9 Building Blocks For A Successful Blockchain Industry

February 2015

I’ve just had a break with the family giving me some time to reflect on what has been an exciting year for blockchain and distil down my thoughts on what its future holds and the challenges it has to overcome.

I’ve framed my thoughts from the perspective of an investor and entrepreneur as what I think is required for a successful Blockchain Industry. It’s deliberately untechnical in language and terminology so as to be as inclusive as possible to those currently outside of the development community.

It’s worth stating up front whilst I’m a libertarian at heart as an investor & entrepreneur I’m pragmatic and a realist when it comes to understanding key environmental factors, many currently missing, that are required for a healthy and sustainable Blockchain Industry.

We will serialise the section in tweets Mon 9:00AM 09/02/15 under the hash tag #8buildingblocks please do let us know your thoughts.

Note: Since 11th May ’15 we added a 9th building block based on the realisation we need ECONOMICALLY VIABLE PROCESSING NETWORKS

1. BRIDGES

There is a wonderful eco-system of blockchain related companies out there in their infancy with the beginnings of some good deal flow. We have tracked over 150 of them to date on an open directory but are adding a couple of every week. 18% of those we would regard as IT Infrastructures for Blockchains and 8% Blockchains as themselves. You can see the summary here.

Whilst some try and be everything for everyone, the reality is the large majority that will survive will likely go on to be specialised to a given function, either by design or by pragmatically adapting to how developers best use them. So for me, the success of the system as a whole will be based on how well and easily they integrate with one another. In fact building, ‘cross-chain’ solutions isn’t just about how to best configure stacks from a technical perspective but also about distributing risk, especially the risk of investment. It’s a given the early days will see many come and go for one reason or the other.

2. ON / OFF RAMPS

Local jurisdictions are figuring out their regulatory stance, first to digital money and then to blockchain companies, Decentralized Apps (DApps) & Decentralized Autonomous Organizations (DAOs) as well as their evolving commercial frameworks. In the meantime, the assumption for many entrepreneurs in this space is to start as decentralised as possible and localise later. But if a commercial entity (note I didn’t say company) lives entirely on the blockchain and is semi-autonomous in its operations then where does it pay taxes or apply for licenses to trade?

This is compounded further as people look to creating an Internet in space to avoid such local issues of regulation and taxes. The problem, much like that faced by early US online gambling companies, is how do you get your money out of the system and into your real-world bank account. The same applies for putting investment into the system. These on/off ramps are critical to investors and entrepreneurs alike and I suspect will spawn friendly small island jurisdictions with established financial infrastructures for the movement of money, e.g. Costa Rica, Antigua and Cayman Islands.

This is heavily linked to the next point (3) on standardized understandings around Roles & Responsibilities because these things are often linked to the directors country of residence or in the case of the US citizenship.

3. ROLES & RESPONSIBILITIES

There still aren’t clear business/ownership models developed for a decentralised world with standardised roles and responsibilities. This is part commercial part ethical and part regulatory. A lot of the debate is centred around ‘can you prosecute someone for developing code that goes on to be used in a criminal way?’. With Pirate Bay being the most high profile case. I think there needs to be a more commercial framework for roles and responsibilities outside of an extreme libertarian worldview or that of an ultra-aggressive legislative view.

From my perspective, DApps are largely tool-kits that can be used in isolation or part of a stack that will be freely open-source or via a SaaS license model. As the creator of the DApp, I can build an automated payment mechanism into its functionality taxing users. If someone goes on to operate that code to sell drugs or child porn that is their legal responsibility. But what if that code runs autonomously as a DAO and breaks laws? Is this then the responsibility of the creator?

If we look at the precedents set in parallel industries like online gambling in the US, BitTorrent and file-sharing or specific blockchain based prosecutions like Pirate Bay having it sit within a ‘grey area’ is not good for founders, users or investors. As such the industry should seek to proactively build a positive dialogue with local regulators to enable them to make an informed decision rather than emotional. Because until there are clear definitions around Creator, Operator, Admin, User, sensible money will stay away from investing and entrepreneurs could risk straying into criminal grounds.

4. IDENTITY

Because of its degrees of anonymity for any business to work on the blockchain, beyond the pure movement of money, being able to verify of a customer as a real-world person to form a binding agreement is tantamount. This is true for agreements both ethical or contractual. In some markets, this is a legal requirement such as FinCEN’s Know-Your-Customer (KYC) compliance.

It’s why I believe OneName.io has raised so much money from such a great class of investor. Having a decentralised and universal ID to establish a trusted relationship with DApps, the commercial entities behind them and their community of users is Step 1 in business building. Without it each DApp must solve the problem itself which would mean major duplication of work and waste of resource. I am currently waiting to hear their next move since their successful fund-raising.

5. REPUTATION

This is closely tied to (4) Identity. A lot of the need for trust is removed at a one-off transactional level from blockchains such as Bitcoin but what if you are looking at using blockchains to establish relationships between people you may only ever know semi-anonymously. We know the likes of Pirate Bay vendors developed their own unique approach to reputation but only for a specific purpose. The big question is how can trust and therefore reputation between users and commercial entities become more portable across multiple blockchains. This is fundamental to the world of smart contracts which may not always be able to rely on local courts to enforce agreements and where reputation, after hard financial losses, maybe the main driver to stop repeat offenders.

