In an age of microblogging and relentless conferencing, zeitgeist is not written in novels but in phrases shorter than 140 characters.
One cannot leave a FinTech or digital currency conference without hearing some rendition of “I love the blockchain, just not bitcoin”. However, as with most clichés, the phrase actually addresses the core of the issue: it begs for a defense of blockchains and the bitcoin blockchain as the best in-class.
Blockchains are data structures that have two distinct features:
- They have native tokens that form the basis of all recorded information and economic incentives for using the system. The tokens are native as they are governed by the protocol that governs the data structure and have no external dependencies like central banks or financial institutions.
- They contain a chain of cryptographic proofs that ensures the data has not been tampered with, lest the chain of proofs would not be able to be reconstructed. The chain of proofs has the neat property that it reveals the amount of work it took to construct the chain. This enables the network to converge on one chain as the true chain, the one with the most work done, and discard all but one.
The title of this article addresses a key challenge that has been the cause for much debate in the industry: do we need to have only one native token with a fixed supply in our data structure, or could we have none – or many?
To miss the value of these native tokens would be to also miss the value of the data structures that store them. I would like to push for blockchains with native tokens rather than just blockchains (innovative, probabilistically immutable databases) which have far lower utility, if any at all.
Security and integrity
Without going into the technical details of how blockchains are secured, it’s important to understand the native token as the incentive mechanism for the security and integrity of the blockchain (for those that want a technical overview of the security model see the dynamic-membership multi-party signatures explained in the recent sidechains whitepaper).
At the base level, the blockchain technology is a data structure that contains within it a chain of proofs that must hold true. This structure allows us to verify that the history of transactions or information that is being presented has not been altered or tampered with, ensuring data integrity.
The reliability of the proofs is directly dependent on the economic incentives provided to the people or organizations that supply the proofs.
In bitcoin, a miner that earns the right to publish a block on the main chain is currently paid 25 BTC (roughly $9,500 at publication time). This provides adequate incentives to have highly specialized hardware running in data centers around the world.
If the reward halved, as it is set to do in 2016, the incentive to provide these proofs would halve and we could likely see a scenario where the proofs would then be far less reliable (partly due to the excess hardware that could be bought on the cheap). In other words, without a high token value on a blockchain, there is little security or integrity of the data contained within.
Universal financial coverage
There are relatively few bitcoin business models out there that are truly harnessing the ability to provide universal financial coverage, due to a number of factors like supply chain limitations, regulatory barriers and bitcoin’s volatility. Isn’t then the obvious solution to do away with bitcoin and keep the blockchain?
Without a native token, though, and with only a decentralized and open ledger we cannot achieve universal financial coverage. Financial institutions that adopt, co-opt, or fork the blockchain technology will produce no better financial coverage than they do at present.
To see why this is the case, we can look at the following examples of applications that have been built on the basis of financial coverage (note this is not an endorsement of any of these services, rather an examination of their use of universal financial coverage).
- Tipping (ChangeTip, Dogetipbot etc.)
- Silk Road 1.0, 2.0, etc.
- Gambling sites (SatoshiDice, Updown etc.)
The Dogetipbot and more recently Changetip have created a frenzy on Reddit. A simple web scraper enables people around the globe to transmit value by typing a few words into a website.
The tips themselves are all recorded in centralized databases so the “low cost” of cryptocurrencies is irrelevant. The important factor is that the coverage is truly universal and that any user can, when they choose, withdraw the bitcoin or dogecoin from the service and use it in their everyday life.
In the future, this could become the basis of integrating virtual realities with physical processes.
Drug marketplaces needing to avoid criminal clampdowns and deliver truly global marketplaces require universal financial coverage (as well as relative anonymity). The extent of the coverage enables these platforms to gain critical mass to win the trust of their user base. Cross-country supply chain integration is possible because of the extent of financial inclusion.
Gambling sites are some of the only places in the cryptocurrency ecosystem that do not give dollar or fiat equivalent currency units. Sites like SatoshiDice and Updown give the bettors information on the extent of the house edge.
The volumes going through these sites are incredibly impressive considering that the operators often conceal their identity and are potentially operating illegally in certain parts of the world.
The demand for transactions is somewhat insulated from bitcoin volatility since the house edge can be as large as 70% on a binary option. Their user growth and reputation was again only achievable due to the universal financial coverage (bitcoin) and ability to independently audit their processes (blockchain).
One of the most popular bitcoin casinos, Just-Dice, conducts their bets off-chain. Wagers are not recorded in the bitcoin blockchain and are only stored on the Just-Dice servers.
With over 1 billion bets made on the platform, it’s clear that the key advantage is universal financial coverage. While there is not the ability to independently audit their processes via a blockchain, bitcoin casinos like Just-Dice provide provably fair gambling.
There is no reason that traditional gambling services could not do this as well, but we seem content to rely on their real-world reputation and the certification of their services by some gambling authority.
Model for innovation
The underlying blockchain technology relies on universal financial coverage and distributed computing to achieve its value as one of the first databases with provable integrity.
Centralized services may operate on top of the bitcoin protocol but will always face high competition due to the relatively low barriers to entry (open source software) and low switching costs (installing apps on a smart phone).
We are still early in our understanding of blockchain technology. The excitement around the integrity of the ledger, its openness and its potential to unlock global financial inclusion must be embraced in a holistic framework. The blockchain’s security and utility depend on its native token. Currently the most secure and reliable blockchain is clearly our dear friend bitcoin, but this does not have to be the case forever.
This article has been republished here with permission from the author. Originally published on Jonathan’s bitcoin blog.
Disclaimer: The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, CoinDesk.
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