At it’s heart crypto is about consensus. The innovation of bitcoin is its solution to the Byzantine generals problem. If multiple armies must decide to attack a city simultaneously from different sides in order to win, how can they coordinate an attack/retreat decision given that messengers may be intercepted and generals may try to undermine the voting process by sending conflicting information? Solving this is analogous to creating a fault tolerant computer network. Through a combination of asymmetric difficulty (hash cracking) and an incentive structure (crypto-currency), bitcoin found a way to establish a trustless, decentralized ledger. The protocol used by nodes of the network to add new chunks of information is called blockchain. Bitcoin was the first implementation of this technology.
In This Article
I’ll focus on covering crypto from a bird’s eye view. What is it? Why do people think it’s so significant? What is the value proposition? How is it contextualized in the larger world? Why is there such a push to regulate it?
I won’t explain the technical details of blockchain, zk-snarks, rollups, sharding, or any specific platform. I won’t talk about how to interact with Web3 or elaborate on the difference between tokens, NFTs, stable coins and wrapped assets.
This article is meant to serve as an overview of what crypto is capable of and what its future may hold.
DApps, Not New Chains
Since bitcoin many new blockchains have come online. Many are associated with some idea or particular application. Each independent blockchain is associated with its own crypto-coin or currency to incentivize participation in the network.
The reason why smart contract platforms have exploded in interest is because they generalize this consensus idea to the point of becoming a Turing complete settlement layer. In other words, the network of a smart contract platform can agree on the execution of arbitrary programs. There are limitations of different kinds for ethereum vs cardano for example. But the essential nature of the technology is captured in the phrase “distributed compute”. It’s a lesser known fact that bitcoin actually has this capability too.
DApp means “decentralized application” and generally seeks to fulfill a use-case for decentralization. A DApp uses a consensus platform to handle its decentralization whilst it focuses on some particular functionality. All blockchain use-cases are absorbed by distributed compute platforms because they are Turing complete. Whatever business logic you were going to put on your own blockchain could theoretically be implemented as a DApp on one of these powerful networks. Once the technology is more mature it won’t make sense to start your own blockchain at all because the secure consensus is something you can simply inherit from an established platform. Some would argue this is already the case. Re-establishing that reliability and trust from zero might prove untenable especially for niche applications. There are only so many people in a position to run node software for only so many networks. For your good-faith application you really just need to look for a network that meets your technical requirements whilst maximizing security.
“Frankenstein-Net”
I think the inevitable future of consensus on the internet will be an eclectic ecosystem of networks, likely several taking the form of consensus platforms centrally controlled by nation states or multinational corporations. Think of Google’s authoritative role in the Google Play market or the CBDCs many countries are experimenting with. Different so-called Layer-1s will offer varying trade-offs between different technical capabilities and security guarantees. This includes varying degrees of decentralization. Here I’m referring to such cases as venture capitalists holding large pre-mines and therefore influence over their investment. Layer-2 platforms can provide greater decentralized compute capabilities whilst inheriting security from their base layer. For instance bitcoin’s lightning network allows many transactions to be made at a fraction of the cost it would take to transact on the bitcoin base layer. In this example lightning is a layer-2 network built on top of bitcoin as a layer-1. In the image below you’ll also see the examples of arbitrum, polygon, and optimism which are layer-2s for ethereum that drastically scale its capabilities. The hydra chains do the same for cardano. This layering can be seen as part of the software architecture of the crypto space. But I’d like to point out that projects for making consensus network use cheaper and faster is a general tendency which is likely to stick around in one form or another. Commercial banks, credit card companies, and PayPal play a similar role with respect to fiat money. Bridges will allow broad interoperability between the most popular consensus platforms.
I suspect that in the future, just as we don’t think about how the internet works, most people will simply make use of the frankenchain seamlessly and implicitly. Tech savvy users, developers, economists and geopolitical analysts may concern themselves with the viability of different parts of the network.
The Value of Cryptocurrency
There is most definitely inherent value in being able to agree on stuff. The value of the cryptocurrency depends broadly on the value of the chain-space in terms of compute features and security. It’s like digital real estate. And no, I’m not talking about NFTs. The chain can only support so much physical data, only so many transactions. How much the data and compute on the chain is worth to the free market is as solid as anything. One chain may compromise security for scale or prefer decentralization to throughput. Another may implement specialized features to make particular kinds of applications more efficient. The value of compute on the network is directly related to the value of the supported use-cases. All this drives demand for the network’s coin. The other factor driving price is supply which is determined by the incentive structure of the consensus mechanism, the specifics of how new coins are minted which will differ from chain to chain. Some cryptos have a finite supply of coins whilst others do not. Some have mechanisms for destroying currency among other variations.
At the time of writing this article (July 2022), although smart contract platforms are ramping up, we haven’t quite reached frankenchain. Implementations are not very mature and people are only starting to get crypto on their radar. It remains a highly speculative market because it’s difficult to discern which aspects of crypto are worth paying attention to and what classes of use-cases will emerge. User interfaces also need to improve for popular use in daily life to drive crypto’s proper integration in the broader economy.
Stability of Consensus
The other major aspect of crypto is the way updates to a protocol are made. It’s important to understand that this dynamic is inevitable as the only thing constituting the network is the software individual nodes choose to run. Bitcoin has a BIP mechanism (BIP = bitcoin improvement proposal) and ethereum has a DAO (decentralized autonomous organization) that oversee changes to the protocol. Just like political parties, these systems have ideological tendencies. For instance one may favour immutability of the protocol, a kind of conservatism, or they might prefer getting features in, like progressivism.
