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Wall Street and Blockchain Hype

The public reception of a new product follows a pattern cynically called the hype cycle, which describes adoption in terms of a five stage process. This is one of the fundamental patterns of the modern economy.

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Hype-Cycle-General” by NeedCokeNowOwn work. Licensed under CC BY-SA 3.0 via Commons.

Since bitcoin is a currency, with a price freely driven by demand, its price plainly traced out the curve for all to see.

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We can see when it reached its peak as prices soared to over $1000 USD, then swooped down to a bumpy ride, and finally leveled out onto its plateau of productivity, holding relatively steady price throughout 2015, as new applications are rolled out, and regulations slowly adjust. 

Meanwhile, the marketplace has reconsidered Bitcoin technology, and realized that its long-term value may not be as a currency, but as a technology. Bitcoin is a term that covers many things: it is an open source software project, and it is the network of all the nodes running that software, and it is the currency traded on that network. Attention is shifting from the currency to the network itself, called the blockchain, and its unique properties that permit it to successfully operate a financial ledger, without a central authority, holding over 1 billion USD, across random computers, many of them controlled by people actively trying to steal money. It has never been defrauded. Not once. It’s an amazing piece of engineering, which will likely be recognized as one of the great technological accomplishments of our age. And business is interested. Too interested.

The blockchain uses heavy cryptography, automated financial incentives, and a tremendous amount of extra computation power to resist fraud and achieve ledger consensus. These requirements impose extra operating limitations as well, such as an absurdly slow capacity of seven transactions per second.  None of that extra work is needed in a trusted computing environment, and any enterprise could privately implement a currency or a ledger more easily without using blockchain technology, just as every bank or credit card company has, ever since mainframes started running COBOL.

But the blockchain has gone from an obscure implementation detail to the latest buzzword taking Wall Street and the tech world by storm. Unclear on the concept, startups are wedging the word into their business models willy-nilly, whether or not it has any legitimate connection with their business processes. It has become the equivalent of “quantum physics” when selling healing crystals: the mysterious magic power that makes the sale. I’ve seen proposals for otherwise reasonable businesses, such as a web forum for a particular industry, or a marketplace connecting investors and researchers in a particular field, suffer the term “blockchain” awkwardly bolted on the side or sprinkled randomly throughout the business plan, providing no value at all but hype. Independent of Bitcoin, Blockchain is now climbing up its own peak of inflated expectations. The hype will settle down and reach the plateau of productivity, once the business community discovers the proper use of the blockchain.

The fundamental value of the blockchain is to provide trust. But where does trust even exist in this harsh world? In the 20th century, there were roughly 2 sources of trust: law (fear of lawsuits and regulatory bodies), and reputation (when future lost business is more expensive than the gains of theft). In the 21st century, we have a new source of trust: cryptography. Software has advanced to a level where a transaction can be rid of fraud by forcing cheaters to solve math problems that are nearly impossible to crack.

Since Fortune 500 companies are already heavily regulated and concerned about reputation, cryptography can only provide ancillary benefits to their existing business models. The new market area opened up by cryptography is that zone beyond the range of law or reputation. Beyond law could mean across jurisdictions, or dealing in monetary figures too small to be of concern to law enforcement. Beyond reputation could mean amateurs without established trading histories, or those who choose to remain anonymous – or distorted industries that are rife with corruption, because the buyers have little knowledge or concern over the actual quality of service. And it includes marketplaces occupied by automated bots that are interacting with each other, not on behalf of people as their agents, but on behalf of themselves as independent profit-seeking actors. Lacking meaningful reputation systems, such actors, that are not necessarily traceable to a legally liable owner, must use cryptography to establish trust – for instance, by binding each other with smart contracts using neutral third-party Oracles, so that transfers of funds are dependent on external proof. New institutions like this will arise, ones without a direct analogue in the old economy.

Those who will succeed with the blockchain will be those Fortune 500 corporations, or startups, that discover lucrative business models in this new ecosystem.

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