The Truth about Bitcoins and the Blockchain — Part 2

Reality vs Hype in Two Foundational New Technologies

Part 1 — Bitcoins, A Real Future
Part 2 — Blockchain Hype, Mania and Scams (this page)
Part 3 — Regulatory Needs, and Promising Startups

[Note: A earlier version of this part was first published July 20]

tl;dr

  • The blockchain (distributed ledgers, tamper-resistant transparent transaction databases) will certainly see piecemeal new uses in the next decade. This technology started with bitcoins, and is being being experimented with by banks and other industries today.
  • These groups are trying out their own private versions, to enable useful new functions like consensus modification of the ledger. They are seeking small, incremental benefits from those applications.
  • Unlike bitcoins themselves, these applications aren’t the crowd-driven, platform-level, “revolutionary” uses of blockchain tech being proposed by so many blockchain evangelists and opportunistic startups today.
  • We won’t be replacing banks or financial systems, rather, those and other users will adopt the best uses of blockchain tech and ignore the hype. You should too.

Fear and Greed, Panics and Manias, and the Scams they Breed

We humans are still far too susceptible to fear and greed, to negative and positive hype, to the panics and manias those induce, and to the scams and waste that each breeds in society. Our digital world, now the fastest-changing system on Earth, is particularly susceptible to both extremes.

Let’s talk about fear first. Remember Y2K Bug? The approach of the last millennium bred herd-like, fear-driven behavior around the world. In the US alone, $100 billion was spent upgrading our IT systems, $9B by the Federal Government. A lot of it was waste, especially in the last few years before 2000, as people rushed to fix things that weren’t broken, paying top dollar to consultants and security firms. Canadian computer expert Peter de Jager started the fear with a breathless Computerworld article, Doomsday 2000 in 1993. He did his best to keep stoking that fear almost all the way up to the big non-event.

A US Senate committee, established in 1998 to monitor the issue, told itself in 2000 that it was all “money well spent”, but that was just self-congratulatory posturing. Read Michael Noer’s excellent piece, Y2K fear merchants, Forbes, 1998, or Wired’s insightful piece from 1997, if you don’t recall the apocalyptic language and the opportunistic scammers who preyed on fear to make an easy and wasteful buck. You might also follow Noer on Twitter. People who call out crap well once usually keep doing it.

In hindsight, a much more adaptive approach for all the individuals, companies, and institutions that got swept up in the Y2K panic would have been to resist all the fearmongering on the way up, and upgrade their systems only when the next release of truly better software or hardware naturally came along. Institutional purchasers could also have created RFPs to drive IT vendors to deliver measurably better security and end-user performance in their next upgrade. That in turn would have required them to do better security and user-performance metrics on their systems. Those metrics were crap in the 1990s, when they even existed. They could also have committed to bigger annual spends on white hat hackers, probing for security vulnerabilities. All of these and others are easily seen in hindsight as more adaptive responses, in proportion to the problem.

Now think about hype. History shows that the overinvestments in immature tech, and the greed-driven manias that result from its hype aren’t as frequent as the panics created by fear. But once manias get going, they are just as strong, and the utopian schemes and outright scams they allow are just as wasteful of our time, energy, and money. We’re deep into a new mania at present, as you may already know.

Bitcoin, Blockchain, and Smart Contacts are Now a Mania, Not Reality

A new mania has risen online over the last couple of years around digital currencies, distributed ledgers, and the promise of distributed applications and “smart contract” technologies. Boosters say these new digital tools will soon “revolutionize” business, and “de-friction” our legal interactions, making them much easier and more automated than ever before. I can see parts of that vision emerging over the next ten to twenty years, but I bet blockchains will just be one small part of the tech involved. Today it’s mostly a massive load of hype.

Remember the fidget spinner fad of earlier this year? Here’s a chart of the “fidget spinner” search term on Google Trends. The fad peaked in May-June and now it seems our novelty seeking drive has moved on to other fields.

