Blockchains Have Feet Of Clay

By Daniel Chapiro :

Editor's note: Seeking Alpha is proud to welcome Daniel Chapiro as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to the SA PRO archive. Click here to find out more »

The future of Bitcoin and other digital coins, as well as their expected value, seems to be based as much on reason as on faith, and there are strongly opposed views. In contrast, even among those who are skeptical about the different coins, many argue that the underlying blockchain technology will become pervasive and is sound. I'll argue it is not.

The reasoning in favor boils down mostly to three premises: (1) that just as with the internet in its infancy, it's easy to underestimate the future impact of blockchain technology; (2) on the soundness of the Satoshi Nakamoto algorithm (SNa); and (3) that it will result in vast benefits in many areas.

Blockchains are the foundational technology that underlies all cryptocurrencies, and they shared a common birth: A white paper that outlined a novel currency (" Bitcoin ") and a novel algorithm (" Blockchain "). Further developments of the blockchain algorithms enabled using blockchains for purposes well beyond just cryptocurrencies.

The following arguments against blockchains are completely unrelated to the ups or downs of cryptocurrencies, and are based instead on (a) the dynamics of networks of miners , and (b) that the further benefits attributed to blockchains are overstated.

1. Parallels with the Internet

The parallels with the internet is the weakest of the arguments, and not a serious one, so I'll get it out of the way first: although the magnitude of the eventual impact of new technologies is rarely fathomed at their early stages - whether the internet, the web, computers, penicillin, etc. - most new technologies do not succeed in such a significant way. From promising new drugs that fail third-stage trials to novel materials, unbeatable startups, or clever algorithms that should revolutionize some area, most actually either fail altogether or end up having negligible impact. However, most failures are less spectacular, and certainly less glorious than triumphs. Hence, they tend to get less press. Failed experiments rarely get published in the academic journals, and in general, it's success that gets echoed and amplified by the general press and the web.

For example, some of the hubris around Bitcoin , or its potential , depending on one's perspective, continues to get amplified by companies and individuals who gain as long as others keep trading it, but do not necessarily own Bitcoin themselves.

Every new idea, naturally, has to go through infancy and teething, but being in such a stage is hardly a predictor of success. Making a parallel between the future of blockchain and the growth of the internet is unfounded: The only true parallels are that both deal with bits and that both had an infancy. But we could make equally unfounded parallels with any number of protocols that went by the wayside without leaving a trace, or in general with other technologies that looked incredibly promising at the outset, but ultimately failed. In conclusion, the success of the internet tells us little about the future of blockchain - one way or another.

2. On the soundness of SNa and Blockchains

So now let's look at a harder issue: whether SNa is a solid foundation for a revolution or just the basis for another interesting, distributed database. I will not go into whether central banks or fiat currencies are good or bad, nor whether privacy, traceability, or security matter, because I will attempt to show that neither SNa nor its variants provide an advantage over ex-SNa technologies. If so, all these other economic and social issues can continue to be debated, but independently of SNa.

To further clarify what I consider as ex-SNa: all types of databases, including centralized, distributed, mirrored, etc.; backup systems, redundancy, and recovery systems and protocols; communication protocols, including consensus mechanisms and any other update and software or hardware-based commit mechanisms; encryption; tamper-detection mechanisms, including incremental hashes; and in general, every other technology, with the exception of SNa.

The key weakness is not in SNa itself. The algorithm is sound and works well. Moreover, some of its limitations in terms of speed, space, or energy are being addressed with clever variants. However, those variants use more or less obvious side channels, weaker protocols than SNa, or other ex-SNa mechanisms to funnel information. Hence, they leave the transactions as exposed as ex-SNa - at least for some periods of time. They are more obscure, and possibly harder to attack than, for example, leaving Bitcoins in a hot wallet, but still vulnerable. Some variants provide for " self-executing " and exceptionally safe contracts - certainly clever and useful. However, such use requires a solid underlying blockchain.

SNa is an algorithm that delivers valid answers with such a high degree of confidence that under normal conditions, we can trust them. However, this reliability is not unconditional: It relies on the assumption that there is a large set of independent, non-colluding miners , in which no miner (or syndicate of miners) controls over half the network. Miners are the entities that run the SNa and cooperate to update the blockchain. SNa allows for anybody to become a miner, and participate in the blockchain updates, while still preserving its integrity. That's the beauty of SNa.