Disputes at this level have resulted in so-called hard forks where blockchains diverge into two parallel histories where one part of the network agrees on one way of proceeding and the the other part chooses the other way. For example bitcoin has split into BTC and BCH. BCH had a further fork called BSV. Ethereum classic or ETC was created in a similar way, except the disagreement wasn’t about technical features, but rather whether or not to roll back a DAO hack which saw millions in funds disappear. Asking which is the true history is a little like asking which religious denomination is the correct one. People will get upset.
No matter your opinion network effects and market forces have unambiguously propelled BTC and ETH to their respective top spots. The long-term stability of these governance mechanisms is yet another open question. Consensus networks might have a cycle of stability similar to how fiat based governments experience large debt cycles, although it’s likely too early to tell.
Web3 Mythos
Web1 was about file sharing. Web2 was about software as a service through interactive web pages. Web3 is about decentralization. In practice Web3 is synonymous with developing a DApp or a new blockchain. The gist of the Web3 philosophy is the idea that people can control their own technology without a centralized authority. Some in the Web3 space flirt with the fantasy of living in a world without government. I find this misguided. After all, you need something to maintain and protect the internet infrastructure. This DARPA funded study outlines incidental centralization that can threaten the integrity of DApps and blockchains. There’s always some level at which any technology is vulnerable. Security is only ever as good as the weakest link.
Maybe that’s why the Web3 mantra has spilled out of the application space and into other domains. Most notably GNU-Net seeks to democratize the whole internet protocol stack above the physical, not just the application layer. Decentralization and privacy are twin goals of this project. Although GNU-Net is a clear extension of the Web3 mythos, some neglect to include projects like it when talking about Web3 because it doesn’t involve blockchain. In a broader context there’s also been growth in appetite for P2P and federated software architectures like IPFS, LBRY, and the Fediverse. This trend may also be thought of as part of the Web3 mythos.
Crypto and Nation States
The pen is mightier than the sword. But it seems you can’t maintain penned laws without an army that wields some equivalent to swords. There are important relationships between government, consensus, force, and money. Basically, the government is the system which people agree on being authoritative. This consensus is reached by some balance of oppositional force, AKA violence. Government enforces the role of the central bank. For the purposes of this article government and central bank are a single complex. Because government is the locus of consensus, it controls currency and therefore also has a strong hand in shaping the economy through financial policy, taxes, subsidies and expenses.
The thinking goes that Bitcoin removes part of this money power from government by providing an alternative money which no one entity can control. Money powers such as setting interest rates and expanding and contracting balance sheets. The use of smart contracts can allow the crypto style of consensus to claim more powers from government beyond the rule over money in this same way. The crypto revolution would be a transition from constitutional, violence-based consensus governments toward borderless, algorithmic, cryptography-based consensus platforms. It is important to recognize the high analogy between the two systems. Influence in both of them is tied to capital. You can use funds to influence elections and policy in conventional politics. In crypto you can own more stake or mining hardware to have your say. Perhaps crypto is more effective at limiting the impact of this kind of influence.
In this transition there is an emergent opposition between those in who’s interest it is for the conventional system to remain, and those who would benefit from the rise of crypto. The former will back regulation of crypto and will fight to limit its popularity. The latter will support the novel consensus mechanisms. Some proportion will do so to the point of breaking the law. Those who already break the law anyway are most likely included in this group.
Government can take direct action against crypto by making it difficult to use. We’re already seeing KYC for exchanges, a US ban on tornado cash, monero being delisted from most exchanges, securitization of LBC and likely all proof-of-stake cryptos, an EU ban on anonymous crypto transactions above 1000€ and so on. Most cryptos have little in the way of privacy features. Individual users could be identified then suppressed through fines, taxation, or prosecution. Where privacy is made an inherent feature of the protocol, users are provided with some real world security which is a step beyond conventional security in crypto. Normally developers are only concerned with the reliability of the ledger in terms of bad actors at the level of fault tolerance. There are ways of anonymizing transactions on the major crypto networks, but those mechanisms are an afterthought most users ignore. Privacy may yet prove to be a fundamental oversight of most networks if the Web3 dream is to be durably fulfilled. Blockchain also requires a sufficiently permissive internet to exist. So crypto could be disrupted at the level of telecom through internet censorship. Beyond that the infrastructure has to be maintained with supply chains and those must ultimately be defended with military force. So in the end crypto needs what conventional governments currently control.
Given that crypto is a novel way of reaching consensus, it may have the means to govern and provide for itself at all these critical levels. I wonder what happens when someone decides to connect a weapon (hypersonic missile, kill bot, attack drone etc.) to a smart contract in order to protect the interests of the consensus mechanism itself, presumably against government regulators. Imagine military contractors, mercenaries, and hackers answering to a crypto consensus network. Perhaps the new balance of power will incentivize conventional governments to ease their grip on money.
Since I find it unlikely that crypto will be stopped, I believe we’ll see a convergence in the long run where conventional governments will be forced to allow more libertarian financial policy given the risk of losing “users” to crypto. Simultaneously, crypto may find itself taking on properties and functions of conventional governance to defend its existence as part of its security value proposition. Perhaps we’ll even see crypto lobbying for crypto friendly policy within conventional governments through smart contracts.
Closing Remarks
The crypto space is huge and fascinating. It makes us think of many aspects of politics, economics and technology in a new light. What is money? How are the systems we rely on every day connected? Hopefully we’ll be able to glean more useful insights regardless of whether crypto really does become the future of money.