Don’t make these five common mistakes about blockchains and cryptocurrency.
Breaking down misconceptions about these technologies
Breaking down misconceptions about these technologies
There isn’t just one blockchain out there. Each cryptocurrency (like Bitcoin or Ethereum) has its own unique blockchain that lists the valid transactions between users on its network. Different blockchains have different security and fraud-prevention guarantees. Therefore, you can’t just “put” some important data on “the blockchain” and assume you have improved recordkeeping or prevented fraud. Always ask the question, “which blockchain are we even talking about?” That question is especially important because the vague word “blockchain” encompasses two very different technologies: permissioned and permissionless blockchains.
Many private companies have developed database products that they market as blockchain solutions even though they’re nothing like a cryptocurrency blockchain. These enterprise blockchain solutions, and some digital currencies like Facebook’s Libra, use permissioned blockchains, which means that some corporation or association must approve would-be participants before they are allowed to help maintain the blockchain and validate the data being added to the blockchain. These permissioned blockchains will only improve record keeping and prevent fraud if you can trust the corporation or association who grants or denies that permission.
Cryptocurrency blockchains, on the other hand, are permissionless. That means that anyone can download the free software and buy the commodity computing equipment needed to participate in securing the blockchain. Permissionless blockchains are (1) open: anyone around the world who downloads free software on an internet connected computer can instantly help maintain the data; (2) tamper-evident: anyone can check the validity of the data; and, (3) censorship-resistant:no single person or organization can prevent otherwise valid data from being added to the blockchain.
Don’t get caught up in false hype. Blockchains solve a limited set of problems. Blockchains are simply a new type of database that’s useful for keeping track of important data that must be widely shared and trusted (like who has paid whom). A regular old database can do that too, and might do it better and more cheaply depending on whether one is willing to trust a database administrator. We might happily trust American Airlines to keep track of who has earned reward miles; after all you already have to trust them to cash those miles in for their flights. But would you want to trust one corporation to keep track of every single payment you’ve ever made or received in your lifetime? If you are not willing to trust an administrator then you might actually need a blockchain rather than a conventional database, specifically a permissionless blockchain, because you want censorship-resistance, tamper-resistance, and open access to data.
The main benefits of permissionless blockchains (censorship-resistance, tamper-resistance, and open access to data) are not possible if a single person or corporation (or group of persons or corporations) is responsible for maintaining the network. But if there’s no central manager, how do the maintainers of the blockchain get paid for the work that they do? A permissionless blockchain network without any owner or central administrator can’t open a bank account any more than “the internet” could open a bank account, so the network as a whole can’t pay people in dollars for their participation. A permissionless blockchain does, however, have the ability to pay people in cryptocurrency; the blockchain, after all, is the authoritative ledger of everyone’s cryptocurrency holdings. Even without a central manager, the blockchain software can automatically reward people with new cryptocurrency whenever they provide verifiable work that secures the blockchain.
For example, if you dedicate computing power to maintaining the Bitcoin blockchain you can get bitcoins awarded to you on that blockchain. Sometimes we call the people who get these automatic rewards “miners” because, like gold miners, they do difficult work to get scarce commodities. Unlike gold miners, however, Bitcoin or other permissionless blockchain miners are doing something more than just extracting new commodities; they’re also maintaining the blockchain ledger and validating the data on that ledger for the benefit of everyone who relies on that ledger to transact.
Plenty of people wrongly say that Bitcoin is “unregulated,” or ask, “can we apply regulations to cryptocurrencies?” The fact is that cryptocurrencies like Bitcoin are already regulated and have been for years. Since at least 2013, the SEC, CFTC, IRS, FEC, CFPB, Treasury’s anti-money-laundering regulators, state consumer protection authorities, and many other agencies have explained how their regulations apply to cryptocurrencies.
Regulations apply to trusted persons within cryptocurrency networks—people who help customers buy and sell cryptocurrency or store it for them. These exchanges and custodians are subject to anti-money laundering regulations (they have to know their customers and file suspicious activity reports). They are also subject to consumer protection regulations (they can only operate if the get a license from every state where they have customers and they must maintain adequate capital). Even persons who aren’t trusted to hold customer cryptocurrency on these networks are subject to some laws and regulations. For example, a person who develops and markets cryptocurrency software is still subject to FTC jurisdiction if they release software products that are unfair or deceptive to their users.
Although cryptocurrencies like Bitcoin are referred to as digital currencies because they exist in discrete units and can be used as money (i.e., traded for goods and services), many are actually are more like gold than like traditional currency. Like gold, Bitcoin derives its value from its absolute scarcity (there will only ever be 21 million bitcoins mined). Given a fixed supply, positive demand means it will have value. This is unlike traditional government currencies like the dollar, which are issued by central banks according to a monetary policy typically aimed at meeting the demand for money. While the Bitcoin network may indeed compete with the traditional bank payments system, especially for large international wire transfers, bitcoins do not compete with the dollar anymore than does gold. Like gold, Bitcoin’s lack of a managed monetary policy means its relative price will be volatile and not suitable for widespread, everyday use as current money. Instead, Bitcoin and similar cryptocurrencies can complement traditional currencies because of their unique benefits: gold-like long-term store of value, machine-to-machine payments, micro-payments, and global availability.