Many Have Written that Blockchain is Overhyped. Is Finance Listening?

As Bitcoin noses the $8000 USD mark and fans and crypto-dedicated media praise the end of “Crypto Winter,” investors and fiduciaries are well advised to have another look at articles circumspect about “blockchain,” the technology undergirding Bitcoin that has been praised as the “foundation of the next industrial revolution.”

Opinion writer Noah Smith assembles a digest of the some of the best blockchain-skeptic articles in his May piece for Bloomberg, “Blockchain Hype Missed the Mark, and Not by a Little.”

Even though “blockchain” has a very narrow proven use case (“uncensorable” payments at a high expense), somehow the sector attracted four times more VC money last year, Smith writes (from less than $1 billion in 2017 to more than $4 billion in 2018).

But if the skeptics are correct, 2018 VCs are late to the party and you should go to bed.

The first skeptic article cited by Smith is Kai Stinchcombe’s, “Ten years in, nobody has come up with a use for blockchain.”

Issued at the top of the Bitcoin hype cycle in December 2017, when the price of one Bitcoin shot parabolic to $20 000 USD, Stinchcombe’s now classic article left no sacred cow of crypto untipped in its wake.

Stinchcombe, who is CEO and cofounder of True Link Financial, a banking and investment service for seniors, was too worldly to drink the crypto cool-aid:

Everyone says the blockchain, the technology underpinning cryptocurrencies such as Bitcoin, is going to change EVERYTHING. And yet, after years of tireless effort and billions of dollars invested, nobody has actually come up with a use for the blockchain—besides currency speculation and illegal transactions.”

“Each purported use case — from payments to legal documents, from escrow to voting systems—amounts to a set of contortions to add a distributed, encrypted, anonymous ledger where none was needed. What if there isn’t actually any use for a distributed ledger at all? What if, ten years after it was invented, the reason nobody has adopted a distributed ledger at scale is because nobody wants it?”

As Smith puts it:

“Stinchcombe noted that essentially all of the proposed uses for blockchain technology are more cheaply accomplished by existing intermediaries such as banks, courts, notaries, stock exchanges, big companies or government agencies.”

Smith also cites a 2018 paper by Joseph Abadi and Markus Brunnermeier, who reportedly, “…argue that it’s impossible for any documentation system to be both reliably correct, decentralized and cost-efficient at the same time.”

At issue is a bizarre preoccupation with trying to replicate the features of Bitcoin in various private settings.

But Bitcoin was designed to operate as an autonomous payment network with no boss that would settle any payment sent through it, no matter who sent it or why.

This is accomplished through an expensive mathematical game called “proof-of-work.”

The game is expensive on purpose. If guessing the numbers needed to encrypt the Bitcoin network and win the “block reward” of Bitcoins were cheap, anyone could hack, cheat and ruin the system.

Privately-controlled payment systems not only don’t need proof-of-work, they can’t afford it and can’t be competitive if they use such a system.

Proponents of Ethereum, meanwhile, are trying to build a “public” blockchain that can support thousands or millions of private projects built on top.

Ethereum engineers have been promising for years that they will move Ethereum onto a cheaper system of securing the network called “proof-of-stake”– but have yet to do so.

In “proof-of-stake,” large holders of ethers stake some of their holdings for the privilege of being able to participate in the game of securing the network.

“Proof-of-work” advocates say “proof-of-stake” is easily cheated, favours large holders and will lead to the privatization of the network.

And if a blockchain system is actually privately controlled, they say, why all the rigamarole with expensive and unnecessary security protocols?

Smith says Abadi and Brunnermeier also, “…show that forking (the splitting of one blockchain into two or more mined or secured by different teams) may mean there are too many blockchains, leading to a chaotic equilibrium where people can’t coordinate on a single network.”

As well, unlike in a private payments system where there is recourse if ripped off, “public” blockchains like Bitcoin have no system for resolving disputes or pursuing recourse. All payments are final and cannot be reversed.

Blockchain and crypto proponents skew young and believe that by “disintermediating” financial and legal networks and replacing lawyers and settlement firms with “pure math,” corruption will be expunged.

Stinchcombe noted that the people envisioning the new world “disintermediated” by blockchain are typically computer programmers in their 20s (like Vitalik Buterin), people with very little real-world business experience:

“In conversations with Bitcoin entrepreneurs and investors and consultants, there was often a lack of knowledge or even interest in how the jobs were being done today or what the value to the end user was. With all the money spent on Bitcoin cash registers, nobody went out and did a survey about whether most credit card users would be willing to give up their frequent flyer miles in return for also losing the ability to dispute a transaction. Presumably, they thought, the reason IPOs are so expensive or venture fund formation paperwork is so onerous is because all those lawyers and accountants are just getting rich sitting around pushing paper… a bunch of smart engineers in their 20s with no industry experience could certainly do their jobs, automatically, in a matter of months, with just a few million bucks of venture capital.”

“So far, not so much.”

But technological systems are created by and orchestrated by humans, and can also fail, writes Bruce Schneier:

“If your Bitcoin exchange gets hacked, you lose all of your money. If your Bitcoin wallet gets hacked, you lose all of your money. If you forget your login credentials, you lose all of your money. If there’s a bug in the code of your smart contract, you lose all of your money. If someone successfully hacks the blockchain security, you lose all of your money.”

All the writings point to a sort of identity crisis in crypto: Are you public or are you private? Are you social or for profit?

If you are public, like Bitcoin tries to be, like other infrastructure, you will probably have to be subsidized, as Bitcoin appears to be. (Brazilian professor Jorge Stolfi has claimed that Bitcoin is a negative sum system “taxed” daily by miners to the tune of $10 million USD).

If you are private, you’d be hard pressed to profit off running a truly public blockchain system designed to be controlled by no-one.

All told, Smith keeps an open mind, including the possibility that “there’s no there-there” with blockchain:

“So although blockchains seem like an important technological advancement, they haven’t yet proven themselves. They remain high-cost solutions, often beset by chaotic competition, and they exist in ecosystems beset with dishonesty, fraud and human error. Blockchains might have a chance to change the world someday, but there’s also a chance they will prove useless.”

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