The weakness lies in the fact that nothing in SNa guarantees the dynamics of the evolution of the underlying network of miners. Nor does it provide for a safe mechanism to monitor its configuration at any given point in time. The network can evolve into a desired configuration if there are enough incentives for large numbers of independent parties to participate actively. But nothing precludes, due to benefits of scale, for example, for larger participants to gain market share (i.e., computing share in the blockchain), leading to an oligopolistic situation, or worse to a dominant miner. Furthermore such coalescence process can be overt or, more dangerously, covert.

Another way in which a network of miners can shift to an undesirable configuration is when the profits to be made, instead of expanding, shrink. As long as growth in the profits to be made outruns the ability of new entrants to join the fray, the network will keep growing. However, at some point, competition must reduce margins, and aside from consolidation , the other possibilities for the network are gradual stabilization, withering, or given the non-linearities of the system and the many feedback loops, possibly collapse. It is interesting to note that although this is just one data point, with the Bitcoin price collapse in late 2018, a number of miners stopped providing mining services altogether, and simply sold their hardware . Collapse may mean that a given blockchain stops operating or, just as bad, that it continues to operate, but under a controlling party.

3. About the Many Benefits of Blockchains

Some blockchain variants support uses beyond those of Bitcoin ( BTC-USD ). Initially Bitcoin was touted as an efficient and inexpensive way to make payments and transfer money. Interestingly, it was lauded both for providing full traceability and also anonymity, usually not in the same sentence. Given the original SNa and its parameters, its original goals were not attainable, resulting in the first forks (variants). Currently the claimed benefits of Bitcoin seem to have shifted towards storing value securely, while other variants focus on the other aforementioned benefits.

Soon it became apparent that blockchains could securely store other sorts of information. Thus the creation of competing systems, such as Ethereum ( ETH-USD ) and many others. One of the obvious problems with this fracturing is that, except when it results in growth of the total underlying assets, it is dilutive and weakens the notion of digital assets as incorruptible stores of value.

With Ethereum, the ability to store information such as, for example, property rights, music ownership, and particularly programs opened whole new vistas: self-executing contracts, automatic payment of royalties, secure ownership of land titles, etc. Furthermore, all of this provided without pesky intermediaries (or otherwise at almost nominal costs) by riding on top of existing blockchains. There are two problems with this scenario: (a) blockchains are run by miners who must be compensated (they invest in machines, cover the operating costs, and presumably would like to see a profit), and (b) the blockchain is just a database, when all is said and done.

To address the first issue (i.e., compensation), the blockchain must be able to attract underlying transactions of valuable assets that are traded frequently and in large volumes, and result in a cut for the miners. Usually, the traded asset is some type of cryptocurrency, as for example, Ethereum. All others can benefit, but cannot get a free ride. They have to pay for the use of this database in one way or another. However, because blockchains are computationally intensive, their operation is significantly more expensive than ex-SNa databases, so fees have to be higher. For a given blockchain, underpricing of transaction fees must self-correct, or its miners will eventually disappear. There's no magic that can change that.

The second issue (i.e., beyond the database) requires providers who will connect the rest of the "plumbing". That is, the database is just one of the pieces, and so is the blockchain. By plumbing I mean everything else that allows providing a given service. To make it concrete, let's look at some examples.

A possible use of blockchains would be to store and manage property rights inexpensively . The narrative sometimes emphasizes the big impact this would have in the developing world, where it is more common to find primitive, incomplete, or conflicting records, and where corrupt officers can tamper records with impunity. However, under such circumstances, we need to ask ourselves where exactly would an alternate database be plugged. The tampering is not due to vulnerabilities in modern databases, but due to a lack of adequate legislation, corrupt judicial systems, and a combination of lack of competence and resources to put it all together.

