Blockchain technologies and their associated market gained tremendous momentum this past year. The colossal developments and the aggressive funding of ideas across this nascent industry have sparked some serious debate as to the veritable value of blockchain. Before implementing blockchain technology, managers, builders and developers need to ask themselves one question: “why blockchain?”
What necessitates a decentralized system?
In order to understand how best to use blockchain technology, we must first define the trust assumptions in the system under consideration. Often, blockchain use cases overlook this question of a third party without ever considering whether that use case could be better met with a distributed or centralized alternative.
Criteria for a decentralized system:
- A uniformly accepted single source of truth.
- The system must receive inputs from two or more parties.
- The parties must not trust each other and their interactions must, therefore, be authenticated via a third party.
Next, we must determine whether a centralized or distributed third party could serve in the place of a blockchain. Centralized third parties do more than simply manage transactions for their clients. They provide usability services and manage disputes. They update the protocols and ensure that they stay efficient and usable. Distributed intermediaries have all of the above advantages yet they are also more efficient. A hierarchical structure keeps the central overseer from becoming overwhelmed.
Thus, by choosing either a distributed or centralized third party, one can avoid the host of token distribution and governance questions that plague modern-day blockchains. One can avoid the scalability challenges and regulatory obstacles and make use of a reliable and productive third party.
That’s not to say decentralized third parties are irrelevant. In some situations, it’s simply impossible to trust a centralized third party. This is key to understanding blockchain’s benefit. If we can establish a framework for understanding when (and why) centralized or distributed third parties should be avoided, then we can accurately predict when and why blockchain should be embraced. Additionally, we can avoid creating decentralized networks that naturally migrate toward centralization given that they may have been better served by distributed third parties in the first place.
Three criteria for why a centralized third party cannot be trusted
The first criteria. A single source of truth is required. The third party cannot be trusted to impartially mediate between clients or parties due to a conflict of interest.
At times, third parties are incapable of remaining impartial. The intentions of such a third party may not even be malicious; it is just that in the case of a conflict, their interests will be served first. We’ve seen this with Facebook and other tech giants time and time again.
With the right incentives, decentralized governance can change stakeholder interactions from a zero-sum short-term game of tit-for-tat to a more collaborative and circumspect long-term game, with rewards to those who act in the best interests of the broader stakeholder set, rather than just any one preferred individual or group.
The second criteria. There is a monopoly that prevents competition from protecting users’ best interests. Interactions across a network necessitate refinement and abstraction.
Provided that competition exists, self-serving or irresponsible behavior by a third party is strongly disincentivized by market forces. However, if there is no alternative because one entity holds a monopoly over the sector or because there exists a resource constraint, then the power of competition collapses and the third party has essentially no constraints on their behavior. Apple’s control of the App Store is a strong argument for why the perceived good intentions of centralized gatekeepers can act contrary to the best interests of the ecosystem they claim to support.
The third criteria. Antifragility is a must. The stakes are too high and the consequences of malicious behavior by a third party would be catastrophic.
Even if the effects of competition are able to penalize malicious behavior, the cost of a single fault cannot be too high. Competition is a reactionary force that only takes effect after a mistake has been made. If the mistake cannot, under any circumstances, be allowed to happen, then preemptive measures must be implemented.
We see this reality reflected in regulation. Governments are more content to let free markets manage the plumbing industry than they are the nuclear energy industry. Shotty plumbing work only results in a few angry customers, while a single nuclear meltdown is disastrous.
As the world and every aspect of our lives move online, there is a growing understanding that over-optimization can lead to fragility and that we need to build more robust infrastructure for essential digital services that ideally can become antifragile. Blockchains have the potential to form the backbone of antifragile systems, which not only survive in adversarial environments but get stronger from every challenge, block by block.
The above criteria help us identify promising blockchain use cases.
Which blockchain use cases are ready?
Banks, markets and other elements of the financial industry generally require third-party management to protect against counterparty risk. This situation demands an impartial third party capable of managing and assessing financial risk. Decentralization serves to mitigate this counterparty risk by serving as a third party, aligning incentives between market makers and users, distributing risk across the platform, and greatly reducing the chance of system default. The extraordinary growth across DeFi ecosystems is a powerful example of blockchain’s disruptive properties and the successful implementation of decentralization across highly valuable systems.
Some use cases propose promising opportunities for decentralization but require an ensemble of technologies to actually benefit a particular value chain. Supply chains are a strong example of a mega-industry ripe for disruption by blockchain-powered solutions and products. They are highly collaborative environments with a low tolerance for error. Especially with regards to high-risk goods such as pharmaceuticals or even fresh meat, proper transport and supply-chain tracking are crucial. The same goes for high-value supply chains like diamonds and art, where the validity of the inputs makes a colossal difference for the different parties across the value chain.
In building solutions for these value chains, blockchain can’t possibly be the end-all. It must be a part of a broader, holistic solution that expands the reach and actual value of the supply chain itself. Blockchain won’t immediately decentralize the private entities that form supply chains, but it can be monumentally impactful by providing a fully immutable, semi-centralized environment for these various entities to interact more efficiently and freely.
Blockchain and you
Understanding which properties of blockchain bring the most value to an entrant or incumbent’s value proposition and business model will be the first step to drive disruptive innovation through blockchain and other transformative technologies.
Quantifying the costs of trust and understanding how the properties of blockchains can enable (or improve) your business is the first step in actually utilizing these technologies for veritable impact — and industry-wide disruption.