What does “initial coin offering”, the new automated venture capital funds being offered to the world by the blockchain community look like? Perhaps just what you’d expect. The term is up massively now, but also seesawing rapidly, as we try to figure out if these new investments are real or bullshit. I think most ICOs are extreme and utopian longshots, and I’m hoping — but not yet predicting — that ICO investment is a fad that dies down by 2018. We shall see. Even if it doesn’t, this investment class should be much better vetted and regulated than it is today, as we’ll argue below.

In my view, the technolibertarians, entrepreneurs, speculators, and others promoting blockchain technology as a revolutionary force in business, politics, and society are tellingly similar to other well-meaning but naive visionaries we’ve seen in the last 50 years.

In their fervor and vision, blockchainers are a lot like the hippies of the 1960s, who dropped out of society to create utopian communes. They are like the open source extremists like Richard Stallman in the 1980s, who wanted all software to be free, and the cypherpunks like Tim May in the 1990s, who wanted an anonymous internet. They are like the internet utopians like John Perry Barlow, who saw the internet becoming a new “country” with its own government. They are similar to the hyperbolic Dot-com founders of the 1990s. Some of these groups had money at the center of their revolutionary vision. Others did not. But all arose around socially or politically attractive but deeply flawed ideas.

Let’s look at one of these visions in a bit more detail for a useful lesson. John Perry Barlow’s seductive political idea, offered in A Declaration of the Independence of Cyberspace, 1996, was that governments might have less sovereignty on the web, as a new environment for social exchange, and that the net that supported the web could remain neutral. It was a lovely idea in theory, but it smelled wrong to many folks even when it came out, and we all saw it was increasingly wrong in practice, as time went on.

As law professor Tim Wu made clear in a great work of history and foresight, The Master Switch: The Rise and Fall of Information Empires (2010), information marketplaces often begin open but become controlled and closed as the money comes, followed by politicians and lawyers. We can try to delay that transition, which is a often a great moral goal, but we ultimately can’t stop it. The more valuable something gets, the more hierarchical it gets. Competition in new markets starts fair and free, then it increasingly gets coopted by the rich, and innovation declines. Initial consolidation is typically good, as it allows higher margins, more capital investment, efficiency, and technological advance. But eventually, as the top leaders keep reducing their numbers and increasing their share, we get overconsolidation, and cronyism, cartels, and all kinds of political and legal barriers to innovation.

This age-old problem, which afflicts all capitalist democracies, is called the law of accumulation. In anything but new markets, the owners of capital increasingly accumulate more wealth and income at faster rates than everyone else. Technology drives the law of accumulation even faster, the more productive and intelligent it becomes. For that reason, we need occasional democratic resets (lower case “d”) to keep our systems in service to most of us, rather than the wealthy elite. In the 20th century we had those resets in the 1900's-1910’s (trust busting, progressive income tax, corporate charters) and again in the 1940’s-1960's (social security, medicare, cheap higher education, civil rights). We’re overdue for another big income redistribution now. Fortunately, in the sim-empowered world that’s coming, those resets are going to be increasingly easy to to do.

One key mechanism that helps fight the law of accumulation is that in industries where things change fast, like IT, new entrants periodically break down industry consolidation. We can cite lots of former IT giants, like HP, AOL, and Nokia, now either gone or nearly so. This healthy turnover of market leadership is called creative destruction. The term was coined by 20th century economist Joseph Schumpeter. For a great read, check out Tom McCraw’s Prophet of Innovation, 2009, which will tell you why Shumpeter’s view of innovation economics and politics is so relevant to our future.

