Blockchain’s trust and cost issue
This article will dive deeper into the problem of blockchain with trust and transaction costs. When blockchain advocates plea about trust they usually say things like “in code we trust”, but this is trust as verification. This is verification, because blockchain’s unique consensus protocol verifies if a block with transactions belongs to the distributed ledger or is tempered with (Rosic, 2017). Blockchain enthusiasts do not understand that trust is not the same as verification (Schneier, 2019).
Blockchain and trust
Kevin Werbach (2018) defines four systems that enable trust: peer-to-peer trust, leviathan trust, intermediary trust and distributed trust. Distributed trust is the foundation in the system underlying blockchain. Blockchain moves the traditional trust in people and institutions to trust in technology. You need to trust the algorithms, consensus protocols and the network. When that trust turns out to be displaced, there is no alternative solution (Munford, 2019). These are three frequent problems to illustrate this problem:
– If a wallet with cryptocurrencies gets hacked, you lose all your tokens and it is impossible to retrieve them (Cluley, 2019).
– If you forget your login credentials, you lose access to your coins and thereby lose your investment (Glaser, 2017).
– If there is a bug in the algorithm behind a smart contract, you lose all your coins. For example, the DAO-attack on a blockchain system based on Ethereums smart contracts caused the theft of $170 million worth of Ether (Buis, 2018).
Therefore you can say it is harder to trust technology than to trust people. A legal system is way more transparent and easy to understand than auditing a computer code to find a bug.
Blockchain and transaction costs
On the other hand, blockchain enthusiasts mention that institutions ask expensive fees while not adding any value (Hooper, 2018). This claim is legit to certain extent, but blockchain has higher transaction costs than institutions. The difference lies with the fact that the costs of blockchain transactions are hidden since the miners pay for the resources to mine an extra block. Furthermore, the energy used by miners creates huge environmental waste. The energy cost for mining bitcoin is currently more than twice the energy cost of mining copper or gold (Hern, 2018). Therefore, you can conclude that blockchain does not change the urgency to trust human institutions.
Economic theory views trust as a cost because it takes work to provide. Ronald Coase (1937) states that negotiations, contracts, arrangements and thereby trust are transaction costs. In reality systems with strong trust avoid the hidden costs that would be created if everyone was cheating the system and users would actively try avoiding being a victim of fraud or theft by others. These hidden costs are currently very high with blockchain technology (Orcutt, 2019). But how can we solve this problem?
Blockchain’s solution
Blockchain’s trust issue could be solved by government regulation. Blockchain is – despite its anarchic reputation – no exception and therefore the socio-technical system behind blockchain including the wallets and exchanges have to become regulated to protect consumers and create trust. Prosecutors will also have to contribute to creating trust by investigating the use of cryptocurrencies by criminals to fund terrorism, money laundering and other criminal activities. Governments with the most effective rules – not with the least rules – will attract economic activity and achieve success. In the end blockchain will have to combine algorithms and human activity. It is not sufficient to solely trust technology, built by human programmers after all. For mass-adoption and real economic value, there must be procedures and laws in place to hold humans accountable as well. This is the best solution for the blockchain community, but also for society as a whole. Do you agree?
References:
Cluley, G. (2019). ‘Cryptocurrency wallet GateHub hacked, nearly $10 million worth of Ripple (XRP) stolen’. Retrieved on 8 October 2019, from https://www.tripwire.com/state-of-security/featured/cryptocurrency-wallet-gatehub-hacked/
Coase, R. H. (1937). ‘The Nature of the Firm’, Economica, New Series, Vol. 4, No. 16. (Nov., 1937), pp. 386-405.