So let's consider a place where those preconditions are satisfied. In the USA, title information is kept by each of over 3,000 counties, some parishes, etc. Each one has its own regulations and record keeping procedures. It requires a leap of imagination to think they would legislate a common system, which would then migrate to a blockchain. OK, so what about just some counties doing it? For that to happen, there are powerful headwinds: (a) the money to be made by putting together localized plumbing is less, and (b) developed world style corruption is less blatant (or at least used to be), but at all levels, money speaks. At the local level, real estate and development companies support candidates favorable to their business; title companies would do likewise if there were any risks that their livelihood would be affected. So why engage in a battle, just to replace a county's database, which is just a cog in the system? Furthermore, are the issues truly in the databases?

So let's consider instead a leading country such as Estonia, where a significant proportion of all government-related activity is already online. Furthermore, Estonia already has built the uniform plumbing needed for easy access, and its ex-SNa databases seem to work already. Assuming that is the case for its real estate too, would this be a good candidate to migrate to the blockchain? To decide, I would ask first: What actual problem does it have, which will be solved with this alternate database?

Going away from real estate into music, let's look at another example. ASCAP and BMI handle a large portion of the royalties owed to musicians when their music is used/performed. For this service, they keep an interesting percentage of the revenues. Some people have proposed (in general terms) blockchain-based systems through which musicians would get their due every time their music is performed, without intermediaries, and at a very low cost. Again, this ignores the need for the "plumbing": at the most basic, somebody needs to generate identifiers for each music piece, to detect when it is performed in any of many forms (from radio and TV, to podcasts, movies, etc.), and to channel funds from some entity to some musician. The blockchain does not do any of that; it can just store information and run a program when fed an event. So the question now becomes, who will do that, and why will they charge less than ASCAP or BMI for providing this service?

Another benefit touted by SNa proponents is the democratization of ownership and operation of the blockchains. Instead of banks and other corporations owning the database, it would be owned and operated by "the people". You and I can become miners and join the club. The idea was nice, but the actual dynamics of the evolution of the network, and particularly of the dedicated hardware needed to participate effectively in a blockchain, rule most of us out. So it's not necessarily banks, but some other corporations, which actually own and control the blockchains. So much for democratization.

At the other end of the spectrum, some banks and technology companies have come up with variants ideally suited for them: Walled-gardens in which vetted miners provide the infrastructure for a blockchain . This might seem like an ideal solution for incumbents with much to lose from a potential failure. However, this does not address communications with the "outside world". Also, just as with the examples described above, any new functionality requires building the "plumbing" to support it. But adding a blockchain-based database adds complexity and cost for transactions between what are already trusted parties - and increased complexity begets increased vulnerability. Furthermore, the weak points tend to be in the periphery rather than the databases. Ex-SNa technology should not be conflated with current flaws, limitations of functionality or security, or lack of performance - these are all indicators of obsolescence. SNa does not solve legacy issues on its own: it's just a secure database. So of all the things that could be improved in banking systems, why precisely this peculiar focus on the databases, as if they could unleash untold potential? Seems there are more interesting and valuable things to do in fintech and in banking systems.

4. Coda

Cryptocurrencies were the initial motivation behind the invention of blockchains. Some researchers, and particularly some economists, are not too enthused by cryptocurrencies. In contrast, there seems to be a much more general agreement - a consensus, almost - on the bright prospects of blockchain technology. They are expected to bring forth dramatic change - from foreign exchange transactions, to self-executing contracts, to enabling accurate record keeping of property rights and transactions all over the world.

None of the arguments, nor the examples above, have the strength of a mathematical proof, which could settle the case against blockchains. However, they suggest that the future of blockchains is not so clear. Research in SNa and blockchains is unquestionably interesting , so perhaps that will perdure, a bit like the radiation left by the Big Bang . But, leaving predictions aside, while SNa is solid, actual blockchains have feet of clay. So it seems that even if not naked, the emperor may be rather lightly dressed.

See also Tesla: Why Trust Elon Musk Now? on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story


Other Topics


Latest Markets Videos


    Seeking Alpha is the world’s largest investing community. Seeking Alpha has unparalleled breadth and depth: from stocks, ETFs and mutual funds to commodities and cryptocurrency, including thousands of stocks (such as small-caps) not analyzed elsewhere. Written by investors for investors, more than 7,000 contributors publish 10,000 investing ideas every month.

    Learn More