Another way we can fight the law of accumulation, a strategy with even more upside, is that as IT continues to creatively destruct at its leading edge, our machines themselves get inexorably smarter. As I argue in my series on personal sims, in the next ten to twenty years our personal software agents will get begin to get smart enough to steer us continually to those products, services, companies, and political candidates that best serve our values. Our sims will use their own algorithms, and those of others in our network who we trust, to recommend what to watch, read, who to connect to, what businesses to start, and in a particularly helpful advance, how to vote. They’ll be continually trained by us in our interaction with them, and will amass private data on our lives that, like our email today, will stay under our personal control, not the marketers. Our sims will even help us crowd draft and vote on initiative legislation that we’ll send up to our local, state, and federal governments. Now that’s a democratic reset I can get behind, and I think we can expect it in the next human generation.

Consolidation is very often good at first, in scores of industries. For example, as The Economist notes in a recent article, Building under water, 8.19.17 consolidation in the dredging and maritime construction industry, after decades with too many small players and no really big ones, finally let previously undercapitalized companies make some big leaps in scale, productivity and innovation. As a result, the cost to cities of dredging harbors, mounting offshore wind turbines and building offshore oil and gas platforms have all dropped greatly in recent years. Top firms in this industry, including Van Oord in the Netherlands can now create new coastal land, and tsunami barriers, in shallow water in seaside cities like Amsterdam, Singapore, Jakarta, and Dubai, at less than one third the market cost of current seaside land in those cities. Such capacity offers great new and environmentally responsible development options for residents of many wealthy seaside cities for their future, though such land management is ultimately a political issue in each city.

But eventually, as consolidation grows, bigness turns bad, overconsolidation occurs, and we need a periodic reset. American politicians were able to effectively regulate firm size and market competitiveness in the early 20th century, when antitrust still worked and corporations weren’t so big. In the 1950’s, over 80% of our top 100 revenue generating entities on Earth were still governments. But now, over 80% of those are corporations, they’ve captured their legislatures in most countries, and effective antitrust regulation has been broken in the US for over 50 years. Even the AT&T breakup was reversed. I don’t expect America’s political priorities will change until we have a sim-empowered democracy, which may come in the 2020’s if we’re lucky and smart, but it will surely take longer if we’re not.

I recommend Chrystia Freeland’s Plutocrats, 2013 for a great set of stories on too much bigness in America today, and how it changes our politics and society for the worse. I also recommend Larry Lessig’s great TEDx talk on Tweedism: Why Our Democracy No Longer Represents Us, and How to Fix It (YouTube, 20min, 10.20.2015) for how overconsolidation corrupts democracy, and what we’ll do about it in coming years.

Fortunately, I am confident that the smarter our sims get, the more they’ll be driven by the global evidence, as first argued by economists like Schumpeter, that managing both the size and the conduct of the large firms we buy from, and the wealth of the plutocrats behind them, by always keeping a healthy ratio of smaller and independent firms in the mix, will be one of the keys to continued economic health and social progress.

In another ten or twenty years, our personal sims, knowing we care about innovation, will ensure that the best-rated new entrants get our business, in every industry and product category we care about. We won’t be stuck with today’s primitive rating systems, either, like those we currently see on Amazon, IMDB or Yelp, which include lots of shill ratings, secretly paid for by industry. We’ll be able to follow just the ratings of the folks whose values we agree with, and their first degree networks. That freedom to follow ratings of users with verified identities and reputations should already exist today our leading platforms. It is something we don’t realize how much we want, until someone gives it to us, and I hope some social entrepreneur does that relatively soon. But this transition to a sim-rich, crowd-empowered economy won’t happen overnight. In the meantime, we humans are going to be stuck with the same plutocratic economics and politics we’ve always had.

We’re already seeing the rising power of the plutocracy over the web, just twenty five years after it’s birth, with the inexorable starvation by malware and legal actions of peer-to-peer networks like BitTorrent. We’re seeing it with the impending destruction of network neutrality by the telcos and their pawns, and we’re seeing it now in digital currencies, the one place where the blockchain has shown economic value so far, nine years after its invention.

