With Blockchain, Where There's Smoke, There's Usually More Smoke

Jonathan Wolinsky is senior managing director and chief scientist of Genesis Project, the company behind the private blockchain platform OpenBlock.

In this opinion piece, Wolinsky – and colleague Robert Wolinsky – focus on the blockchain technology industry's inability to deliver on its promise: the bone crushing, market flattening creative destruction of the Bitcoin-style blockchain innovation.

In recent weeks, hot topics in the banking and blockchain technology sector have been the heist of $81 million from Bangladesh's central bank facilitated by hackers manipulating the SWIFT (Society for Worldwide Interbank Financial Telecommunications) messaging platform, and the oft-repeated buzzwords "blockchain" and "distributed ledger" as the "white knight" technology duo that's going to correct all that ails SWIFT.

SWIFT is a global interbank messaging service connecting 11,000 financial institutions in more than 200 countries and territories around the world. SWIFT handles 25 million transfer messages worth approximately $5 trillion daily. However, because of SWIFT's importance to the global financial system, SWIFT's activities do not happen in a vacuum. Plainly said, the SWIFT hacking problem is a global banking industry problem.

Seeking to address this and other questions, since 2014, SWIFT, along with many major firms in the securities and banking industries, have banded together through consortia and collaborations to investigate how to reduce or eliminate mutualized costs, and improve security and reliability. These companies are embracing distributed ledger blockchain technology initiatives as a new means to long- term sustainability in an increasingly digital challenged marketplace.

Of course, there's nothing new about technology collaborations, even amongst competitors. So, let's chalk that up to just good public relations. However, despite the collaboration, the what's "new" is the increasing clarity that saying the word "blockchain" may be more about selling the "old" than delivering the "new".

Recently, I collaborated with colleagues at our firm to pen a contrarian viewpoint entitled "Can Trust-based Private Blockchains Be Trusted?". Our call-out was simple: permissioned or trust-based blockchains without the proof-of-work protocol provably do not deliver historical record immutability and are merely distributed databases impersonating blockchain technology. And since the article's debut, many blockchain development initiatives including the R3CEV group have fessed-up: they are not building blockchains at all. Investors take note.

A little history is in order. Since the inception of Bitcoin there's been two distinct evolutionary or generational steps. First, there was Bitcoin, the tour de force of market flattening and all sorts of disruption. In the abstract, Bitcoin was a fresh idea with tremendous promise. Nonetheless, enterprise- class users had problems using it right off the bat. And rightfully so.

Think about it. Having to get involved with or entangled by the openness of a public blockchain, the Bitcoin brand and its checkered history, internal convulsions, software rigidities and forks, regulatory murkiness, and having to rely on Bitcoin in perpetuity is a really big ask, especially for the folks in the C-suite. The reality was obvious, absent some miraculous innovation – Bitcoin's purpose is to be a digital currency, not an enterprise platform.

The eureka moment came in 2013, when the 2nd generation blockchain salesmen said, "We don't need the openness of a public blockchain; we can build 'private' blockchains without the limitations of Bitcoin, and build them better! Let's separate the blockchain from Bitcoin and make private, permissioned blockchains."

And, soon "the blockchain is going to change the world" meme made selling anything with the word "blockchain" easier. And, the idea of the "blockchain" as a discrete element conveying heretofore not seen revolutionary new efficiency to non-digital money activities was born. Capital started to flow into so-called "use cases" for blockchain technology.

However, in their zeal to harness the awesome power of blockchain technology for enterprise users, many newly minted "private" use-case innovations quickly jettisoned the blockchain data structure and the proof-of-work protocol. Because without having the market flattening disruption and network effect of a public blockchain, it's hard to rationalize the inefficiency of a blockchain database and its associated proof-of-work energy costs.

So what's left?

Once you remove the technology that makes Bitcoin what it is, what's left is a shared or common protocol platform consisting of existing "permissioned" parties inside the walled garden. Yes, getting onto a common platform can add some computational efficiencies between parties, but it's not a true P2P blockchain experience that changes worlds, levels markets and generates maximum efficiency – the type of disruption people think about when they hear the term "blockchain."

