In order to understand why people are excited about blockchain technology and cryptocurrencies, it is useful to take a step back and understand some of the limitations of our current way of organizing the world. We are becoming a more global society and technology is changing the world quickly; reorganizing it to be more efficient.
One of the breakthroughs of Bitcoin (BTC-USD)(COIN)(OTCQX:GBTC) was the way it distributed truth by allowing anyone to join and participate. The blockchain was a way of achieving distributed consensus without a central authority. The first practical application was for money, but there's a lot more coming down the pipe.
Before we begin; a word of caution. Not all blockchain projects are a good idea. Be wary of people using blockchain as a buzzword, which is what it has become.
Let's start with some applied science.
The Speed of Light Problem
One of the limitations we face on a planetary scale is how to synchronize computer systems. The way the GPS system works is by having a bunch of clocks orbiting the earth. Depending on your position, we can calculate the difference between how long it takes for a signal to reach those different satellites. This is then used to triangulate your position with a high level of accuracy.
Without the speed of light limitation, the GPS systems would not work. However, this also presents us with the problem of knowing the order in which events occurred when synchronizing computer systems in different locations.
In order to solve the speed of light problem, the solution we use today is to have a centralized system where all the computers are a fixed distance from the center point. This enables high frequency trading, in which the cables from the central server are measured down to the nearest millimeter and connected via fiber optics. If my cable is fractionally shorter than yours, I can execute a trade faster than you, and I have the advantage.
Limitations of the Current System
Now, since trading on the FOREX markets, or stock market, or any market is done in this way; you might be wondering what the problem is. Why do we need a solution to this approach?
Well, it comes down to trust and control. If the central exchange is in New York, then what happens when tensions between the US and China escalate? Who is going to arbitrate disputes? Would you trust another country to have this kind of control if there was an alternative?
This problem goes much deeper than tension between the US and China. Think about all the geopolitical turmoil going on today. We had the Arab Spring, there are issues going on with the WTO, look at the drama in the EU, look at the situation with Russia and the Crimean peninsula, disputes over islands near Taiwan, NAFTA... the list goes on.
This tension results in lost opportunity, and world leaders have been looking for alternatives. Further issues complicating the matter are the US dollar acting as the centerpiece of global trade. Do you think the whole world trusts the USA to deal fairly with them? They accept the current state of affairs because right now, what's the alternative?
How Blockchains Handle the Speed of Light Issue
The approach of Bitcoin and Ethereum (ETH-USD) is to use a blockchain to address the speed of light issue. The way it works is that we simply "stop time" every once in a while; reach consensus on what happened in that time frame, write these transactions to a block and then continue on. With Bitcoin, you get a block every ten minutes or so, and with Ethereum it's every 15 seconds on average.
What this does is that it allows us to have an agreed upon record of history that does not involve a central authority. Bitcoin has been doing this since 2009, and Ethereum since 2015.
Can you see how this approach might have value outside just transferring Bitcoin back and forth? The challenge is that in order to replicate this method of distributed consensus, you have to have decentralization on a number of levels. If you keep a blockchain in a central repository, what has been gained? If there's someone who can edit, approve, or change a record by force; then why would anyone trust the new system?
The difficulty that we have is that people don't want to let go of control. But, that's precisely what needs to happen if we're going to have a source of truth without a single person (or committee) sitting behind the kill switch.
Friction in the Current System
Have you had to ship something internationally recently? What was that experience like?
It has been estimated that when we started shipping things in containers; there was a boost of perhaps 7% to global GDP. It's clear that any time we can standardize, automate, and agree on common protocols (like standard sizes of shipping containers that fit right on a truck after the boat), the net effect is positive.
Paper bills of lading are obviously not the future. What is the opportunity cost that we're paying by sticking with an antiquated system like this? Why haven't we switched to something else by now?
I think the reason we don't have a digital bill of lading system is because we (the different countries of the world) are not willing to put our fate in the hands of a central digital authority. It's too hard to reach agreement about what the standards are and who's going to run the thing.
How many assets go underutilized today because we are stuck in our old modalities? Is there another way?
Think about the value that was unlocked by AirBNB (AIRB) and Uber (UBER) for example. Houses, cars and people were being underutilized!
Blockchain - the Long Term Solution
If we can manage to shift our thinking, it is possible to automate global supply chains and trade. The puzzle has many parts, and we are clearly not there yet. But, if we can chip away at digital identity, automating ports and logistics, and creating digital bills of lading; then we will approach a future that is much richer in opportunity simply by activating underutilized assets and removing friction.
Smart computer systems that know the rules of each jurisdiction could automatically and faithfully execute their code and calculate the optimal route, determine price given all global tariffs, and allow full auditability and visibility which is sorely lacking today.
One day, moving things around could become as automatic and as simple as moving data around is right now. Projects like Bitcoin and Ethereum are proof that such a system can work. What we need now is a reliable way to connect physical objects to digital systems.
Criticism and Skepticism
Some people have claimed that organizing the world's value and information on a blockchain is patently absurd because blockchains can only process so many transactions per second. However, to those people I would like to introduce two concepts. These concepts are that of the hashing function, and the Merkle Tree.