A politically clever use of blockchain is happening with Ripple, a payment protocol being marketed by a shrewd group of VCs to banks and financial networks as a system to allow “secure, instant, and nearly free global financial transactions of any size, with no chargebacks.” Ripple will likely be better than the current terrible legacy systems, for both consumers and banks, even if the blockchain tech underperforms. Making Ripple a standard, and getting a stake in it, is also the best way for banks to compete against other digital currencies. Ripple is already the third-largest digital currency by market capitalization, and it will soon become the leading digital currency in the US at least, if more conventional banks and networks adopt it. China’s government is launching a competitor in Neo, and we may see Europe get its act together and launch something EU-backed too.

Valuing Bitcoins, or Distributed Digital Currencies (DDCs)

As we described in our first post, what bitcoins (distributed digital currencies, DDCs) have demonstrated that they are a trustable and exponentially growing medium of exchange and store of value, one that offers users a hedge against our rapidly-inflating paper money. DDC’s also have other very important benefits. They democratize assets, empowering bottom-up wealth creation far more than in the past. They allow individuals to get assets out of countries with autocratic currency controls.

They also allow citizens under financial oligopoly, like Americans, to avoid steep fees for digital fund transfers. That problem doesn’t exist in a few countries, like Korea, but in the US and many other countries, the financial plutocrats are preventing their emergence, and thus also preventing disruptive Crowd-Benefiting Business Models (CBBMs), from emerging.

So what is a reasonable annual value appreciation for this technology app? At first guess, well-managed digital currencies should presently be at least 6% a year more valuable in their anti-inflationary benefits alone, if our paper money continues to be inflated at its present rates. Add in the wealth democratizing and microtransaction benefits just mentioned, and the annual marginal productive value of bitcoins might be closer to two or more times that annual value growth at present, until all those CBBM startups emerge and reach market saturation, which may take ten to twenty years.

As an upper cap on annual bitcoin value growth, I can’t see them having an annual appreciating value anything like IT itself, including computing, storage, communication, and data, all of which show annual performance growth of 30–40%, and many of which, as platforms or software, need a multiplier added to that for economic network effects just like bitcoins do.

Thus I think a prudent investor should expect bitcoins annual marginal value growth to continue to be rapid, particularly in these early years of adoption, but not necessarily your fastest growing asset class. Investments in other businesses that use accelerating IT, in computing, bandwidth, storage, sensing, virtualization, and other domains, might easily be as good or better.

Consider that our leading bitcoins still aren’t accepted broadly, their exchanges and governance are primitive, and they still have technical drawbacks. The longer the ledgers get, the slower the verification algorithms perform. Bitcoin’s verification doesn’t work at the point of sale, for example, so people who accept it must do so on faith. In that sense they are remain like today’s credit cards. It would be nice to see a coin emerge where that is no longer true, and expect we’ll get there eventually. But in the meantime, there’s a lot of work to be done.

So bitcoins should be part of a good exponential investing portfolio, but a minority part, for most of us at least. Their back end technology and adoption will grow slower than boosters think, and they’ll be much more volatile, up and down, than your other asset classes. Many coins, thankfully, will eventually die off. So diversify your coin investments, and if you see any grow too rapidly, I’d recommend waiting for their next big correction before buying in.

Bitcoins that advance particular social values also deserve your support, as part of a social investing strategy. Sometimes those values are quite explicit, as with SolarCoin a coin that promotes solar electricity generation. So besides their currency value, coins that serve a valuable social function, and are used by and benefit their communities, are also likely to survive.

Distributed Apps Aren’t Easy, and Today’s Smart Contracts Aren’t Smart

Is it hard to write, update, and manage distributed apps like the blockchain? You bet. Remember BitTorrent? Similarly lofty goals were floated for that decentralized solution becoming a content streaming and distribution platform. But it lost out to centralized streaming solutions in the cloud, which could become more STEM compressed (densely and efficiently connected and upgraded, whether measured in Spatial, Temporal, Energetic, or Material dimensions) at much faster rates. STEM compression is perhaps the biggest picture reason why we should expect distributed systems to play second fiddle to typically more rapidly-improving centralized solutions.

