Many articles have been written on the merits of particular aspects of blockchain and tokens. However, I haven’t seen a comprehensive overview of the key pillars that make blockchain and tokenization so disruptive. The power of blockchain + tokenization comes from the simultaneous implementation and usage of 4 key capabilities and innovations:
· Ultra-secure and immutable store of information
· Decentralization of transactions
· Built-in gamification
· Open source software
I’ve explained these points in greater detail below with a number of simplifications to keep things easily understandable.
Ultra-secure and Immutable
It is well popularized that blockchains are digital ledgers that can provide high levels of data transparency, security, and immutability. They achieve these characteristics through a combination of open data accessibility, cryptography, decentralization, and a strong consensus protocol.
A well implemented decentralized public blockchain and consensus protocol, such as provided by the Bitcoin and Ethereum blockchain communities, shows the power of an ultra-secure and immutable blockchain. Notably, since 2011 for Bitcoin (BTC) and since its inception for Ethereum (ETH), neither blockchain has been successfully hacked or altered even though both blockchains provide targets worth billions of dollars.
What this means is that the transactions stored in these well implemented cryptocurrency blockchains are essentially unhackable and tamper-proof. Since each blockchain transaction is also digitally signed using public key cryptography, these blockchains provide an untarnished record of ‘truth’. This feat is quite amazing considering the litany of other well-known organizations that have been hacked successfully for financial gain recently and in the last few years: Equifax, Experian, BlueCross/Blue Shield, JP Morgan, Sony, eBay, Yahoo, etc.
This does not mean that all aspects of the ecosystem are ultra-secure, as multiple centralized exchanges and wallets have had serious hacking incidents that have led to the loss of hundreds of millions of dollars of cryptocurrencies. Even though the ecosystems are not yet secure, these blockchains themselves have proven their security and immutability value proposition in the real world.
It is important to realize though, that not all blockchains are created equal and a blockchain is not ultra-secure by default. Blockchain security and immutability are highly dependent on the strength of the consensus protocol for block additions. The standard consensus protocol models, proof of work (PoW) and proof of stake (PoS), are able to maintain the integrity, security and immutability of the data store as long as more than 30% of the nodes are trustworthy (see articles on Byzantine Fault Tolerance) and there are a sufficient number of nodes. If a project has a weakly implemented consensus protocol it will be vulnerable to many types of attacks (i.e. 51%, Sybil, DoS, Bribe, Selfish Mining, etc.) that may compromise its integrity.
Current well known blockchain implementations are highly secure and immutable, however, they can suffer from serious scaling issues and generally have very low transaction speeds. Solutions are being developed for both but cannot be implemented quickly since security is paramount.
Decentralization of Transactions
Many in the industry talk about decentralization but fail to explain why it is such an important concept behind blockchain. Some core aspects of decentralization were visible in peer to peer (P2P) file-sharing environments (i.e. Napster and BitTorrent) more than 15 years ago, but blockchain has taken decentralization to a whole new level.
For Ethereum-based blockchains (ERC20), decentralization is achieved in part through the use of trustless smart contracts and tokens. These smart contracts are trustless in the sense that there is no trusted third party mediating the smart contract transaction. The contract is executed automatically between two parties as long as the required contract parameters are met. The transaction itself is recorded and stored within the blockchain as an immutable record via the mechanisms I’ve discussed above. The benefit to the parties using smart contracts for their transactions can include faster time, less bureaucracy, and lower cost.
Many companies deploying public blockchains based on the ERC20 protocol and others can create decentralized applications (DApps). DApps can carry out a wide variety of transactions and so have the potential to disintermediate many trusted centralized players in today’s economy, such as banks, governments, and large tech companies. Any such large intermediary organization which is typically needed to maintain trust, and which uses centralized processes to achieve scale and power, can be potentially displaced or severely diminished with the rise of decentralized smart contracts.
This is one of the major reasons that governments, banks, and large centralized organizations fear the disruptive power of public blockchain-based systems that they do not control. These systems have the ability to fundamentally reshape the world and can remove or reduce the power of large trusted entities that have existed for hundreds of years.
Many of the benefits of decentralization have to do with how companies become restructured under this new paradigm. Companies that are powered by decentralized processes can be very small and lean because they leverage the resources and power of their community. As a result, companies do not scale their own centralized resources, instead they incentivize members of their community and scale the community to provide a combination of computing power, storage, human resources, and bandwidth.
