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.