Even centralized hardware and software solutions regularly have trouble staying relevant, in rapidly changing industries like IT. Remember Second Life? That open and unscripted virtual world launched in mid-2003, and boosters saw it as a new, more democratizing economic environment. By Nov 2006 Ailin Graef (SL name: Anshe Chung), claimed to have become the first virtual world millionaire, making US $1M from trading virtual real estate, on a platform that claimed as many as 3 million occasional users. But Second Life failed to upgrade their U/X, features, and performance, and the novelty soon wore off. Most users left for other, faster-improving and better managed virtual spaces, mainly in massively multiplayer and strategy games.

Great decentralized systems do continue to periodically emerge. Just look at the web. But they are particularly hard build in the US today, given our crap bandwidth (again, courtesy of the oligopolies). Go to Korea or Japan if you want to see real bandwidth. That won’t change in the US anytime soon. It’s too threatening to the incumbent cable and telco companies walled content and what we can call Oligopoly-Benefiting Business Models (OBBMs).

Unfortunately, there’s very little that is smart about the decentralized “smart contract” technologies being peddled today, and not nearly enough intelligence for their legal de-frictioning promise to emerge. Today, legal de-frictioning is happens at the level of companies like Legal Zoom, and their plain-English forms for entrepreneurs and families, and outsourced paralegal services supporting the law firms. Most folks are either too scared or unforesighted to even use “smart contracts” like Nolo and Quicken’s WillMaker ($40) available since 2004. They keep going instead to human trust attorneys, in far higher numbers than they really should.

As I see it, in coming decades, most folks will need a trustable and minimally smart personal sim to guide them into ideal legal de-frictioning activities. Agents and sims, and their digital logs, will be central to better mediation of future legal disputes as well. Those disputes (and their resolution mechanisms) will also grow, not diminish, the wealthier we all get.

In sum, we’re going to see smart contracts only once we have smart agents, with real AI behind them, and AI-backed innovation platforms for agents and their people to interact on. I think we can expect such distributed and effective AI about ten to twenty years from now, depending on both luck and execution. We’ll see very little of it before 2020.

But much sooner, enterprising and risk-taking folks will be able to use today’s not-yet-smart contacts to quickly set up company structures and legal arrangements. They’ll surely also figure out new crowd games, like today’s ICOs, that can be hyped. With today’s dumb IT platforms, that mostly means we’ll see a lot more startup volatility, higher failure rates, and startups that get into new kinds of legal troubles. Progress is messy, but it doesn’t have to be a slaughterhouse. The more evidence-based and realistic we are, the better we can back real winners, and improve these tools and companies from their currently very primitive states.

All Aboard the Hype Train — Ethereum, DApps, DAOs, ICOs … Next?

But to keep the frenzy going, digital entrepreneurs keep thinking up new ways to dazzle and mystify investors. Blockchain opportunists are now launching Initial Coin Offerings (ICOs), bypassing the recent JOBS Act legislation that now lets small companies to legally sell equity to small investors, on platforms like StartEngine and Wefunder, which is where the current legal line for crowd investment actually exists.

In legally and ethically improper activities, the Ethereum gang and its users are selling digital coins as investments directly to the public, on unregulated exchanges, and our political system is too unforesighted and moribund to require user protections to slow or stop the bubble prior to the catastrophe.

This ICO scam is what has fueled Ethereum’s Ether coin rising to near-Bitcoin market cap in just the last six months. The term ICO is marketing play on the term “initial public offerings”. It’s a clever phrase, as it makes investors think there’s some kind of due diligence, or intrinsic value involved. But there often isn’t any of either, unfortunately.