Since this manner of scaling doesn’t build fixed overhead, decentralized companies can be significantly more efficient than centralized companies. The result is less bureaucracy and lower costs as noted above. If ample processing power can be provided in close proximity to users of smart contracts and the consensus protocol is scalable, then faster time can also be provided.
The mechanisms for scaling the community are directly tied to incentives, and incentives are usually provided by tokens. In the following section, I discuss the power of tokens when used effectively with the blockchain.
Those of you who are familiar with video games or loyalty programs know that tokens or points can be used to gain access to perks, incentivize behaviors or pay for things. Tokens or cryptocurrencies have similar applications and uses within the blockchain ecosystem. Broadly speaking, there are 2 classes of tokens, those that are a store of value, like BTC or Litecoin (LTC), and those that give access to network services, primarily ERC20 tokens built for the Ethereum blockchain.
Even though Bitcoin is seen primarily as a potential universal currency that can replace country-based fiat currencies, it is also the reward token for Bitcoin’s miners. Currently the miner who is the fastest to compute a correct answer to the PoW puzzle (used to obtain consensus) receives 12.5 BTC or nearly $140k at $11k per BTC(the reward halves every 210,000 blocks). Since blocks are mined every 10 minutes there are about 144 blocks mined per day for a total of 1800 BTC rewarded each day (nearly $20 million at $11k per BTC). These significant rewards keep the Bitcoin miner community actively engaged and incentivized.
Since the major consensus protocols, PoW and PoS, both have block rewards, every token is also a reward token which is used to gamify the consensus process. Without the block rewards it is unlikely that people would commit resources to mining tokens, and without miners there would be no ability to extend or secure the blockchain. Gamification is therefore built in, however, this is only the tip of the iceberg.
For blockchain tokens that give access to a broader network of services (i.e. ERC20 DApps tokens) such as access to personal health records, secure file storage, and exchange services, the tokens can be used in many other ways. For example, non-mining transaction processing (i.e. retrieving files, encrypting/decrypting information, and running algorithms) is typically done on decentralized nodes that make up the token-developer’s community. Like miners, those running nodes are rewarded for their actions by receiving a piece of the block reward.
Similar to the mechanics in video games, tokens can also be granted as rewards for token holders who carry out certain tasks or reach a particular goal. Once earned, these tokens can then be spent or exchanged for virtual or real-world services and/or products. Many examples abound with existing tokens such as achieving a fitness goal (walking a certain number of steps), helping with a business goal (promoting an event through social sharing), maintaining a certain behavior (wellness), or providing personal information (for advertisers or health providers).
In some cases, these incentive tokens are Exchange tokens (those tradable on exchanges) while in other cases a company may create additional specialized tokens. These additional tokens may be convertible into exchange tokens while in other cases they may have their own separate economic model. Regardless of the case, tokens have the inherent ability to be leveraged as incentives to increase user and community engagement and retention.
The massive rise of social media and video games within the last decade means that Internet users today are well primed to understand, engage with, and expand the reach of decentralized cryptocurrencies. You could call it the right technology at the right time.
Open Source Software
Another powerful shift for blockchain companies is that they are based on open source software, which in turn creates transparency, a fundamental strength of blockchain. The most common frameworks — ERC20 from Ethereum, Graphene from EOS, and NEOContract from NEO — are all open source. This is a large shift as the majority of current product development in technology companies and startups is closed source.
With open source software, anyone can access the source code and any approved developer can join the developer community. It is actually quite common for investors to view a blockchain company’s open source software code and developer activity, called commits, on Github (the most common location for blockchain open source software development) when evaluating the company for investment.
Open source does not just mean that the source code is freely available; it also means that there can be no secrets about or patents on the technology. It eliminates the concept of proprietary and makes the software something that can be fully understood and even forked by the community. As a result, no individual or company actually owns the source code. Furthermore, because any derivative works based on the open source code are also by definition open source, open source software perpetuates itself.
In summary, a public blockchain, powered by an active decentralized community engaged by tokenized incentives, combined with open source software projects a vision of the future in which the world is dominated by small, nimble companies working closely with their communities to provide ultra-secure services for the greater good. This is clearly a major paradigm shift from the existing landscape and presents both an opportunity and threat for the world at large.
Acknowledgements: Thanks to Radhika Iyengar-Emens for her contributions.