What most fail to realize is the blockchain structure becomes largely superfluous without the trustless environment. The blockchain data structure by itself – blocks of information chained together through cryptographic signatures – is not a particularly efficient way of storing or distributing information. However, when combined with the proof-of-work protocol, this ordinary chain of blocks transforms itself into an immutable record with tremendous potential.

Add an objective mechanism for determining the record's validity along with a consensus protocol and, poof, say "goodbye" to the necessity of a central authority and trusted or permissioned parties to maintain the veracity of a multiparty record; say "hello" to uber-efficient P2P transactions without counterparty risk.

In the case of blockchain technology, the benefits gained by removing counterparty risk results in an efficient peer-to-peer environment facilitated by the elimination of multiple and varied rent seekers. These benefits outweigh the costs of using an inefficient data structure as well as the energy costs required by the proof-of-work protocol to secure the provenance of the historical record in perpetuity.

However, when practitioners of 2nd generation blockchain technology reintroduce trusted third-parties in the form of permissioning, or trusted nodes, in order to maintain and "guarantee" the validity of the record, the inefficient blockchain data structure provides little to no value. The blockchain salesmen therefore logically remove the blockchain data structure or modify it into a pseudo-blockchain without real immutability, resulting in an information sharing network strangely similar to the systems that currently exist, albeit maybe using a new, common protocol.

It's important to note that pseudo-blockchains may have cryptographically signed blocks but lack the deterministic and external validation capabilities provided by the proof-of-work protocol that ensure the immutability of the record and the famous self-enforcement blockchain efficiency gains.

The gain comes at a price, though. Bitcoin pays approximately $400m to $500m a year to provide immutability for its record.

Second generation blockchain technology practitioners have repeatedly attempted to circumvent the costs of mining with various software, validator round-robins and circularity workarounds like proof-of- stake, not realizing or carelessly ignoring that both the externality and the resource consumption associated with the proof-of-work protocol are essential to providing immutability of the record, without which a blockchain becomes just your usual common protocol information-sharing environment.

Of course, a common protocol for sharing information may be beneficial, particularly for a system that lacks a common protocol. That's pretty obvious, but it is certainly not the type of efficiency provided by authentic blockchain technology. Nevertheless, the Bitcoin-style, trustless blockchain efficiency is the type of "efficiency" being sold with the term "blockchain" but not being delivered.

By 2016, the wheels started coming off the story. Not only did R3CEV admit they are not building blockchains, it appears Ripple, Blythe Masters' Digital Asset Holdings' Hyperledger, Chain, IBM and a lot of others may be just hawking the same-old common protocol (permissioned) information sharing systems along with varied round-robin consensus software, dressing them up as something new and revolutionary.

And, of course, gaining only the efficiency of going from a non-common-protocol environment to a common protocol environment, not delivering the bone crushing, outside the walled garden, creative destruction of the Bitcoin-style blockchain innovation.

And, so, with a bit of alchemy the "old" became "new" again.

While all this profound thinking was churning the blockchain technology intelligentsia, there remained a small cadre of blockchain enthusiasts, entrepreneurs and data scientists, not alchemists, which understood the poetry behind the blockchain technology.

In the world of digital money, Bitcoin is a technological haiku, a masterpiece of simplicity, balance and rationality. We should not easily dismiss this amalgam of proportionality because, like haiku poetry's unique ability to convey a deep thought in the simplest of word and sentence, a blockchain does one thing extremely well: it eliminates counterparty risk in a transaction, leaving gobs of parties that previously ensured the completion of a transaction without jobs. This is both the simple elegance and the disruptive force of blockchain technology.

To be specific, Bitcoin's "high-art" blockchain innovation is the "trustless" or "self-enforcement" environment powered by the proof-of-work protocol. Without it, all you have is...a bunch of computers talking to each other the way they currently do.

