At its core, blockchain is the candidate technology which should enable the shift from an ‘Internet of Information’ to an ‘Internet of Value’. The internet has so far enabled its users to share, exchange and modify most of the information formats which commonly form part of human experience: text, image, sound.
By contrast, the frictionless transfer of value over digital channels has so far proved unattainable. Exchanging or modifying assets (securities, intellectual property, wealth) or trusted information (such as identity or ownership) over the internet is not as straightforward as exchanging or retrieving songs, e-books or video-on-demand online.
When one wishes to modify or exchange value online, one generally has to go through procedures, which are still predominantly taking place offline rather than online. More importantly, a trusted central authority is required to inspect, validate, clear and settle digital modifications and exchanges of trusted information and assets.
Trust deficit can be resolved through technology
The fundamental issue is one of trust – or rather the lack of it. It is the core hurdle impeding the frictionless transfer of value over digital channels. Indeed, if value exchanges or modifications were seamless and instantaneous, how could the proper verifications be carried out? At a high enough processing speed, for instance, a malicious party could sell or send two or more of a given asset to two different counterparties, despite owning just one – an instance of the so-called ‘double-spend problem’.
Blockchain technology, and its first and most widely-known application – the cryptocurrency known as ‘Bitcoin’, initiated in 2009 –, emerged precisely as a response to the double-spend problem. It offers concepts and mechanisms – derived from cryptography, economics, mathematics and network theory – which seek to embed trust into a protocol, to which all participants in a business network can agree, in order to modify and exchange value. Technology, not law, thus becomes the source of trust between participants, enabling the digital notarisation of information and exchange – and the Internet of Value.
Technology, not law, thus becomes the source of trust between participants
By contrast, in a ‘classical’ set-up, in which laws and regulations are the primary source of trust for network participants, we see important failings emerge. Their responses to the trust deficit and the double-spend problem are comparatively inefficient.
The failings of classical ledgers
Ledgers are records of value: trusted information and/or transactions (e.g. a record of bank transfers, or a registry of real estate titles). In the classical case, participants in a business network each hold their separate ledgers to keep a record of value ownership and transfers at any given time. For instance, in a nation’s banking system, each bank will hold a record of asset ownership, as well as of asset transfers with other banks. This is the classical case illustrated in the figure below, in which each participant in a business network holds its own ledger of network transactions.
As you will note, a central authority is inevitably required in the classical case, as business network participants might (1) not trust each other, and (2) hold inconsistent records across their respective ledgers. A trusted central authority thus emerges as a consequence of holding multiple ledgers within the same business network. This central authority performs reconciliation and risk management on behalf of the participants. In most cases, this trusted counterparty is recognised in laws and regulations as the guarantor of trust within a given industry – say, a central securities depository holding a permanent record of which banks and banking clients own which securities.
This holds some evident downsides: the processes of reconciliation and risk management slow down the modification of trusted information and the exchange of value, also making the processes more expensive and resource-intensive. Furthermore, were a trusted central authority to be compromised or turn malicious, both censorship and fraud are a possibility, as it could tamper with the records and processes of the business network.
The comparative advantages of blockchain set-ups
Blockchain-based (i.e. distributed or shared ledger) implementations, on the other hand, require neither a trusted central authority, nor the holding of separate ledgers by network participants. Rather, a single ledger exists, with identical copies distributed among participants. Importantly, trust between participants is also not required. This blockchain set-up is illustrated in the figure below.
In the blockchain set-up case, participants need not waste resources or time validating modifications or transactions with the support of a trusted central authority, which leads to gains in efficiency. Furthermore, blockchain-based ledgers are theoretically both immutable and secure: they cannot be tampered with, and one cannot, in theory, record fraudulent modifications or transactions onto them.
Turning the internet of information into an internet of value creates a myriad of use cases such as ‘cryptocurrencies’, ‘smart contracts’, and the digitalisation of real-world financial and physical assets. In other words: blockchain will revolutionise how business networks operate. In part 2 of this series, we will look into the foundations of this promising technology.
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