A Brief History of Governance in Cryptocurrency Land

I recently had dinner with someone who holds sizable cryptocurrency positions. He reiterated what I hear often from people bullish on public blockchains: private projects like R3 are great insofar as they will win the banks over to using a cryptocurrency as their form of value transfer.

Though I’m sympathetic to cryptocurrencies as a social and economic experiment, I believe this transition will never happen. Most cryptocurrencies are optimized to achieve a high-integrity ledger while evading censorship. The design choices that allow for cryptocurrencies to thrive in hostile environments also pose a tax on the throughput and efficiency of these systems.

Many of the design choices that render cryptocurrencies unsuitable for financial services can be altered through forks, whereby the cryptocurrency’s protocol uses new conditions for validating transactions in the network. While these events can make cryptocurrencies more attractive to financial institutions* (likely while alienating their existing user base), the methods available to implement forks point to a larger issue with cryptocurrencies: a lack of robust governance structure.

Two Case Studies
The world has already seen two major crises arise from a lack of governance mechanisms in the two most popular cyptocurrencies: Bitcoin and Ethereum.

Over the last eighteen months, the Bitcoin community has undergone a debate over how the Bitcoin protocol should scale to support more transactions. Without getting into the technical details, several proposals were made to achieve this – some of which were mutually exclusive to one another. Ultimately, the debate over how to amend the protocol led to intense disagreement among the Bitcoin developer community. The path forward had no means to transfer from debate to enforcement in a dynamic fashion.  

More recently, some aspiring former Ethereum developers created a smart contract-based, kickstarter-esque, investment project called “The DAO.” Unlike traditional investment management shops, The DAO was to be governed exclusively by a few thousand lines of code and the votes of its token holders to pick investments. Though it was known to have several critical deficiencies prior to launch, the brazen developers behind the project pushed it to market. When one of the many issues with The DAO was exploited to the tune of ~$50 million going to one clever hacker, Ethereum holders were incensed and called for some form of time-out.

In the heat of The DAO exploit, a hard fork to “undo” the DAO was proposed. At first, the Ethereum Foundation said that they miners would decide if a soft fork to freeze the hacker’s account would take place. Then, the Ethereum Foundation incented miners to soft fork. Soon after, a proper hard fork emerged. For concise summaries, see my colleague Tim Swanson’s posts on the topic – and related ppt for consultants. Long (and unfinished) story short: though the Ethereum Foundation, miners, etc. pursued a course of action, it remains unclear what threshold of dispute over ETH/ETC at the hands of buggy code will cause them to hit “reset” again. 

Closing Thoughts
In short, cryptocurrencies allow stakeholders to benefit from the integrity borne of the incentives for miners… until they don’t. This is a poor value proposition for banks, which are already subject to the will of many external parties. In order to survive, cryptocurrencies will have to learn how to incorporate governance.

* – Though probably not ever because the world still does their accounting in terms of dollars, pounds and the like.

The Weekend Read: Mar 20

1. The Economist as un-Hype Man

The Economist is back on the blockchain beat with a pair of short articles. The first is a pseudo-cold shower for the enthusiasm within financial services to “put a blockchain on it,” lead by a quote from the Blockchain Beard himself. The article ends on a more hopeful note:

Yet it would be wrong to conclude that the blockchain is no more than a fad. It is merely moving through the same hype cycle as other next-big-things have done before it: inflated expectations are followed by disillusionment before a technology eventually finds its place. Although it will take a while for distributed ledgers to rule the world, they are an idea, to paraphrase Victor Hugo, that will be hard to resist.

The second outlines the nascent love affair between central bankers and distributed ledgers: our oft-cited Regtech theme which we will discuss further down the page. The article does end with a nice crypto-libertarian head exploder: “The technology first developed to free money from the grip of central bankers may soon be used to tighten their control.”

2. Good News

A warm welcome to SBI Holdings as our newest R3 member institution. It is great to have their team on board, as SBI has been quite active in the ledger space, including their recent JV with Ripple to create SBI Ripple Asia. Another member bank, Unicredit, recently released a white paper discussing the potential applications of blockchain tech to financial services. The authors Matteo and Vittorio have a wealth of hands-on experience to draw from and the paper is well worth a read in full. And a congrats as well to the TradeBlock team for their recent announcement of a successful PoC with ICAP as well as their new sister company Axoni.

