The Decentralized Future Series

by Ramon Recuero2/14/2018

Premises, Promises, and Reality

There is a massive divide between the promises of cryptocurrency and the use cases they currently support. Most skeptics point out reasonably that there’s little to show regarding real adoption. At the same time, people in the industry argue that they need time to finish the infrastructure before they can deliver game changing apps. And the tribalism clouding the topic doesn’t help. There is room for dialogue that would benefit both sides.

A good method for discovering startup ideas is to look into technological breakthroughs and think about what they unlock that wasn’t possible before. In this introductory post, we are going to use this framework. We’ll look at Bitcoin and consider potential use cases that we can directly deduce from its properties. We’ll discuss the common counter-arguments and what needs to happen for each use case to become widely adopted. Finally, we’ll outline the posts coming up in this series–each will dive deeper into specific use cases.

Why

When Satoshi Nakamoto released the Bitcoin Whitepaper he defined it as a peer to peer electronic cash system. Its main achievement was solving the double spending problem without any centralized authority. It was a significant leap, allowing us to transact without intermediaries. It’s not a coincidence that the whitepaper was published after the 2008 subprime mortgage crisis. Just like the printing press removed the power of knowledge from governments and religions, Bitcoin and other cryptocurrencies give people the tools to control their own money.

Bitcoin kickstarted the so-called decentralized future1, where products could be built not by centralized companies or authorities but by groups of peers that work together towards a common goal. These new products would exhibit the main features and benefits of Bitcoin. Let’s dive into the clear use cases.

1 – A New Asset Class

With most cryptocurrencies anyone can make transactions but, once they are confirmed, nobody can alter or roll them back. They are tamper-proof. Most cryptocurrencies also have a limited supply of coins by design. The maximum number of coins is set in the source code and nobody can create more. Bitcoin, Litecoin, and Monero are examples of this. And its value isn’t stored in a physical object therefore nobody can destroy or seize your coins.

This property leads to the first real use case of cryptocurrencies, a digital store of value. Bitcoin is probably the best-positioned to dominate this use case because it’s the most adopted and its network is the most secure because it has the most miners. So far, we have seen adoption by citizens in countries with record-setting inflation rates like Venezuela2.

However, for first world countries and their institutions to take the Bitcoin market seriously it needs to grow. The gold market sits at around $7T3, and the offshore-account market is about $30T4. The Bitcoin network value now is around $130 billion, so there’s still a long way to go. The release of futures by the CME and rumours about a potential ETF are signs that point in the direction that adoption is going to keep increasing.

Investing in crypto assets to gain a financial return has been incredibly profitable for the last few years. However, skeptics would quickly remind you that it has been a market with high volatility and big doses of speculation. That said, cryptocurrencies and crypto assets might be the philosopher’s stone of a modern portfolio. Chris Burniske and Jack Tatar suggest that crypto assets have low/negative correlation with traditional asset classes5. They could offer diversification and thus, reduce the risk of your portfolio. The asset class is starting to gain traction as an investment; according to a Citi report, it amounts to several GDP points in countries like Russia, New Zealand, Nigeria, and the UK6.

There are still significant risks when you use cryptocurrencies as a way to store your wealth or as an investment. The price volatility is an emotional test for investors, seeing them decrease by 60% in a week is not easy to stomach. Investing in it and keeping your investment safe is not simple. Your private keys can be damaged, lost forever, or stolen. Nobody can save you if it happens. Nobody can rollback illegal transactions made with your private keys. Multisig wallets, hardware wallets, time-locks and vaults are initial attempts to solve this problem but they are way too complicated for the normal user. In the next few years, custody is going to become more and more critical, and a new industry will be created to solve it.

2 – Disintermediation

Thanks to blockchain technology, all transactions included in the ledger can never be altered. Every transaction contains an identifier from the previous one and you cannot change the ID without changing the content. That makes this ledger immutable and tamper-proof. Today, we resort to many layers of documentation and mediators to ensure that transactions happen. In many cases it is more costly and time consuming to prove that you did something than actually doing the work. You can see this behavior in real estate property rights and transfers.

