A new report from Coin Center examines the “blockchain” buzzword to help regulators avoid all the noise and get down to the implications of the various financial technologies that have been inspired by Bitcoin. In the report, which was authored by Coin Center’s Peter Van Valkenburgh, permissionless blockchains are described as essential to the future of the internet.
The report points out that the most useful aspects of Bitcoin’s blockchain technology are not found in consortium-based solutions — at least when targeting specific applications, such as electronic cash. According to the report, the consensus mechanisms used by these systems are what differentiate them from each other.
Blockchains Won’t Cure All of Your Ailments
To many, “blockchain technology” is a vague and undefined buzzword. Many of the largest banks in the world have snubbed Bitcoin but embraced the technology that underlies the peer-to-peer digital cash system; however, the report notes that a distinction needs to be made between open– and closed-consensus mechanisms.
According to the Coin Center report, the phrase “blockchain technology” is viewed as a loaded term that turns real technical innovations into generalized cures for problems found in any industry. “The phrase suggests a vague design pattern, which is then trumpeted as the solution to all manner of societal and organizational problems,” reads the report. “And amongst all of this cheerleading, almost nothing is ever offered in the way of real design specifics.”
Statements like these echo those often expressed on Bitcoin Uncensored, a podcast that often pokes fun at the lack of substance found in various blockchain-related projects. The intent of this report, on the other hand, is to offer clear, specific details to a wider audience.
Consensus Mechanisms Are What Matter
“Consensus mechanisms . . . are the truly disruptive, interesting, and critical component of the design,” reads the report. And these mechanisms are the aspect of blockchain technology that merits the largest amount of focus.
The report explores proof-of-work, proof-of-stake, and social consensus mechanisms, as well as closed, consortium models. It notes that open consensus mechanisms are superior to closed systems from an innovation policy perspective due to the fact that no permission is required to build or run applications built on top of them.
“In an open consensus mechanism anyone with a computer and an internet connection should be eligible to play a role in writing consensus data; in a closed consensus mechanism only those who have been identified by a centralized authority and given an authorization credential are allowed to participate,” notes the report.
Open Blockchain Tokens Are as Good as Cash
Due to the limitations of closed blockchains (or closed consensus mechanisms as the report calls them), some specific applications may be better suited on open, permissionless systems. One of the key applications of these sorts of systems up to this point (and perhaps the only one that has gained marginal use) has been digital cash — mainly through the use of Bitcoin.
The report points out that closed-blockchain money transmission systems do not simply work without any added effort from the end user. “I cannot send or receive money until I open an account and establish a legal relationship with a company,” explains the report.
The fact that users are unable to accept tokens on a permissioned blockchain without signing up for an account means that the system does not work like cash. Whenever a system requires permission from some other party in order to create accounts and send transactions, that system will be incompatible with a digital cash model by default.
It should be mentioned that even Bitcoin has not completely solved the issue of permissionless transactions. Due to the lack of advanced privacy features, the ability of bitcoin miners to censor specific transactions has not been completely abolished. Improvements in this area are in the works, but it hasn’t been a major issue up to this point.
Having said that, Bitcoin should, in theory, be in a much better position to act as a digital cash system than a blockchain controlled by a consortium of trusted signatories. “Only open consensus mechanisms, by fully automating the creation and maintenance of a ledger according to pre-established rules and economic incentives, can offer electronic transactions that are as good as cash,” says the report.