3. Regtech and Identity

The US Dept of Homeland Security (DHS) recently announced requests for proposals in two blockchain related areas. One area is not too surprising: “Blockchain Applications for Homeland Security Analytics.” But the other one (“Applicability of Blockchain Technology to Privacy Respecting Identity Management”) truly piques my interest, both for their desire to learn more about identity management and in their concern to respect privacy!

Continuing the identity theme, Barclays announced that they are “one [of] a group of nine companies certified by Gov.UK.Verify to supply and manage public IDs for services.” The Gov.Verify program has had some ups and downs, but the effort to create a digital identity service, if only for government services, should be commended. Speaking of the UK government, we have yet another article touting their aggressive push towards central bank digital currency as part of the government’s fintech hub strategy: “The speed with which the digital-currency agenda has captured the imagination of U.K. officials hints at its potential strategic value for both central banking and the economy.”

…and finally, an article that I missed from last week by the always excellent Ben Thompson at Stratechery. The post is nominally about the block size debate, yet it is more a meditation on how a lack of diversity within tech can lead to blind spots in decision making:

Ultimately, I don’t know what will happen to Bitcoin, but I’m skeptical of folks who are attracted to it because it allegedly removes humans from the equation: that is and always has been an idea that only makes sense in the very narrowest view of a single Bitcoin transaction, as we are seeing all too clearly in the community’s inability to address a relatively minor issue.

More broadly, I hope that the fundamental humanity that goes into any decision — product, policy, or otherwise — is appreciated by everyone in tech. Just as products and companies are either growing or dying, so too efforts to make the technology industry more accurately reflect, and thus better serve (and better monetize!) the diversity of the human race, are either explicitly improving the status quo or implicitly embracing it. There are no neutral “rules.”

The Weekend Read: Valentine’s Day

And Lo! A Rutter brought forth The Words of The Swanson (see article)

And Lo! A Rutter brought forth The Words of The Swanson (see article)

1. (D)App Store

FoTWR Alex Batlin has a thought provoking post on the potential evolution of smart contracts where the protocol and business logic are separated (i.e., Ethereum and its ilk). This is a topic that we have been discussing quite a bit internally and one which our newest team member Kathleen Breitman will expand on in the coming days. Alex does a great jonb in framing out possible market models as well as being candid that the introduction of business logic into such a protocol will inevitably (and rightly) introduce some level of trust into the system:

Based on that assessment, we may end up with a DApp Store model where folks purchase a licence to deploy an instance of a well written, standards compliant, tested and proven DApp onto a blockchain. This however implies that the DApp creator does not provide operational guarantees, so who does?

There are parallels today e.g. iOS developers rely on Apple to provide the device, the OS and the App Store, and both rely on the broadband and mobile internet service providers (ISPs) to provide connectivity, but none of them guarantee entire front to back service to the app user.

Conclusion therefore is that a new type of entity is required – a blockchain service provider (BSP).

2. Blockchain 90210

We were thankfully treated to a lighter news week, giving everyone a chance to catch up on the recent deluge of white papers published in January. Instead we have a selection of articles that are less New Yorker and more US Weekly.

First up, there seems to be a resolution to the Ripple-Jed McCaleb break-up and subsequent XRP sale “crime of passion,” with Jed maintaining ownership of his coins but agreeing to a strict sale schedule overseen by Ripple. Both sides have claimed victory and hope to move on. Next up, the “he said, he said” Bitcoin block size slow motion train wreck continues, with this article giving a good overview.

…and finally, we have a front runner for most overheated blockchain headline of 2016: How fire departments can use Bitcoin technology. It is official: BLOCKCHAIN SAVES LIVES!

The Weekend Read: Back to School Edition

Summer is (un-officially) over and the Bitcoin livin’ aint easy

1. Bitcoin Nerd Fight Update

Since our last posting, lots of e-ink has been spilled and reddit sock puppets besmirched over the Great Block Size Debate of 2015. There are countless articles and think pieces available on the topic; for a good high level review of both sides, see this New Yorker article. This week, the broadly anti-XT Bitcoin core dev crowd (representing roughly 90% of Bitcoin Core commits) penned an open letter to the community:

There will be controversy from time to time, but Bitcoin is a security-critical system with billions of dollars of users’ assets that a mistake could compromise. To mitigate potential existential risks, it behooves us all to take the time to evaluate proposals that have been put forward and agree on the best solutions via the consensus-building process.

In other words, you can stick your XT hard fork…Let’s see if anything constructive comes out of next weekend’s Scaling Bitcoin nerd summit in Montreal.

