The Truth about Bitcoins and the Blockchain — Part 1
· I am bullish with respect to bitcoins, and I expect much less to come from most other blockchain startups over the next five years.
· I recommend that you get into bitcoins now as a minor speculative investment, as you can financially benefit from holding and using them today.
· I also recommend you avoid almost all non-bitcoin blockchain ICOs, and be very skeptical regarding their near-term future. Most are massively overhyped, and many aren’t even legal, in my and the SEC’s view.
· WhalePanda has a nice short piece, I was wrong about Ethereum, 6.12.17, that blames this ICO insanity on the developers and leaders of that company.
· There are of course a few promising blockchain startups, and we’ll discuss some of those as well, in Section 3, after we first consider the hype.
What is the future of these two related yet very different technologies?
First, let’s define a term. I’ll use bitcoins to refer to what are commonly called digital currencies or cryptocurrencies. We need a shorter single-word name like this. Cryptocurrencies is a poor and confusing name, because while the future of bitcoins is to use encryption, it is not to keep transactions secret. Libertarians need to realize this use will be going bye-bye in coming years. The world simply won’t accept anonymous, subpoena-escaping digital transactions for much longer. It’s just too easy to use them in service to corruption and crime.
Privacy will be maintained better than ever by our smart agents, but anonymity is disappearing. Good riddance, too. Most of us are tired of all the anonymous trolling and flaming on the internet today. Time for us all to grow up and recognize we’re accountable for our views.
A great place to begin this story is Iansiti and Lakhani’s article, The Truth About Blockchain, Harvard Business Review, Jan-Feb 2017. I’ve named my piece after theirs in homage. These authors see blockchain as a foundational technology innovation, like TCP/IP, HTTP, or email. Skim that first for a quick primer if you’ve never heard of distributed ledgers (the blockchain) and some of its potential benefits as a tamper-resistant public record of transactions.
They observe that foundational technologies emerge and spread first in single use cases, then they are experimented with in local private networks, then finally, we see their substitutional and transformational uses in broad society. Like other foundational technologies, they predict that the new transparent protocols and algorithms provided by the blockchain will take decades, not a few years, to be broadly adopted in society.
Everyone writing about and investing in this space should get that, and start calling bullshit against all this money-grabbing blockchain startup hype.
Bitcoins are the Blockchain’s Best First Use Case
Bitcoins are an ideal first use of the blockchain. They may even turn out to be the best of all the good use cases to come. They are a B2C use, not a B2B use, as all great digital innovations have been. Digital B2C disruption usually comes first, as the major value unlock, then B2B follows.
Bitcoins eliminate major, longstanding consumer pain points in the current global financial system, while providing us all with powerful new benefits. Here are the top ones I can see so far:
The Top Six Benefits of Bitcoins
- Free microtransactions. Finally, we escape the financial industry’s parasitic fees and delays for micro exchanges of economic value. This feels like the biggest benefit of the six, by a good margin. We can attach microtransactions to any value we care about.
- Direct financial benefits to the crowd. We are all paid for validating and operating bitcoin systems. In some important new ways, we “own” and benefit from the use of bitcoin money more than we did before.
- Banking the unbanked. Bitcoins will bring the neglected billions into the financial system. A great moral benefit.
- Less fraud and waste in our monetary systems. This is due to blockchain’s distributed trusted security, resilient to bad actors.
- Escaping government taxation. Today this happens legally, via escaping annual money supply inflation, and illegally, via present misuse of the “crypto” aspect of cryptocurrencies to avoid reporting income.
- Impressive profits for early entrants. High-exponential annual bitcoin value increases. This is what’s fueling the mania we’re seeing today.
Most of the last benefits will eventually disappear, as governments get smart, exchanges get regulated, and bitcoins adoption saturates. But I bet it will take at least five years for that to happen, and perhaps a bit longer. But parts of these benefits will persist. Most importantly perhaps, for Benefit 5, crowd-owned bitcoins are a permanent new counterforce against annual devaluation of our money.