One such startup looking to tackle reputation on the blockchain is Bonafide.io but just how transferable and how universally accepted it will become is to be seen.

6. GOVERNANCE 

Discussion about the governance of blockchains in large part has been limited to the Bitcoin blockchain and how centralised or decentralised this should be named the rights and privileges of Bitcoin Foundation whose aim is to ‘create an open and participatory body for the Bitcoin Core Project’ headed by Gavin Andresen and with annual elections for its 5 x Board Seats.

The challenge is these open protocols are trying to balance varying degrees of philosophical and commercial considerations all at the same time. Some of these are technical considerations but their implications have significant consequences to how and indeed if at all a blockchain can be applicable to a particular industry’s requirements. One such consideration is the transaction speed of the network. Applications such as gaming may require a very different transaction speed compared to say insurance of smart assets. Linked to that is the priority of transaction which opens up the same debate as general Internet 1.0 bandwidth Net Neutrality: centralized parties have the power to determine who comes first. In Bitcoin, this is already happening with mining pools choosing to include or exclude transactions in the blocks they mine.

These governing bodies are generally highly technical and generalist at a commercial level whilst every industry is going to have very particular nuances and therefore requirements. We believe it will be the duty of existing trade bodies for each individual industry that will need to formally consider the relevancy of various blockchains and if what’s required is a sidechain (effectively a splinter off the main bitcoin blockchain) or an entirely new custom made protocol. It is here where we aim to become guiding hands as industries embrace these innovations via a consultative and change management process.

7. USABLE SECURITY

Although the basic technology of Bitcoin and blockchains is extremely secure, its history has been ridden with hacks and theft. There are no documented cases of successfully hacking a blockchain of significant size. There are, however, a great amount of cases where cryptocurrencies were lost or stolen. These cases can all be attributed to flaws in applying or using the technology, creating opportunities for these breaches to occur.

For example if a Bitcoin exchange stores private keys for its Bitcoin addresses in a badly secured database server, and a bad actor obtains access to this server, they can steal the Bitcoin funds. The problem here is not that Bitcoin in itself is insecure, it’s that the security of the exchange was not up to the high security standard that working with cryptocurrencies requires. The weakest links are in the technologies surrounding the blockchain and the people using them.

To realize a service that is secure on a holistic level, good security principles have to be applied throughout the board. This means, at the very least, encrypting all interactions between components and actors, and handling the encryption keys in a secure way. This applies to all parties in the ecosystem including blockchain businesses, merchants and end users. From the current situation where passwords are the most-used form of online authentication and many people use the same password for many services, big changes are necessary. Educating users to change their passwords more often is not the answer. For blockchain businesses to succeed, we need usable security: better ways for everyone to work with online services securely.

As a future development we expect to see more user-friendly ways to apply good security principles. For example two-factor authentication, multisig transactions and hardware cold storage wallets etc. will become more mainstream. This is a two edged sword with on the one hand the tools becoming available and on the other hand people realizing that they need them and applying them.

8. TOKEN OF EXCHANGE STABILITY (TRUE BITCOIN 2.0) 

I’ve avoided taking a firm position on this for some time but I’ve come to the conclusion that whilst Bitcoin has been a wonderful experiment if complex things like global currency exchange markets can be manipulated then Bitcoin is a sitting duck. There is far too much opportunity and advantage to be had from its comparatively huge daily fluctuations to ever be a viable token of exchange for day-to-day trading relationships. As a true currency it suffers the equivalent of hyperinflation / deflation in its weekly movements which means that people or companies beyond speculators won’t want to keep bitcoin treasuries or holdings.

Aside from the well documented challenges this is causing to people investing in bitcoin mining operations when your company operates with fixed costs it makes sensible modelling and forecasting next to impossible. So any form of commerce beyond arbitrage that requires a degree of stability can never rely on Bitcoin as its main token of exchange without huge change to its fundamentals which requires consensus from people with very different agendas as discussed in point (6) Governance.

We will offer some ideas around possible solutions in a forthcoming post which includes; wall street backed / govt backed digital tokens and some more radical ideas about how private corporations could use their off-shored reserves to underwrite industry specific coins.

9. (NEW ADDITION) ECONOMICALLY VIABLE PROCESSING NETWORKS

As detailed here.

‘Bitcoin Mining largely doesn’t make sense. The economics of which mean on the one hand it’s something that’s only commercially interesting at an industrial scale, in opposition to Bitcoin’s decentralised character. But on the other hand as economies of scale are won the algorithm, in direct response to these efficiencies, alters the risk vs reward mechanism in order to secure the network.

In other words it’s deliberately wasteful. Which is unsustainable both from a financial and ecological perspective. At this centralised level, with the cost of running a rig fixed in real world fiat currency, the risk vs reward algorithm working against me and the reward in volatile cryptos, its a very risky long-bet. As we have seen with recent documentaries on mining farms in China you can see where this is heading. In other markets where there was a natural pressure to reduce costs and increase output we got sweat shops. These artificial pressures unique to Bitcoin put that scenario on steroids bringing serious ethical considerations too.’

We propose for mining to work it needs to tap into existing latent processing networks such as gaming or it be replaced entirely with peer-to-peer distributed systems similar to Eris Industries approach with Decerver or an Altcoin Proof of Stake.


Image by Steven Depolo.