2. Blockchain on Wall St. (cont)

The ‘bank love for blockchain’ articles continued unabated during our brief hiatus. First up was this NY Times article, which features a mention of our own David Rutter and reviews the blockchain excitement across Wall St:

Many in the financial industry hope they can find a way to use the blockchain concept — what is often referred to as adistributed ledger — without using the blockchain associated with Bitcoin. Although the bankers working on the idea disagree on how this will happen, they show surprisingly little disagreement on whether it will happen. One of Goldman’s top Internet analysts, Heath Terry, said in a recent company podcast that “the whole blockchain tech behind Bitcoin has massive implications for really any kind of asset — and the ability to transfer ownership of digital goods.”

“It’s hard to see a world where that blockchain technology doesn’t end up changing the way we think about asset
ownership,” he said.

Next up is Bloomberg Markets magazine with their blockchain cover story on Blythe Masters and DAH (which also includes a pic of Sunil practicing for the Staring Contest finals). The always excellent and irreverent Matt Levine followed this up with one of the most on-point rundowns I have read in Blockchain for Banks Probably Can’t Hurt:

You could have a centralized model where the participants get together, set up a DTC-like entity, and let that entity keep track of ownership and transfers. Or you could have a semi-decentralized model where the participants get together, agree to run the same blockchain code, and keep track of ownership and transfers by consensus. There might be good technological or practical reasons to prefer one or the other, and certainly the blockchain excites many technologists. But the point is: Either of those models seems much better than waiting 20 error-prone days for a trade to clear.

Then for the banks themselves. Here is Aditya Menon, managing director of global digital strategy at Citigroup, quoted in The Economic Times: “For us it’s not so much about bitcoin because bitcoin is something that has very volatile value, questionable in terms of an entry in and entry out from a regulatory perspective. But if you think about the distributed ledger -that is extremely valuable.” Barclays also garnered some headlines, with ArsTechnica managing to over-interpret the announced charity pilot with Safello into the headline Barclays to become the first major bank to accept Bitcoin [later updated and somewhat softened to reflect the truth]. Chief Design and Digital Officer Derek White followed up in other stories with more updates on Barclay’s work: “We looked at how many experiments we wanted to do internally with the blockchain. The first wave led to 22 experiments, we’ve now got over 45 experiments our businesses want to do.” And finally, UBS made a big splash late in the week with an overview of their efforts in distributed ledger, which includes a smart bond prototype as well as a ‘settlement utility coin.’

3. Odds and Ends

ICYMI, in late August Richard Brown channeled Barclays’ Lee Braine in FREE ADVICE CAN BE VALUABLE… BUT ONLY IF YOU TAKE IT:

Thirdly, consider the complexity of banks’ existing IT environments. An idealised, “wouldn’t the world be perfect if…” solution is no use to anybody if it requires the whole world to move at once and/or if there is no credible migration path. This points to a need to listen to the incumbents when they object. Furthermore, consider the non-functional requirements which are simply a given in this space.

Fourthly, if we assume that today’s current hyperactivity will lead to a new understanding of the possibilities for banks but don’t assume that today’s blockchain platforms (permissioned or permissionless) are the (whole) answer, then surely we’re back in the land of engineering, architecture and hard work? Perhaps this means that the combination of persistence, data models, APIs, consensus, identity and other components that we need won’t all come from one firm. So a common language, some common vision and an ability to collaborate may become critical. Where is your distinct differentiation? Where would you fit in an overall stack?

And for something completely different…music royalties on the blockchain have been getting quite a bit of buzz lately. This Billboard article How ‘the Blockchain’ Could Actually Change the Music Industry gives a good overview. I bring this up for two reasons. One, this potential use case is one example where Bitcoin itself could ‘win’ as it is applying new principles to create new markets, as opposed to trying to optimize existing financial infrastructure. Second, it led me to read this very good reply to the hype by Alan Graham. The reply is meant to be specific to the music industry, but Graham does an excellent job of playing the optimistic skeptic for blockchain:

The blockchain, in theory, shows some promise as an immutable public ledger that provides some needed transparency when it comes to important transactions, whether they be purely financial or a public statement of fact. However, if it is going to get past the point where it is being funded for the sake of finding the next big thing (beyond bitcoin), to actually being the next big thing, it has to solve five main issues, Authority, Immutability, Scalability, Legacy, and Privacy.

I encourage you to read it in full. Enjoy!