Four Elements of Blockchain Innovation
What about the blockchain itself, the main technology behind bitcoins? That is a different animal, with many more barriers to adoption. One of the better simple models of blockchain business innovation proposes that it requires four elements:
- Better Business Processes and Models
- Automated Legal Contracts (“smart contracts”)
- Tamper-Resistant Public Distributed Ledgers (“blockchain”)
- Cloud or Distributed Databases
The blockchain gives us just one of these four. It’s not a complete solution, and it has its own drawbacks. Current distributed ledgers are quite slow at verification, and they can’t handle high transaction volumes. Bitcoins users put up with the inefficiency and slowness of the blockchain because they get so many benefits, in that ideal first use case. It is not at all clear how many other use cases will be successful against future centralized, cloud solutions.
You can easily automate simple contracts, as the ICO community has done for raising money, but that doesn’t make them smart. They get smart when they have intelligent legal frameworks and dispute and conflict resolution built into them, which I believe will require smart agents, as we’ll discuss. Highly distributed (peer-to-peer) databases are in their infancy, and they may not even be necessary. Relatively centralized cloud databases may also be combined with the first three elements to do blockchain innovation.
As we’ll see in Part 2, it is reasonable to expect it to take five to ten years for the next blockchain business innovations to gain significant adoption in their markets. Most of today’s blockchain experiments will also fail. In the meantime, bitcoins are already a great use, and will go from fringe to global adoption over that same time period. I believe they deserve far more of your attention and investment than the rest of the blockchain, which has some great ideas, but is a different animal entirely.
“Bitcoin $30,000” by 2027, and Perhaps a Bit Beyond
I think it is reasonable to expect that over the next five to ten years, Bitcoin, the supply-limited original, BTC, may be worth five to ten times its current value. At the same time, I cannot believe we’ll see an order of magnitude more appreciation in the next ten years (eg, BTC at $300K or beyond) as many manic Youtubers propose today. By then other bitcoins with much better infrastructure, governance, and buy-in should be in greater global use, and many of today’s and tomorrow’s coins will have disappeared. Today’s coin leaders will very likely still be exchangeable and transactable then as well, and a few, including BTC, will retain some historic or collectible value.
But once we have a few bitcoins with global adoption, perhaps in five to ten years time, we can expect their values to stabilize, like all money. Getting adoption of new coins should be a lot harder at that point as well. New coins will then need a value proposition that isn’t already in the market. That gets increasingly unlikely with time. Thus we’ll eventually saturate their use cases, and most of us will no longer think about bitcoins as investments, but simply as money. But in the meantime, we can expect a wild ride.
So how might we we expect crowd adoption and profits in bitcoins to play out over the next five years? Some good arguments are made Michael Casey’s post, Speculative Bitcoin Adoption/Price Theory, Medium, 12.27.2016. We should expect bitcoins adoption to remain rapidly exponential, as ever more people understand their value, as we see increasingly secure and respected bitcoins exchanges emerge, and as we get increasingly more and better digital wallets to tie the leading bitcoins into the existing financial system.
TenX is a promising example of a digital wallet advance. It is a blockchain startup (and an ICO funded company) with a debit card and banking license. They now offer users a $15 card that can be used to spend your bitcoins anywhere you can use a debit card. I don’t know if they are well insured, or well managed, but they are definitely pushing the bitcoins community in the right direction. If you have any coins, go get one, now, and start using it for small transactions.
If you send money to folks outside the country, you might also want to use Abra for bitcoins money transfer (“remittances”), a service far cheaper than greedy Western Union ($5 fee for a $90 remittance, for example) and even cheaper than PayPal. It works with any smartphone. It will be exciting when a voice-only bitcoins remittance and payment platform works end-to-end with Google Assistant, to bank all the illiterate. Google just added voice support for 8 more Indian languages this month. There are now dozens of voice-exclusive apps that tens of millions of illiterate folks in India are using daily on their ever-cheaper Oppo and Huawei smartphones in emerging nations.
In 2015, the WEF estimated that bitcoins represented 0.025% of Gross World Product transactions, then $80 trillion. But bitcoin adoption is growing far faster than GWP. Their future value will to some extent be based on their velocity of transaction, as this Quora discussion considers. But as long as adoption of top coins keeps growing fast, and leading providers are smart enough to keep their supply limited, they will remain remain more desirable than government currency, both as investments and as money. That recognition is part of what is fueling the current mania around them.