As an aside (but relevant to deeper meanings), maybe Bitcoin's inventor chose the Japanese pseudonym Satoshi Nakamoto to hint at his creation's Haiku-like perfection.

Nowhere!

Only seven-odd years since exploding onto the world, "blockchain," once a descriptor of elegance, is now a pop-culture money slogan entering middle age. The slogan has raised over $1 billion from venture capital firms, businesses, angels and incubators. Many have likened it to the halcyon days of the Internet all over again.

Yes, slogans are useful for some things. However, blockchain slogans are not of the useful kind. Because when it comes to blockchain technology, where there's smoke, there's usually more smoke.

And the fall has been fast. In a mere seven years, cadres of blockchain salesmen and their academy cohorts have devolved and deconstructed the "high-art" into its several components, selling various elements as "blockchain technology" while either excluding or redefining the one component that animates the ordinary distributed ledger to become disruptive Haiku art, the "trustless" or "self- enforcement" environment made possible by an immutable record.

I would like to digress for a moment into a small technical discussion in order to elucidate the preposterous notion that blockchain components are malleable, interchangeable or removable while expecting the type of disruption associated with blockchain technology. Blockchains are comprised of three main interlocking components: 1) consensus, 2) authentication and 3) immutability. And, for the sake of clarity, the technology behind each of these components predates Bitcoin and the "blockchain" hype by decades.

Both the consensus mechanism (built into the underlying application logic) and authentication technology (provided by public key cryptography) are commonly used in distributed systems. However, prior to Bitcoin, the third component, immutability (provided by proof-of-work), was never before used in concert with the other two technologies. And, when all three were combined, something truly fresh and amazing, almost magical was created. In other words, proof-of-work tied the other components together into what became known in modern parlance as a "blockchain".

Of course, not everyone's happy with the inelasticity of the proof-of-work protocol and the science behind immutability and its cost, especially the promoters. So, in eagerness to commercialize, many promoters watered down the definition of immutability in order to shoehorn blockchain technology into their dream state. Unfortunately, the vaunted resiliency of blockchain technology – self-enforcement – is not transferable without the historical record immutability provided by the proof-of-work protocol.

In the face of the prior discussion, the most common response – said in a matter-of-fact manner to disguise the contempt for being caught – is: "well, we're not really building 'blockchains', we're building 'distributed ledgers'."

That is to say, they got rid of the inefficient blockchain data structure and the proof- of-work-enabled immutable record and brought back trusted third-party validators that merely reimpose a modified or virtual central authority scheme.

To use another big concept, what came – although, very slowly – was an understanding that blockchain promoters are just back where they started. And, the "where" is merely "work for hire" software projects, not the Internet all over again kind of stuff worthy of big investments and high-multiple financial exits customarily expected by the sophisticated investor class.

Until now, use-case validation schemes have guided investment. And there's likely many use-cases for common protocol systems in various sectors and industries. However, to achieve Nirvana, common protocols require en masse existing participants' adoption.

There's two problems here.

First, experienced financial individuals instinctively know that amassing whole industries is like herding cats and will likely never happen. The second problem is that investors didn't invest their cash into building common protocol software, they invested into (disruptive) blockchain technology.

So, investors need to take hold of the situation before too much money is lost and reputations destroyed because most if not all blockchain investment has gone into common protocol use-cases masquerading as "blockchain technology" with a return on investment likelihood of zilch. If you are one of those investors who thought you were investing in disruptive blockchain technology only to find out you got a "distributed ledger," I'm sorry to tell you – you got played. This isn't the Internet all over again, get used to it and cut your losses.

Moving forward, I recommend the following two guidelines.

One – investors need to differentiate between the few projects that unleash the Bitcoin-style disruption into new markets from the many so-called "blockchain" (use-case) projects that merely repackage common protocols that empower existing participants; and, two – if the blockchain technology industry persists in pretending to build blockchain technology, then the investment community should "pretend" to invest money.

As for the folks at SWIFT, be careful what you wish for. A real implementation of blockchain technology will put you out of business!

This piece was co-authored by Robert Wolinsky

Image via Shutterstock