What the hashing function does, is that it takes in some data of any length, and produces a unique output of a fixed length.
What a Merkle Tree does (among other things), is that is allows you to know easily if a certain node is a child of a parent simply by evaluating the hash of its output.
Taken together, this means that you could condense down a nearly infinite amount of data into a single output; which means you could ship a million widgets to a million towns and only write a single transaction to the blockchain. Then, someone could verify a shipment easily using that one hash that was written to the blockchain. How's that for efficiency?
Store of Value
Some people think that Bitcoin is failing because it doesn't store value. If Bitcoin is failing, then maybe there's not so much to this whole blockchain thing, or so the thinking goes. Or, maybe the blockchain is a good thing but Bitcoin, not so much.
Well, I'd like to refute this misunderstanding from the Keynesian Economists once again. First, Bitcoin was not designed to "store value." Are you shocked and surprised by this? Go read the Bitcoin whitepaper and search for "store of value."
Bitcoin was designed in such a way that with a fixed supply, and attractive features that make it robust, the number of users would increase over time. This creates more demand, which pushes up the price over time.
Don't believe me? Let's look at a chart. After all, data is king.
See how Bitcoin has increased in price by a factor of 10, five times now? Can you also see that each time it crosses another factor of ten, people panic and the price goes down for a bit? Can you see that after the dip, the price goes up again?
Bitcoin is working just fine. I apologize to the economists in the room who can't accept reality because their ideas about the world conflict with new information. It's time to wake up and smell the Bitcoin, folks.
How to Position Your Portfolio
The last time we saw a phenomenon of this scale, it was the emergence of the internet. There was a general sense that something big was happening, but it was difficult to know what to do about it.
On the one hand, we had this exponential growth of the new technology which seemed to have the potential to change society, but on the other we had a lot of confusion about what it meant and even if it was a big deal.
Here's a Nobel prize winning Keynesian Economist on the subject:
The growth of the Internet will slow drastically, as the flaw in ‘Metcalfe’s law’—which states that the number of potential connections in a network is proportional to the square of the number of participants—becomes apparent: most people have nothing to say to each other! By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s. - Paul Krugman, 1998
Later, as the internet continued to grow, we saw the emergence of the tech companies. The dotcom bubble is still talked about like a running joke. But, have you seen which companies are the most valuable today?
Will the blockchain revolution play out like the internet revolution? I think the answer is "partly." But, there is one key distinction that we need to discuss.
Blockchain flips the value capture to the network itself
With the internet, there wasn't a good way to "own" the infrastructure. You could invest in telecom companies, with the idea that everyone has to pay to get online in some way or another. But, this strategy hardly seems like it was the best. AOL tried to capture people and make their experience of the internet actually become their platform. But, that didn't work out.
Fast forward to now, and look at what happened with the ICO craze. One of the reasons that the last cryptocurrency bubble was so big, was that in a single stroke, Ethereum made it possible for anyone to launch their own project and create their own digital currency.
Fund raising for these ICO projects was done with Bitcoin and Ethereum, which put massive upside pressure on the price. However, when it became clear that the blockchain networks were not ready to handle the amount of traffic they were getting bombarded with; the whole game started to unravel. After that, the SEC started to get more active in regulating these offerings as securities, and the bubble was popped.
You can see from the chart above, that the price of ETH was impacted to a much greater degree than the price of BTC. Also, much like the dotcom bubble, this isn't the end of the line for these new technologies.
What happens next?
I see two key trends emerging in the next few years.
- We will see expanding use cases for blockchain technology, like logistics, supply chain and automation. These use cases will be synergistic with the IoT, and the emergence of machine learning systems. As we move into a more digital world, these technologies will get smarter and get simply woven into the fabric of daily life in much the same way that smart phones and social media have done already.
- Platforms like Bitcoin and Ethereum will implement scaling solutions which will enable the next wave of adoption. In fact, this is already happening now. People said the internet wouldn't scale and they were proven wrong. We're going to see the same thing with blockchain technology.
As blockchain technology gets adopted, holders of these cryptoassets will be the primary beneficiaries. But, eventually the benefits of hyper-liquid physical and digital assets will benefit everyone. I think this technology is going to change the world in ways we can't even imagine right now.
At the very least, investors need to be aware of what's going on in this asset class.
Not so long ago, some experts argued that personal computers would never be adopted, and that tablets would only be used as expensive coffee trays. So I think it may not be wise to dismiss virtual currencies. - Christine Lagarde, IMF Managing Director
Investors need to understand the risks and opportunity posed by new technology. Getting informed and ultimately involved with Bitcoin or Ethereum is a great place to start, even if these crypto assets only end up being the tip of the iceberg.
As Vinay Gupta says:
First we organized information, matter is next.
We don't know exactly what the world will look like in the future. But, I believe we will see more blockchain-like systems and not less.
I think Bitcoin paved the way for this revolution. But, in the long term, we'll see that when blockchains become one of the primary ways that we organize our world, that the value of Bitcoin (and Ethereum) is only reinforced.