So even if the most-used coins are presently much overvalued in our current bubble, and they drop in value by 50 to 70% in the next year or two, as long as adoption stays rapidly exponential, they’ll eventually surpass their current manic valuations and go far beyond them. So we can expect the upward seesawing in value described in Casey’s article above to continue until we start slowing adoption rates, perhaps five to ten years from now.
It also seems obvious that an annual or quarterly rebalancing of your portfolio toward the winning coins should capture the majority of their growth in value. You don’t want to be an obsessive and credulous day trader, wasting your day looking for nonexistent patterns in the short term market, being Fooled by Randomness, as Nick Taleb would say. At the same time, don’t avoid bitcoins as an investment. Like all foundational new technologies, you should experiment with them, look for ways they can be useful, and have at least a small stake in their exponential adoption.
Fortunately, Neither Government or the Financial Industry Can Eliminate the Top Four Crowd Benefits of Bitcoins
Governments aren’t going to outlaw digital currencies. It’s too late now, fortunately. The egg is in the omelette, and we’re eating it. That means the first four benefits will endure, no matter what governments or financial leaders do, as we’ll see next. So we truly are in a new and better world.
As far as I can see, Government’s most powerful response, if they were both foresighted and responsive, would be launching federally-backed digital currencies that also have very low fees for microtransactions. They might even be smart enough to build their system on a blockchain, and pay the crowd for operating it, like current bitcoins. They would then be able to inflate their digital money on an annual basis, a power they will likely never give up, but they wouldn’t be able to do it as much as they presently inflate paper currency, or we’d jump back into our crowd-owned bitcoins.
In other words, bitcoins are a new and permanent backstop against what financial doomsayer James Rickards calls Currency Wars, 2012. He’s right in pointing out that leading countries all engage in continual tit-for-tats of currency devaluation to improve their export economies, which unfairly taxes the average bank saver. But he’s wrong in arguing the political monetary system will “destabilize and collapse.” Our currencies aren’t going to do that, because the global growth of crowd-owned bitcoins, as a permanent new asset class, now limits their ability to play this “race to the bottom” game. From here on out, crowd-owned bitcoins are a permanent new counterforce against excessive government (read: plutocrats) monetary greed.
At the same time, governments will keep stressing the crypto problem (crime, terrorism, tax avoidance) with current cryptocurrencies, and I expect they’ll eventually outlaw bitcoins that don’t have subpoena-based transparency behind all their transactions. Financial anonymity must eventually disappear, as there is no other solution to superempowered individuals, as we’re all rapidly becoming, due to accelerating tech.
But given how little gets done in our plutocratic modern governments, I don’t expect the above responses anytime soon. Hopefully we at least see regulatory guidance on bitcoins and blockchain ICOs in the next few years. In ten years, a few of our most foresighted governments might be using blockchains for public asset management, and even tax collection. But I wouldn’t bet on it. Governments just don’t have strong incentives, today, for such change.
At present, as we’ve mentioned, bitcoin users can legally escape coercive money supply inflation (a hidden annual tax on holders of dollars) levied by governments without citizen input into that decision. The public never votes on it, in any nation, to my knowledge. Shadowstats estimates America’s M2 inflation ranges between 2 and 10%, with an average of around 6%, getting taken from our pockets annually, for the privilege of using US currency.
So it’s a great new freedom for us to be able to presently legally avoid that hidden tax, by keeping some of our deposits in any of the major exchanges, like Coinbase, which tie directly to our bank accounts, making it easy for us to convert our bitcoins back to dollars when we need them, with just a click of a button. Just keep in mind, when you do those conversions, that bitcoins are going to be very volatile on the way to mass adoption, so don’t sell them in a value valley. Hold on at least until they are more valuable than their price at which you invested, even if it takes a year or two.
The financial industry can’t stop the growth of bitcoins either. But they are already doing something clever. They are trying to steer us all into using the bitcoins they prefer, coins over which they exert governance power, or own a majority stake in. I think this strategy is very likely to succeed.
