For at least a year now, the magic word in technology circles has been “blockchain” – the accretive cryptographic system behind Bitcoin and other virtual currencies.
A distributed ledger
A blockchain serves as a distributed ledger, a record of transactions or other information that is secure from alteration and that operates without any central authority. Its security derives from the digital signatures required to affect the record. It foregoes a central authority by residing simultaneously on very large numbers of computers on its network (which is what “distributed” means in this context, in contrast with “centralized”.) Each such computer contains the whole chain of transactions, so it is not feasible for a would-be fraudster to alter all of them. A plain-language description of Bitcoin, done a few years ago, is here.
It is clear that Bitcoin, and presumably its emulators, can function to make payments. Serious businesses are willing to accept Bitcoin in payments – even some law offices such as this one. How they establish a value equivalent to the dollars used for accounting and tax purposes, given the fluctuations in value of Bitcoin, is a separate issue. Early adopters have made considerable money. My ISP has earned more from Bitcoin appreciation than from operating profit in recent years.
Many people now say that Bitcoin is only a special use case of the blockchain, which can be used for far more transactions that need to be secure but that now rely on trusted intermediary institutions whose role causes delay, expense and even uncertainty. This week’s newspaper reports that the Canadian Stock Exchange (an alternative stock exchange) wants to record stock purchases and sales via a blockchain. The blockchain is also apparently an “opportunity for lawyers.”
At present there do not seem to be many actual implementations of blockchains for purposes other than cryptocurrencies. Many thoughts have been generated, many patents issued (most to financial institutions, whose traditional role of financial intermediaries is said to be threatened by blockchain applications.) Not much on the ground – or in the ether, no pun intended – yet.
As a result, it is not quite clear how these applications are going to work in practice. Whether it is a good thing to have an open field of innovation fenced off by multiple speculative patents at this stage is a separate question too.
It has been suggested by an expert observer that any blockchain application is going to have to operate in a well-defined legal framework, including laws of general application, system rules and implementation specifications. It is not just the technology, in other words. The technology has to “be” somewhere.
I raise for discussion the question whether blockchain applications are going to be prohibitively expensive.
Cost considerations – Bitcoin
Start by looking at the primal application, Bitcoin. One obtains bitcoin by “mining” it, which involves solving complex mathematical problems. The problems are so complex at this stage (the complexity increases over time) that they take a lot of computing power to solve. Despite amazing advances in technology and techniques (said to be a hundred million times faster than a decade ago), the amount of electricity needed to drive the banks of computers devoted to mining Bitcoin is also huge.
A common measurement is that running Bitcoins in the world today uses as much electricity as all of Denmark. (One sees Ireland and Israel mentioned in such comparisons too.)
It should be said that some authorities challenge this measurement, or say that improving technology will reduce the demands, or that it is not as expensive as it seems if you consider that it aims to replace entire governmental monetary systems. (Please stand by…)
But as transactions go, Bitcoin is said to be some 5000 times more expensive than a Visa purchase. And Bitcoin can handle under 4 transactions a second, while Visa does nearly two thousand. (Ethereum by contrast may be able to do 20 a second in an ideal state, and PayPal something over 100.)
Moreover, to get one’s transaction added to the Bitcoin blockchain requires payment of a fee, whose amount depends on how busy the system is and how quickly one wants to get the transaction recognized (“to get your transaction processed quickly you will have to outbid other users”) – and thus made irrevocable. There can be backlogs. What this can feel like in person is described in this Maclean’s article from January 2018.
Those fees have been described as “skyrocketing” to something over $20 per transaction. At some point the traditional systems start looking economical. The fees seem to have declined somewhat in the past few weeks, but they are volatile, unlike credit card fees. In any event, payment with Bitcoin is not just a matter of generating a practically free electronic message.
It may be argued that overall, the overhead for Bitcoin is far less than for fiat currency, when you consider the cost of all the intermediaries. The electrical cost of mining Bitcoin comes from the proof-of-work requirement. It requires massive processing times. The processing difficulty, matched to scale in terms of volume, is what generates the security of the blockchain.
