Get Ready for the Rise of the Blockchain

Say Bitcoin in a crowded room, and you'll find at least one guy who believes it's going to start a financial revolution. Most people remain skeptical of the libertarian utopia wherein the government cedes control of the money supply to Bitcoiners. But some are starting to come around on the blockchain as an important part of our digital future.

Since blockchains are new, and we've gotten along very well without them so far, their value proposition is neither simple nor obvious. Ask a competent programmer, and he might say that blockchains provide an auditable log of updates, check-pointed transactions, or distributed communications. But these features aren't what make blockchains remarkable. In fact, all these features have been around since long before the Internet came into existence.

What makes blockchains remarkable is that they perform these functions without a central authority. The blockchain is not run by any company. For all intents and purposes, there is no one person making decisions about what can and can't go into the database. There is no way to remove data from the blockchain and no one who can flip a switch and turn it off or on. The blockchain is an agnostic ledger. This quality means that blockchains can drastically reduce counterparty risk.

To date, the best way to perform low-friction transactions is to have a trusted third party such as Visa, American Express or the SWIFT payments network sit between buyers and sellers. These parties administer an IOU to the seller, settle money with creditors and perform fraud, credit analysis, identity management, and risk mitigation functions.

For many, this system has worked fairly well thus far. But interjecting parties into transactions is nonetheless a source of inefficiency — and one that has become increasingly obvious in the wake of Bitcoin. Credit card companies extract fees of approximately 3% from merchants to use their network. Remittance companies extract fees of 5-20% from senders. Large asset transfers, such as those in property sales, involve so much risk that licensed legal representatives are needed to escrow the payment. And simple check deposits can take days to clear due to the inherent risks of settlement failures with our current systems.

Blockchains entirely displace the need for third parties, and even large institutions, to manage value transfers. In the case of Bitcoin, the blockchain allows individuals to move value from one place to another at a cost of nearly $0 in under 10 minutes, without the need for an intermediary. For anyone who understands the complexity of moving money from place to place, this should seem like a remarkable achievement.

The additional security benefits of the blockchain also have the potential to enable new forms of commerce. And while risk-reduction within transactions is the goal of every merchant on the planet, there is perhaps no place where innovation is more needed than in the world of web-based value transfers.

For card-not-present transactions — which most online retailers perform when they accept a credit card over the Internet — the inefficiency of the current system is painfully obvious. Credit card companies will often take seven days to put money from transactions into a merchant's bank account. Merchants don't have a good way to accept payment from customers that do not have a banking relationship. And for customers, the necessity of inputting personally-identifying information can discourage privacy-sensitive buyers from purchasing goods and services.

Moreover, while credit cards seem like a simple and elegant solution to online purchases, they are completely unusable for payments under 50 cents.

Before you discount the need to transact in such amounts, consider the current state of monetizing content online. Videos are often preceded by a 30-second obnoxious advertisement. The user tolerates it because the ad acts as a gateway to content.

In exchange for your view, the content provider receives what amounts to tenths of a penny in revenue. Given the option of a frictionless, risk-free payment technology, most users would gladly sacrifice an entire penny to avoid the watching an ad — especially for a content provider they use often. Consider the possibilities of paying 25 cents to YouTube each month in exchange for never looking at an ad again. For the company, per-user earnings would be orders of magnitude higher than their current earnings, all while making their users happier. With a blockchain, that world is possible.

Furthermore, the reason users can spend value without being concerned about security lies in the blockchain's decentralization. A detailed account of how decentralization works requires an article upon itself. But through clever cryptography, and at the great expense of miners' energy, no individual can make the network stop working without destroying an inordinately costly amount of his or her own money. This acts as a significant disincentive for anyone to disrupt the network.

Understanding the Bitcoin blockchain as a trustless and agnostic settlement engine provides a good beginning framework for those who are new to the technology. Much of its utility can be couched in its ability to ensure almost free, almost riskless, and fully auditable settlement.

Bitcoin's ability to remove the extra costs added by transactional intermediaries will likely force financiers to have a come-to-Jesus moment. In the same way that Napster and peer-to-peer file sharing changed the face of the recording industry, blockchain technology will force financiers to reconsider their traditional roles. Banks and financial institutions will never disappear, but there will be major changes to be made in how they create value for their customers. Luckily for them, the newness of the blockchain makes innovation a low-hanging venture. 

The next article in this series will explore the more technical aspects of the blockchain and how it settles "truth" when everyone involved has an incentive to lie. 

Chris DeRose is the community director of the Counterparty Foundation. Follow him on Twitter @derosetech.