, this censorship resistance is what has made it so appealing to so many as a store of value, or ‘digital gold’, free from the threat of government interference or debasement. With a market cap of close to $400bn as of this writing, more than the next seven cryptocurrencies combined, and 85m bitcoin wallets in existence, no blockchain application has achieved greater adoption or real-world impact.
Bitcoin and its Proof of Work consensus mechanism can appear a little tired compared to the constant parade of shiny new cryptocurrencies. And ironically it has strayed away from Satoshi Nakamoto’s original 2008 design of ‘a Peer-to-Peer Electronic Cash System’. With it’s 10 minute block time and transaction fees in the several dollars, cash it is not, and likely never will. There is a satisfying permanence to the fact that any meaningful overhaul of the Bitcoin network would require coordination by thousands of actors who don’t know each other.
The need for digital gold can appear limited to us in the West, with our robust banking systems, respect for private property and stable (ahem) currencies. And Bitcoin will likely never be much more than it is today. But it is simply inarguable that for a large subset of people it has emerged as a credible, self-sovereign way to store value.
PAYMENTS AND DEFI: why credible neutrality helps
Jeff Bezos is famous for having said ‘your margin is my opportunity’. If blockchains could speak, they would look at the likes of Paypal ($110bn), Stripe ($95bn), Adyen ($50b) and say: ‘your market cap is my opportunity’. Seriously, those are big valuations just for pushing money around on the internet.
The ‘original sin of the internet’, according to Marc Andreesen, is the inability or unwillingness back in the 1990s of incorporating payments into the first mainstream browsers. Hence a slew of advertising-based business models, misaligned incentives, the harvesting of user data, outrage-maximising machines and other 21st century maladies.
Cross-border payments are notoriously antiquated. Even large corporates wiring funds from the US to Europe will have to deal with several days of processing times, correspondent banks, $50 wire fees, 1% FX conversion rates, and the possibility of the payment getting stuck at any turn, with no real-time visibility and arbitrary value dates. At the heard of the problem is the SWIFT Network, a Belgian cooperative founded in 1973 that is essentially an interbank messaging layer. And a hornet’s nest of legacy technology. Remittances between individuals are harder still, with Western Union still taking 10%+ cuts. Even within the US a 2017 ‘Real Time Payment’ initiative has still not gained mainstream adoption, and Paypal and Venmo reign supreme.
The permissionless nature of blockchains, the fact that anyone can interact with them, and that no trust in a central actor is required, make them the ideal settlement layer for every global bank to plug into. It’s less about blockchains’ inherent speed and cost than the fact that they solve a coordination problem. The thousands of global financial institution are never going to coordinate and agree on much of anything, but they can all plug into a credibly neutral settlement layer that is built for them.
Purpose-built payment blockchains with fast block times and low cost like Ripple ($40bn market cap) and Stellar ($5bn) are showing the way. As are general purpose blockchains like Polygon, together with stablecoins like Circle’s USDC ($50bn outstanding). USDC is emerging as the money token of the internet. In recent months both the fintech giants Stripe and Checkout.com ($40bn valuation) have announced support for USDC on the Polygon network as a new payment method.
USDC Market Cap ($bn):
Alongside payments, a whole new set of open protocols that enable the trading, borrowing, lending, hedging of digital assets have come to be known as decentralised finance or ‘Defi’. These names might be familiar to you, and have been operating without fail for several years: Uniswap (a spot exchange - $5.5bn), Aave (a lending platform - $1.2bn) or dYdX (a derivatives exchange - $1.2bn). Each of these protocols is non-custodial: no trusting a centralised bank or exchange with your assets. Transparent: no hidden liabilities, off-balance sheet items or racy accounting. And permissionless: anyone can use them, no one can stop them. What they lack is a connection to the real world, a way of facilitating the trading and financing of real world assets
In summary, crypto is ready to provide a totally new set of financial plumbing to businesses and retail alike. The technology is ready and has been de-risked over several years of operations. What it still lacks is mainstream adoption, and a regulatory framework and on-ramp / off-ramp solutions that will allow it to facilitate meaningful real-world activity.
WEB3 and the benefits of transparency
Finally, for a set of use cases which are not technologically mature yet but hold huge promise, we turn to so-called ‘Web 3’. The case for Web3 is a simple one: interoperable online web communities, owned by their users, free from the Big Tech monopolies.
In this analogy, Web 1 represented the early online services that only sent static, one-way information to their users: AOL, Yahoo, Google. Web 2, brought about by the ability for web pages to be interactive, ushered in the era of ‘User Generated Content’: users would each upload the content to Facebook, Twitter, Youtube etc. The ’network effects’ of having everyone’s content on the dominant platforms quickly turned them into monopolies. Monopolies with every incentive to lock the users into ‘walled garden’ experiences and prevent any compatibility or ‘interoperabilility’ with other services. A set of Facebook friend (a ‘social graph’) is not exportable to Twitter. And a tweet is not exportable to Facebook.
What Web 3 promises is a decentralised set of internet applications, owned by its contributers and users, which aim to break the Web2 monopolies.
The easiest one to understand is perhaps Audius, a decentralised Spotify. Spotify, the music streaming service that achieved incumbent status, is worth $20bn, and does very little: the music comes from artists and their labels, who get paid $.004 per stream on average. A smartphone app and a little bit of content curation is all that’s left for Spotify to do. Artists have no idea who their fans are, are unable to reach them outside the app to sell them merchandise or concert tickets, and are at the mercy at any point of an arbitrary ban by the platform, or of not appearing on playlists anymore (a ‘shadow ban’).
Enter Audius, which is not a company or an app but a protocol: Artists upload their tracks to a decentralised file storage network for all to see. Third party developers build apps to allow listeners to stream the music from the network and on to their devices. Everything is transparent. Artists know who is listening to them. The collection of music rights is mechanical. There are no more intermediaries. There is no more company.
The network is owned by the holders of the native $AUDIO token, which in the hands of early artists who are incentivised to help the network succeed and publish exclusitvely on Audius is a potent growth mechanism. Web2 business like Airbnb or Uber managed to create very strong network effects and competitive moats without ever issuing any equity to hosts or to drivers. Web3 tokens, and their ability to create ‘internet-scale capitalisation tables’ of incentivised users, mean the Web3 alternatives should explode out of the gate even faster than the Web2 giants did.
In summary, there are several attempts at the decentralised Spotify, the decentralised Twitter, the decentralised Amazon Web Services - with always the promise of offering in a transparent way the set of features that came from the opaque, data-hoarding and rent-seeking centralised incumbent.
How long these Web3 primitives will take to emerge is anyone’s guess.
But the history of internet has taught us to never bet against permissionless innovation.