Challenging A Brave Blockchain Prediction

by Mercator Advisory Group 0

This article in Techcrunch is written by Olaf Carlson-Wee, the Founder & CEO of Polychain Capital and a founder of Coinbase, so I respect his vision but find it impossible to ignore unresolved issues that in my mind challenge the conclusions. Olaf argues that blockchain will create a large number of new economies, each economy consisting of value generated by the overall network effect of successful blockchain solutions:

“Using this new model, entrepreneurs create blockchain-based tokens that represent ownership in the network they are building, and also act as fuel for their network. For an investor, there are not shares of a company available, only the blockchain-based token. As the blockchain space expands, disproportionate returns will go to holders of the actual tokens, not traditional venture investors betting on a shares of a company. These tokens are application specific — they are not meant to be general-purpose units of value like bitcoin. For example, tokens built on Ethereum like REP and GNT power a decentralized prediction market and a peer-to-peer market for renting computation, respectively.

Imagine being able to actually make money when you contribute on social media.

These application-specific tokens, or app-tokens, are built on top of existing general-purpose blockchains like Bitcoin and Ethereum. For the first time, open-source project creators can directly monetize their open-source network. Historically, successful open-source projects like the torrent protocol or the Tor network were not directly monetized at the protocol level. Now, the founder of a decentralized file storage network can issue blockchain-based tokens that represent ownership in the network.

However, these tokens are not like stock certificates, which represent ownership but have no real use. App-tokens are actually used in the network to participate. In the file-storage market example, they are used to prove file ownership and buy and sell storage space. The founder of the network keeps roughly 10 percent of the tokens for themselves and their founding team, and if their network becomes popular, the demand for tokens rises, and because the supply of the token is fixed, the price increases. This means that founders can monetize their networks directly by simply holding their tokens and making the network useful. If they need liquidity to continue funding the project, they can simply sell the tokens on the open market.

In addition to rewarding founders, these app-tokens allow participants in networks to actually own a piece of the network. This network equity ownership is unprecedented. Consider how many networks the modern western internet user is a part of — Facebook, LinkedIn, Twitter, Uber, Airbnb, eBay, Etsy, Tumblr — the list goes on. In each of these cases, the network’s value is created by the users, but the value each individual user generates goes to the owners of the network. In this new blockchain-based model, that value is actually given back to the users of the network, proportional to their contribution.”

My problem is not with the concept presented here but with the state of the technology and the business risks associated with participation in these micro blockchain economies.

As an ex-product manager for peer-to-peer data communications products, my evaluation of blockchain is that it has yet to be proven reliable, secure, and scalable. I think Olaf agrees with this position in that he states:

“If this sounds complicated, it’s because it is. To be sure, the blockchain space is still mostly in a phase of experimentation, but the first breakout apps will be explosive because they financially incentivize users to participate in the network. Imagine being able to actually make money when you contribute on social media.”

While I assume Olaf expects this experiment will succeed in due course, I find myself doubtful that research will find a mechanism to sufficiently decouple the blockchain trust problem from the performance problem. If these economies are built on tokens of value, they will need to be openly traded, as is bitcoin. Most blockchain implementations eschew the Bitcoin trust model for private blockchain which in theory minimizes the performance problem by eliminating key aspects of the Bitcoin trust model (anti-collusion). I fail to understand how these economies will operate unless they can scale as fast, or faster, than Bitcoin in a public environment but without miners, since miners would introduce yet another economic cost into the operational model. I am unaware of a technological solution to this problem.

Then there is the business issue. I admit to being old school on this one. Criminal activity swirls around bitcoin exchanges and blockchain initiatives such as the DAO. Without a criminal justice system, or some similar construct, that recognizes the entities obligations and the value of the tokens there can be no recourse when trust is betrayed. The idea that all code will be perfectly vetted and trusted ignores a long history of software error and corruption.

Eventually a construct may evolve that addresses this problem, but it won’t be soon and there are not enough experts in the world to vet every blockchain solution introduced and there is no incentive for those experts to take the time to vet any given solution. So we have an unregulated system, controlled by a small cabal of developers, offering services to the generally uninformed public that goes out without even a peer review. In this scenario some small number of people will indeed get rich, but I expect it will mostly be the criminals.

Overview by Tim Sloane, VP, Payments Innovation at Mercator Advisory Group

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