Ripple’s XRP, presently being adopted by leading US and global financial institutions, and China’s Neo, funded by the Chinese government, seem to be the two current leaders in that regard. Perhaps Europe or Germany’s financial institutions will also build out transaction infrastructure for just one coin over which they have the most control, and ignore the rest. So have some of these financial-industry-backed coins in your portfolio too, and realize that they may become the top bitcoins in the future.
But fortunately, just as open source software will always function to keep proprietary software from becoming too coercive and expensive, crowd-owned bitcoins will always be available to prevent financial industry- and government-owned or run bitcoins from clawing back too many of the first four crowd benefits described above.
Crowd-owned bitcoins may be both less convenient and less used than the financial-industry-backed coins in coming years, but they’ll always be here, so the crowd is now in a much better place than it was just a few year ago.
The Power of Microtransactions:
Crowd-Benefitting Business Models (CBBMs)
The first benefit of the six in our list, the ability to do microtransactions using bitcoins, is their greatest benefit, in my opinion, as it enables what we might call crowd-benefitting business models (CBBMs). We’ve barely begun creating CBBM-based startups. Forget the rest of the blockchain vision for a moment. We’re just talking about bitcoins and entrepreneurship here. There’s a lot of upside to come just with that.
For example, consider Steemit. They are a Reddit clone, founded two years ago, that pays its writers for writing posts, and simultaneously pays its readers for reading and rating, or “curating” posts. That CBBM will help make using the future web a more profitable and educational experience. What I like particularly is that it incentivizes the use of human intelligence to filter up the best stories, and kill all the crap being circulated as news today.
Steemit uses microtransactions, paid in its own bitcoin, called Steem. If you believe their numbers (and I presently don’t, as I see no mechanism to validate them), top posters on Steemit are already multimillionaires. Whatever the actual payments turn out to be, consider that Steemit is a truly valuable new way of doing user-created content. Let’s call it user-valued content (UVC). CBBMs like Steemit couldn’t have occurred before bitcoins. Now anyone can launch them. Reddit’s Redcoin, a way of tipping posters who you like, seems truly lame and useless by comparison to CBBMs that automatically pay people real money to write, read and rate.
Steemit today is not without drawbacks. For one, its interface still sucks. You can’t find posters using its search. They pay reader-raters only 25% of their pay pool, while paying writers 75%, (50:50 would be much better) and have flaws in their curation rules, so their curation is still weak. It’s algorithms don’t yet steer readers to read and rate little-read posts in the long tail of content. Most importantly, you can’t use their platform to filter you toward posts rated by people whose ratings you admire, allowing you to escape folks whose ratings you disagree with. Thus Steemit’s current content is still a blend of popularity contest bullshit, favoring the Biebers and Kardashians and other publicity whales of the world, and values-based collaborative filtered content. The latter is what good readers (and writers) want more of, what Thomas Jefferson called the “diamonds in the dung.”
Steemit also doesn’t yet offer a way to pay posters a small amount each month, for a fixed number of months, allowing us to support our favorite Writers and Curators, as we might on Patreon. Patreon, for their part, presently forces users into an unlimited monthly support commitment, denying users the obviously preferable option of giving support for a fixed number of months or years, so we know the total and don’t have to remember to go back later and turn it off. So until Patreon adds features that are more supportive of the typical user, rather than coercive, I recommend you avoid them. The crowd deserves better treatment. Fortunately, it seems an easy prediction that these first-gen drawbacks will be fixed, either on platforms like Steemit, Patreon, or those of their coming competitors.
How far can CBBMs penetrate the web?
Will major companies, like Facebook, Youtube, and Amazon’s reviewers, eventually have to pay users real money for their time and attention? Let us hope so, at least a bit.
For example, do you know about AliExpress, the consumer arm of Alibaba?They’re the web’s first real competitor to Amazon. Their prices are sometimes half of Amazons, and they’re now building US warehouses, to make their shipping times competitive as well. If you don’t yet have their app on your phone, I’d recommend it, and also recommend checking them against Amazon for high-value or frequent purchases in coming years.
