1.2.3 The “blockchain” pattern and the role of decentralization
-68. In Part 2 and Part 3 I am going to argue that MiCA is at best a partial answer to the multi-level innovation phenomenon sparked by Bitcoin, blockchain technologies and the crypto-assets, and back my analysis with empirical observations. However, such an argument triggers a natural question: how could the EU come up with such a misguided response? Several reasons are likely to have contributed and one of them, “regulatory capture” is mentioned in Part 2. Another reason is … the technology itself, which displays many impressive qualities under different angles of analysis, to the point where someone looking at it might “miss the forest for all the trees”. Why such an error might have occurred can probably be traced to a slew of early influential sources, such as the “Blockchain revolution” book by Don and Alex Tapscott. This section briefly presents some of “the trees”. The next chapter will be dedicated to identifying and describing “the forest”.
-69. Designing an IT system allowing the creation and secure transmission of “cash-like” data objects without the need for a trusted third-party (i.e., “peer-to-peer”, P2P) involves solving a set of not only technical but also legal problems. Satoshi’s paper correctly identifies those problems in an exhaustive manner, proceeds to select pre-existing technological solutions to each of them, and describes the practical way in which a computer program can combine them. That is to say that Bitcoin does not contain any previously unknown technology; what is new in the Bitcoin paper is the way these technologies are combined to specify an application which can function as a “peer-to-peer electronic cash system” in the absence of laws or a legal framework.
-70. Mueller et. al. summarize the blockchain pattern thus: “a blockchain is a distributed, verifiable database, which operates through a confluence of public-key cryptography, the concept of [a consensus mechanism (was 'proof of work')] and P2P-systems.” They conclude: “Bitcoin, and especially the underlying blockchain system, is a very valuable technology from a scientific computer point of view …” Indeed, when Haber and Stornetta had described blockchain, they did so in the context of securing intellectual property rather than P2P cash, which goes to show that several different uses can be imagined for it.
-71. A 2016 report by the UK Government Chief Scientific Adviser reports on how the Estonian government uses Guardtime “KSI” blockchain solution to prevent tampering with and performing illegal acts inside the government networks and allowing citizens to verify the integrity of their records on government databases and generalize the technology further speaking of “distributed ledger technologies”. However the report does not explain what motivated the Estonian government to implement that solution, especially since, despite its obvious benefits, no other government has taken a similar path neither before nor, remarkably, afterwards.
-72. Most of the enthusiastic accounts of the potential of blockchain and, more generally, “distributed ledger” technologies insufficiently (or completely fail to) account for the trade-offs and costs these technologies involve. While resilient, IT systems developed using blockchain technologies are redundant and thus “cost-inefficient by design”. The Estonian government network had been the victim of a massive cyberattack from Russia in 2006. The consequences of this attack were so severe and the likelihood of a similar one happening again were high enough to warrant the implementation of a military-grade blockchain-based system in a trade-off of “higher costs” in exchange for “increased security and resilience”. In the absence of such serious threats, other governments have, and still are using different, more cost-efficient IT designs for their networks. This also goes to explain why, despite Bitcoin’s success, examples of widely-used blockchain systems which do not undergird a crypto-asset are few and far apart.
-73. It is also the area where subsequent blockchain-based crypto assets have brought “Schumpeterian” innovation: their blockchains tend to be faster, cheaper to deploy and operate, and able to process more transactions per second. However, such technological improvements often involve trade-offs at the governance level.
-74. In one of the rare articles recognizing the value of the technology while acknowledging its inherent costs, Jimmy Song writes: “The main thing distinguishing a blockchain from a normal database is that there are specific rules about how to put data into the database. That is, it cannot conflict with some other data that’s already in the database (consistent), it’s append-only (immutable), and the data itself is locked to an owner (ownable), it’s replicable and available. Finally, everyone agrees on what the state of the things in the database are (canonical) without a central party (decentralized)”.
-75. He pursues: “It is this last point that really is the holy grail of blockchain. Decentralization is very attractive because it implies there is no single point of failure. That is, no single authority will be able to take away your asset or change “history” to suit their needs. This immutable audit trail where you don’t have to trust anyone is the benefit that everyone that’s playing with this technology is looking for. This benefit, however, comes at a great cost.” We can say that this increased cost is the “flip side” of the “predictability” which these systems provide.
-76. To compensate for this great cost, blockchain systems need to unlock new sources of value. But given that, as Jimmy Song further writes, “blockchains are hard to upgrade, hard to change and hard to scale, most industries don’t have much use for a blockchain. The one exception we’ve found is money. Unlike most industrial use cases, money is better if it doesn’t change. Immutability and difficulty in changing the rules is a positive for money and not a detriment.”
-77. Coming back at Douglass North, difficult to change rules and constraints are what defines institutions. This is, among others, why Davidson, De Filippi and Potts deem blockchains “an institutional technology” rather than a “Schumpeterian”, “general purpose technology” , as we’ll see in more detail in the next chapter.
-78. To sum it up, innovation at the governance level (“decentralized, consensus-based decision-making”), combined with innovation at the economic level (incentive-based economic mechanism design, lower transaction costs) are inextricably linked to Bitcoin’s and crypto-assets’ success, whereas the underlying blockchain is rather a technological enabler, and one which imposes such difficult trade-offs that it is barely viable when not used in combination with appropriate economic and governance mechanisms.
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[56] D. Tapscott, A. Tapscott, “Blockchain Revolution”, Portfolio Penguin, 2016
[57] S. Nakamoto, op. cit.
[58] P. Mueller., S. Bergsträsser, A. Rizk, R. Steinmetz, op. cit.
[59] UK Government Office for Science, “Distributed ledger technology: beyond block chain”, 2016 https://www.gov.uk/government/news/distributed-ledger-technology-beyond-block-chain
[60] J. Song, “Why Blockchain is Hard” 2018 https://jimmysong.medium.com/why-blockchain-is-hard-60416ea4c5c
[61] ibid.
[62] S. Davidson, P. De Filippi, J. Potts, op. cit.