Many people would argue that all you need to solve this excess of paperwork is a good distributed database. However, a distributed database without incentives wouldn’t be maintained but if this distributed database is maintained by a company, you are trusting a third party. When you put sensitive data in the hands of a single trusted entity like a health company, a bank or Equifax, your information is eventually going to get exposed7. The question is not whether they are going to be hacked or not, the question is when. These are natural honeypots for hackers.

Another benefit of removing intermediaries is that you can perform tasks that were prohibitive before because of pricing. Now, with LTC or the Bitcoin Lightning Network you can send cents or fraction of cents to anyone in the world with nearly zero fees. Micropayments may seem like a pretty niche use case. Many people would be right to remind us than Venmo, Paypal and other solutions work perfectly for us today. Why do we need an alternative? How often do we send fraction of cents?

A compelling answer may be then that six billion people don’t have access to these applications, let alone bank accounts. Andreas Antonopoulos argues that the same way many developing countries leapfrogged directly into mobile phones and skipped landlines, they will skip traditional banking and have a crypto account in their mobile phone8. They will still need to compete with services such as M-Pesa that attempt to solve this problem and are quite mature.

Cryptocurrencies provide a clear path to transact without borders and offer banking resources to the unbanked. In order to do so, they need to improve their wallet user experience considerably. Clearer and more natural ways to convert to/from fiat currencies are also needed.

3 – Governance

The Bitcoin whitepaper also created a network of participants that collaborated on a single project without knowing each other. Bitcoin has a primitive governance mechanism that ensures that the incentives are aligned. Mutual trust is built-in, enforced, and ensured by the miners.

“But miners are centralized!” Yes, they are to some degree. Decentralization is not black or white, it is a range and it is going to keep evolving. We can see Bitcoin as the first iteration. It is just the starting point. The mechanism for change and how to evolve a network based on consensus from the participants is what matters. Dfinity, Tezos or Aragon are exploring this space further.

We also touched on incentive alignment. The average tenure of an employee in Silicon Valley is less than two years9. One of the causes is the lack of alignment between employees and the owners. This is called the Principal-Agent Problem. Every group of people has principals (owners) and agents (employees) and it is easy for them to become misaligned. What may be good for the employee may not be good for the company. In startups, principals and agents are the same. That’s why they are all really motivated to work together and can create enormous amount of progress in small periods of time. The velocity in crypto development teams like Ethereum exhibit this same energy along a greater number of participants.

Another interesting parallel happens between startups and cryptocurrencies. Most corporations govern by law and process. Startups in their early stages govern with a limited process. Most actions occur implicitly, built on trust. As companies get bigger, you have to deal with procedures and rules to get anything done. An avid reader may note that Bitcoin’s community lack of consensus also stalled the network and it precipitated the creation of several forks like Bitcoin Cash. The difference here is that there is a mechanism for evolution (forks) and the decisions are taken by all the participants, not just by the owners (consensus mechanism).

Cryptocurrencies provide a way of organizing people at scale with the potential to prevent the Principal-Agent problem and the tragedy of the commons. Bitcoin participants were so aligned, and the network effect was so strong that they ended up creating the most prominent computer network.

4 – Tokens

Bitcoin is also programmable. It’s programmable money. You can define certain conditions to trigger transactions if they are met. For example, if you want to add extra security you could say that any transaction bigger than $1,000 USD needs to be verified by both you and your father. Ethereum took the concept a step further and supported more complex functionality in its smart contracts. Everyone can now create their own token that models their network, assets or team and distribute it accordingly. We wrote more about this token effect here.

The token conversation is particularly confusing because of the variety of tokens and use cases they support. Tokens are being used to raise money through ICOs. They are a way to raise funding from many contributors. It is important to note that you can also have a cryptocurrency or token without raising money through an ICO. Bitcoin or Litecoin never did an ICO.