Think how great it would be if AliExpress started paying folks in bitcoins for reviews, in a formula based on how helpful other folks found those reviews. With good publicity around that CBBM, they might rapidly build some great reviews, to match all those great reviews on Amazon, which is one of Amazon’s greatest crowd benefits, so far.
I would prefer that Amazon be the first company to see the value of paying people to post, and other people to rate, their product reviews, to require Real Names from reviewers, and of course to have retroactive penalties for folks who don’t disclose any commercial affiliations in their reviews. But I’m also glad that there’s now a competitor who could get to this CBBM first, and create pressure for others to offer that crowd benefit as well.
More generally, I don’t think there should be any online service categories where we consumers don’t have at least two major companies we respect and regularly use in mind. When you think Facebook, who else comes to mind? Google Plus? If no one does, we all surely live in a poorer digital world.
Bitcoins Aren’t Perfect, Just Good Enough for their Great New Use
It is true, as their detractors point out, that bitcoins are based on an inherently inefficient distributed algorithm that gets worse at verification as the distributed ledgers grow. But remember that many other software products and services started out bloated and inefficient, and many still are. Think of Oracle’s Java, or any popular product from Adobe and Microsoft. Most of that bloatware gets saved by accelerating computer power, and so will bitcoin blockchains be saved by Moore’s law. The benefits from its use will continue to far outweigh its problems. That’s the key insight, I think.
As computer scientist Radia Perlman at Dell says, in her brownbag presentation, “Blockchain: Hype or Hope?” 5.9.2017, centralized software solutions come first, and will likely remain the backbone of online platforms, because they deliver far better compute, throughput, bandwidth, storage, and latency reduction than decentralized solutions like the blockchain can ever offer us.
Today’s blockchains can validate a few transactions a minute, at best. Centralized systems, once parallelized in the cloud, can handle millions or more per second. Centralized systems also allow efficient mediation of disputes, as they give us people to complain to, and our legal system can make those trusted middlemen take out insurance against risk, fraud, crime, and loss. With the blockchain, it is computationally expensive to create integrity proofs. Again, for things like bitcoins, the crowd benefits are so great that we’ll put up with poor blockchain performance.
But what about other blockchain applications? We’ll discuss a number of them in Section 3, but as a general point, for most of the ones I’ve heard, it is not at all clear that the value of the ledger is is so great, or that existing communities are so low-trust, that its worth putting up with slow decentralized solutions. In many cases, simply adding better feedback, transparency, reputation systems, and intelligence to centralized solutions should let them continue to dominate their markets, as they do today.
All the naive futurists who talk about blockchain as some kind of “ideal low-trust network” need to wake up and realize that trust between people has historically been more efficient, and it may continue to win the majority share of the future. Most people would rather risk trust, for its efficiency gains, than try to build some post-trust libertarian construct. It smells like ideological crap, to me. There are always lots of reasonably trusted “middlemen” who can launch better-performing new cloud solutions.
For that reason, blockchain applications for IoT and supply chain management don’t sound that exciting to me. Sure, some companies like Samsung and IBM are now experimenting with them, as they should, but like most corporate experiments, very little of value may come of them.
IoT and supply chains are also more B2B than B2C, and I don’t think B2B will tolerate lame blockchain performance. Consumers will, if you are solving a major pain point for them, like digital currency, but most businesses already have enough data on each other, and enough trust, to keep running and upgrading their faster and more-rapidly improving centralized solutions.
What seems real is that blockchain can be a valuable minor competitor to centralized systems, and it can develop new distributed trust algorithms that will force centralized systems to give us better centralized trust systems as well. So we can root for advances in both majority centralized and minority decentralized platforms in the future we’re creating, and not fall victim to hype that “blockchain will remake the world.” I stop listening now every time I hear that kind of language, and I believe you should, too.
Our next post will explore the current mania around blockchain startups and their ICOs, to help you invest smarter in the blockchain business applications that seem reasonable, and avoid getting burned.
John Smart is CEO of Foresight University and author of The Foresight Guide. You can find him on Twitter, LinkedIn, or YouTube.
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