The paradox is that when you attempt to reduce expense to make generating tokens more economical, you correspondingly impair the robustness of the blockchain. One reads of so-called “permissioned” blockchains, which depend on trusted “nodes” that govern who gets in and on what terms. The nodes already trust each other, though such a system may lose the trustworthiness that a distributed network of strangers is alleged to create. Sometimes – often? – creating a permissioned blockchain may be a lot of effort – or the application of a trendy label – for a system no more secure or tamper-resistant than traditional centralized databases.
On the plus side, it’s possible that a shared private blockchain (say for securities trading among existing intermediaries) could eliminate some need for disparate back office systems and eliminate reconciliation requirements that cause delay and expense. But these largely remain to be invented.
Cost consideration – blockchains
One important question in determining how a blockchain application will cost is how users gain access to the system. How do they acquire what they have to contribute to the ledger, whether that is a vote as a shareholder, an interest in a contract, or shares in a public company? Does somebody have to set up mathematical puzzles that need to be “mined”? Or is there some other “proof of work” to participate? The latter is most likely – but rather obscure in practice. What work, how done, and proved to whom?
Ethereum is said to offer, or be about to offer, a “proof of stake” system that will address overhead concerns. Permissioned blockchains can make entry cheaper, though the cost of authentication may still be high for large-scale systems.
Will participants in any commercial blockchain need to expend computing and thus electrical resources to get into the system? Will they all have to maintain the records of the whole ledger in their hard drives, as part of the distributed security process?
Will such computing demands be put on participants for every blockchain application they use? So if a person owns shares in, say, twenty-five companies – not an unduly heavy portfolio – must they mine or work their way into every company’s ledger?
If a company has a hundred million shares outstanding – again not an unduly large number – how can all the shareholders be provided with blockchain tokens to vote by proxy at meetings. Perhaps such votes would not be considered by proxy – an intermediary, after all, which the blockchain promises to eliminate – but a direct vote. In any event, how do they acquire a demonstrable right to vote, and authenticate themselves to the system when they vote? Proof of work? If a trusted organizer has to govern how they come and go, is the fancy computing of a blockchain really cheaper or justifiably better than current centrally-managed systems? There does not appear to be any actual proxy voting blockchain app on the horizon.
And all this must be combined, presumably, with a digital signature system to encrypt one’s block in adding it to the chain. Digital signatures rely on public key cryptography, a process that is extremely difficult to apply to a large body. The mathematics can support it, but key management is a challenge, and tends to be centralized rather than distributed.
Would the operation that proposes a blockchain application provide a user-friendly package of signing/encryption software – on a token? Delivered online – securely, to the right people every time? That starts to sound like a system that needs intermediaries, or a great deal of sophistication on the part of users. There are no examples of publicly available, generally usable digital signatures, though the dream has been active for decades.
Will the blockchain voting system, to continue that example, have transactional limits like Bitcoin’s, so only a few voting instructions could be processed per second? Recording votes of 100,000,000 shares for several votes per meeting might take a while.
How much electricity would all that take, including the qualification – proof of work in some way – and the processing both at the voters’ end and the corporate end?
Multiply these numbers by the thousands of applications promised for blockchains – thousands of public companies dealing with their shareholders, but then countless other promised uses as well. Smart contracts, anyone?
Some people – including the founder of Ethereum – contemplate that in less economically developed parts of the world that do not have the intermediaries that are familiar to us, the blockchain can avoid the need to create them, the way that mobile phones have taken the place of banks in payment systems in some parts of the world. Will the demands on power delivery infrastructure in such places cause problems for this ambition?
A large number of very smart people are excited by the potential of the blockchain and are working to develop applications. Perhaps all the questions raised above will be readily, or eventually, resolved. But if a new system offering theoretical advantages is a lot more expensive than a less ideal alternative, the move to the new offering may be slow and its success far from guaranteed.
We have lived through the stock market’s technology bubble at the turn of the century. Some technology companies survived its bursting and thrive today. Perhaps the blockchain is a conceptual bubble that needs to blow up in a lot of faces before its really solid – and affordable – applications become clear.