A common question about raising money through tokens is “how are they different from crowdfunding?” There are three key differences. First, you don’t trust any centralized entity to do the fundraising. Second, you have a lot more flexibility in what you can offer to your contributors (equity included). Third, contributors can transfer their assets instantly and easily to other people (pending regulation).

Tokens can be used to incentivize participants and prevent the rent seeking behaviour that affects many communities and networks. This problem basically states that many participants of the network look to capture value without creating any. One specific version of this is spam. Any sufficiently adopted tool will see many people advertising their own endeavors for their own personal gain, decreasing the overall quality of the network and reducing trust. Online communities are littered with this problem and all of them devote countless amounts of time and money to keep the quality of their community safe from trolls and spammers.

Tokens resolve these two problems. You need to contribute if you want to participate in the network. If you want to run some code on Ethereum you need to pay for it. It basically makes spam and rent seeking costly and, ultimately, not viable. If you have an online community, in order to post you need to stake your reputation. If your post benefits the network, you get rewarded, if it doesn’t, you get penalized and next time you want to post you will be charged accordingly. Steemit is experimenting with some of these ideas.

Historically it’s been very complicated for companies to give equity to early adopters that help kickstart their products. Using tokens new companies can create network effects that help them compete with established incumbents. Tokens allow new ventures to bootstrap networks from the beginning with a solid wave of early adopters invested in their product that are committed to help it grow. Ethereum, from its inception and through its ICO, has created a strong decentralized community with skin in the game.

Experts like David Sacks and Balaji Srinivasan believe that ownerships will get blockchained the same way content (video, text, and music) got packetized and sent over the internet10. Once tokenized, they can be subdivided into near infinitely small pieces and exchanged freely, providing liquidity. Legal instruments of ownerships like deeds or securities will benefit from using a blockchain in terms of affecting transfers and chains of title. At the same time, it is also true that many things that are being tokenized now are just attempts of raising quick money from unwary investors. We need some type of regulation here and a solid framework to foster innovation while minimizing bad actors.

5 – Power (And Data) To The People

Bitcoin is cryptographically secure. You can transact with other people without ever exposing your private key i.e the series of characters that give you access to your funds. It is like signing up to many websites on the internet without communicating your password.

Bitcoin has a 150 billion dollar bounty on it. So far the protocol has never been hacked. People may argue that Mt Gox, Okcheck, and other exchanges have been hacked, but Bitcoin the protocol has never been hacked. Exchanges, wallets, and custodians were compromised. Again, central, trusted parties can be hacked and will be hacked because they are honeypots.

In this day and age, we see hacks happening every week. We need to handle dozens of passwords with complex passwords managers. Blockchains and cryptocurrency will solve this problem. Using a Decentralized exchange or playing Crypto Kitties without needing to create an account is a magic moment.

You can now own all your data and assets. Nobody can access your information without your private key. Third parties like social networks would not be able to benefit from it without your permission. Your privacy, finally, belongs to you. This use case is gaining adoption. For example, Microsoft is working on decentralized digital identities11.

However, right now you need to install browser extensions like Metamask to interact with websites that enable “crypto functionality”. They are still really clunky and the average user does not know they even exist. Native and more polished experiences both on web and mobile to sign and validate transactions need to happen for this to become meaningful. Until then, only tech savvy adopters will benefit from secure identification on niche use cases.

6 – Permissionless Innovation

Bitcoin, Ethereum, and most cryptocurrencies are open source. Every person in the world can contribute and send a pull request. Innovation is pushed to the edges. Innovation is not controlled by Satoshi, Vitalik Buterin, or any group of developers. It is permissionless. You can rely on being able to build your business on top of it.