ICOs are automated venture capital funds, built on top of these “smart” (actually, just automated and dumb) contracts. Some of the startups being funded by them are being peddled technolibertarian investors with the fancy name “Distributed Autonomous Organization” (DAO). One of the first ICO offerings to use this term called itself “The DAO,” and now there are a number of them using this term. Several of these DAOs have been hacked, with folks are stealing tens of millions of dollars from the funds, as blockchain tech is so new, so they have lots of security issues to work out.

Traders are mesmerized by all the money they’ve made, as in any bubble, and now everyone is getting in. New entrants will inevitably peak, and probably soon. Meanwhile, Bitcoin is up sevenfold in the last year, with a market cap (for the currency) of $42B. Ether (Ethereum’s currency), with much more coordinated hype, went from $10 in January of this year to $350 by mid-June, and is now $227, with a market cap (again, for the currency) to that point of $34B. Bloomberg’s Nir Kaissar and Barron’s Randall Forsyth called the bubble in May, and The Economist finally called it in June. Folks like Finance professor Craig Pirrong, in A Pitch Perfect Illustration of Blockchain Hype (Oct 2016) and Bitcoin evangelist Chris DeRose (blog and YouTube) have come out against the madness, but too many aren’t listening.

Below is a lovely update of Gartner’s Hype Cycle, reenvisioned for investing. We’re deep in Mania right now with blockchain startups and their ICOs.

Investors should remember that Ethereum (the company) is just a platform startup. Virtually no one is using their distributed computing network yet. It’s just a bet. It’s Ether may end up outcompeting Bitcoin as the leading digital currency, or it may not. I’m betting that it won’t, though I must admit that bet is just a gut desire, based on what I think of their values, not their community of software entrepreneurs, the majority of which I’m sure have good, if commonly naive, intentions.

In my view, the only valuable thing Ethereum has demonstrated so far are their (in my view, unethical) new fundraising techniques. Their and all DDCs have insufficient regulation, and most of the startups launching coins to fund themselves on their platform have no viable business models, in my view. Their platform may be soon be tainted in investor’s minds, after the inevitable crash. That won’t stop them from making tons of money off all the small investors in the meantime though.

Meanwhile, coin launching is a free-for-all today. These DDCs aren’t just investments (their minor component), they are also attempts at creating a trusted currency (their major component), so valuing them is particularly challenging, which is one of the reasons they are so subject to hype. Unfortunately, there’s no due diligence or required safety mechanisms to protect users. I wish there were more oversight damp down this mania, because lots of small investors will continue to get hurt.

As John D. Rockefeller said, when he found even his shoeshine boy offering him stock investment advice in 1928, he knew it was time to get out of the market. That’s where we are today with all this blockchain hype. Tulip mania, Gold Rush fever, and the Dot-com bubble of late 1990s could each continue for only as long as the hypemakers, traders, and entrepreneurs could manufacture interesting and distracting new bullshit, schemes and ideas novel and plausible enough to both interest and befuddle people, attracting more speculative money, and adding a few more months or years to the game.

Smart contracts, DAOs, and ICOs are the latest version of this hype. Eventually the BS-creation machine runs out of plausible stories, and the train runs out of track. Don’t be on it when it does, friend.

Meanwhile, if you have speculative money to invest, I recommend putting it in a few of the leading bitcoins trying to become a dominant new form of exchange, and in a few of those scrappy startups on StartEngine, Wefunder, Localstake, or another equity crowdfunding site. Such companies usually require only a $2,000 investment (and sometimes, just $400) to get an equity stake in an enterprise you admire, and would like to see succeed. Don’t get involved in yet another utopian blockchain ICO.

PS (July 25): Consequent to the SEC investigation into the $50M hacked from the original DAO, they have just produced a report saying many of the digital coin ICOs are presently skirting securities laws. It seems they want to bring both token offering registration and coin exchange regulation under their jurisdiction, which would be excellent. Let’s hope they can help to deflate this bubble before more folks get hurt.

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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Part 3 → Regulatory Needs, and Promising Startups

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CEO, Foresight University. Author, The Foresight Guide.

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