Buis, J. (2018). ‘How the $170 million Ethereum bug could have been prevented’. Retrieved on 8 October 2019, from https://hackernoon.com/how-the-170-million-ethereum-bug-could-have-been-prevented-819053c3b2cb
Glaser, A. (2017). ‘People Who Can’t Remember Their Bitcoin Passwords Are Really Freaking Out Now’. Retrieved on 8 October 2019, from https://slate.com/technology/2017/12/people-who-cant-remember-their-bitcoin-passwords-are-really-freaking-out.html
Hern, A. (2018). ‘Energy cost of ‘mining’ bitcoin more than twice that of copper or gold’. Retrieved on 8 October 2019, from https://www.theguardian.com/technology/2018/nov/05/energy-cost-of-mining-bitcoin-more-than-twice-that-of-copper-or-gold
Hooper, M. (2018). ‘Top five blockchain benefits transforming your industry’. Retrieved on 8 October 2019, from https://www.ibm.com/blogs/blockchain/2018/02/top-five-blockchain-benefits-transforming-your-industry/
Munford, M. (2019). ‘How I lost £25,000 when my cryptocurrency was stolen’. Retrieved on 8 October 2019, from https://www.bbc.com/news/business-49177705
Orcutt, M. (2019). ‘Once hailed as unhackable blockchains are now getting hacked’. Retrieved on 8 October 2019, from https://www.technologyreview.com/s/612974/once-hailed-as-unhackable-blockchains-are-now-getting-hacked/
Rosic, A. (2017). ‘Basic Primer: Blockchain Consensus’. Retrieved on 8 October 2019, from https://blockgeeks.com/guides/blockchain-consensus/
Schneier, B. (2019). ‘There is no good reason to trust blockchain technology’. Retrieved on 8 October 2019, from https://www.wired.com/story/theres-no-good-reason-to-trust-blockchain-technology/
Werbach, K. (2018). ‘The Blockchain and the New Architecture of Trust’, Information Policy, The MIT Press, Massachusetts.
I actually do not agree. Everything you said is absolutely true, although most are specifically for Bitcoin/Ethereum, rather than blockchain technology as a whole. However, I definitely do not want the government to have anything to do with cryptocurrencies.
The decentralisation of cryptocurrency is what made cryptocurrency successful. I trust an exchange/wallet like Coinbase a lot, but if I wanted to be 100% certain my coins do not get stolen I need to keep my own private keys in for example a hardware wallet. Not your private keys, not your Bitcoin; a common saying for a reason.
The energy used by miners is insane, although mostly an issue for Bitcoin. There are already coins out there that instead of using Proof of Work (mining) to ‘keep the network going’, they use Proof of Stake. Uses way less electricity and is arguably just as safe.
The use of coins by criminals might be a necessary evil. Bitcoin is still a lot easier to track than cash would be. Where movies used to talk about an offshore account in the Cayman islands, now it’s bitcoin bitcoin bitcoin.
In all honesty, I do not think Bitcoin should still be the biggest coin out there. The technology is advancing quickly and there are many more interesting coins out there. Ethereum was already a huge improvement over Bitcoin/Litecoin. There are now thousands of coins, many of which have very interesting concepts.
And let’s be honest, the government is incapable of creating good policies/regulation on stuff like this…
Thank you for your interesting comment Sander. I would like to react to several arguments:
– Yes, you definitely should save your coins in a hardware wallet. I only think that only 1% or less really buys one and therefore it also limits the potential of crypto for mass adoption. And mass adoption is needed if you really want to start using crypto as an alternative to other currencies.
– Yes, I am glad that we are moving to new consensus protocols and new coins use the Proof of Stake concept. They use way less, but I think the transaction costs are still high. Not to mention the time it takes to register a transaction. Waiting time for bitcoin transactions is currently averaged on 30 minutes with extreme cases of 16 hours (https://coincentral.com/how-long-do-bitcoin-transfers-take/) vs less than one second on regular databases. Of course this is an argument specifically for Bitcoin, but other currencies/ chains do not outperform regular transactions on transaction costs as well as security.
– I agree that bitcoin would be a bit easier to track than cash, but tracking is not the problem. Accessibility is. I think that cryptocurrencies enable a lot of people to engage in malicious transactions (via dark web for example) with less risk than the old-skool way. This gives a huge influx to the scalability of criminal activities. Consequently, there will only be a few kingpings in place who benefit from the most effective supply chains, distribution networks and economies of scale. This growing influence of criminals causes a threat to the rule of law and thereby huge negative side-effects of not monitoring crypto. So in conclusion there are huge negative effects and very few (questionable) positive effects.
– I agree that bitcoin should not be the coin with the biggest market value, but I think this shows that other coins do not (yet) have any underlying value. Currently, it is nothing but hype.
And yes, I agree that the government does not have a solid track record, but I think this is why there should be a debate with experts from the blockchain industry involved to help them draft the right regulations. This is why I wanted to emphasize it is in the interest of the blockchain industry as well!