The Internet started the same way. It was built on open protocols like email or TCP/IP and everyone was able to create an easy to discover website. That’s not true in the internet anymore. Closed networks like Facebook or Twitter are gated communities that use their user data to gain an unfair advantage. They also have the potential to shut you down as soon as you compete with them or violate their ToS 12 13 14. And rightly so, they spent many years building their walled gardens and they don’t want to grow their successor in their yard.

These closed entities or corporations argue that it is all about blockchain, not about cryptocurrencies. They say that private blockchains would be used to empower business process and increase efficiency. In my opinion, a blockchain without a cryptocurrency is just a distributed ledger or a glorified spreadsheet. There is no censorship resistance, no alignment of incentives, no network effect, and no trustless collaboration. This is extremely important if we want to empower equal networks where any individual can participate without being censored.

An inclusive network allows any participant to innovate and the group benefits from it. Organizations and networks that restrict innovation will eventually stall and lose momentum. It already happened on the intranet vs internet debate. A lot of people argued for intranets at the beginning. They become really difficult to maintain and the content eventually stalls. A similar thing is happening between permissioned and permissionless blockchains right now. Permissioned blockchains will probably exist in closed organizations, but they will be interconnected by open permissionless blockchains.

These open blockchains are powering protocols that will support open and permissionless applications. Decentralized computing, storage, and payments are setting up the groundwork for the proclaimed next web15. These decentralized alternatives are fighting a difficult battle because their unit economics and/or customer experience may not work better than centralized options like Amazon Web Services. Censorship resistant may not be appealing enough for end consumers in many applications.

However, because of its permissionless nature, you now may access a global and decentralized world computer that nobody owns. Whether this world computer would become the new standard or just for use cases where censorship-resistance is important remains to be seen. It has been true in the past that open innovation trumps permissioned innovation and we can sincerely hope this trends continues. The alternative doesn’t look different from an Orwellian future where we use government cryptocurrencies. Everything is recorded but still in the possession of the few.

Conclusion

In my opinion, real adoption is coming. There is an infrastructure inversion on the horizon. We have suffered several infrastructure inversions in the past century. They are never obvious, only in hindsight. Cars were made fun of when they got stuck in mud roads dominated by horses. Once the infrastructure switched and roads improved, horses could still walk on them, but cars got way faster. Telecommunication companies refused for years to switch from analog to digital to communicate more data. Once they did, it was trivial to run voice over their new infrastructure, but the other way around was almost impossible. I think the same is true with Bitcoin: traditional banking that takes days and charges high fees can be easily implemented on Bitcoin, but the opposite is not true.

That new infrastructure is being built today. During this series we are going to speak with subject experts that are building it to make these long held promises possible. We are going to release deep-dives on the following topics:

A New Age of Investing.
The Future of Payments.
The Future of Organizations.
Turning Assets into Tokens.
Security starts with Identity.
The New World Computer.

Stay tuned and HODL on for more!

Notes
1. Bitcoin Decentralization. Wikipedia.
2. When the prices are too damn high. The Economist.
3. Bitcoin Market Cap vs Gold.
4. Trillions in offshore Havens. Reuters.
5. The Bitcoin ‘Consensus’: Yes It’s a Bubble, Buy It Anyway. Barron’s.
6. Citi Bitcoin GDP study.
7. Equifax Hack. TechCrunch.
8. The Internet of Money.
9. Retention Rate Silicon Valley. Business Insider.
10. David Sacks on Craft Fund and Harbor. CNBC.
11. Decentralized Digital Identity. Microsoft.
12. Twitter ShareCount endpoint shutdown. The Stack.
13. Facebook Advertising Algorithm Changes. Fortune.
14. Apple Itunes Spotify rejection. Recode.
15. The Dapp Developer Stack.

Thanks to Raul San Narciso, Alex Shelkovnikov, Brad Lightcap, and Craig Cannon for reading drafts of this post.

Author

  • Ramon Recuero

    Ramon was a Hacker at YC. Before working at YC, he worked at Zynga, Moz and founded Netgamix.