Last week, we had a bit of fun describing basic cryptocurrency blockchain technology functions using an X-Files analogy. This week, we’ll dive deeper into the blockchain based cryptocurrency fintech space (yes, we are excluding Ripple for now) to identify strengths and limitations of the blockchain application in banking and law.
How Blockchain/Bitcoin Protocol Actually Works
Last week’s example was meant to familiarize newcomers with blockchain basics on a simple conceptual level. However, to really understand the power of blockchain, one needs to understand the underlying mechanics. This is not an easy task and requires significant background reading. Depending on your learning style and knowledge level, start with Khan Academy’s introductory video, Kaye Scholer’s presentation, and eventually progress to Michael Nielsen’s work. Mr. Nielsen does a fantastic job explaining Bitcoin protocols in detail and also provides a nice background link to Nick Szabo’s detailed description of “smart contracts”. Take your time to review these works and build your knowledge base. If you already understand everything herein, congratulations and continue on.
Bitcoin History – Branding Issues and Other Limitations
At this point, you are probably saying, “Ken, why do all this reading, if, as Mike Hearn declares, Bitcoin is dead?” Taavet Hinrikus of Transferwise also says bitcoin has failed. It is true; Bitcoin is running up against several limitations. Bitcoin is not widely accepted or used, has not gained significant market share as of late, has high fees, does not allow you to smoothly move existing money, causes long transaction backlogs and delays, and is literally running out of space because of the current rule base and architecture limitations.
If those problems weren’t bad enough, Bitcoin also has a tough public image problem. The Mt. Gox $460 million collapse (Bitcoin theft/loss) and closure of the Silk Road have contributed to the publicly held notion that Bitcoin is only used in the dark and seedy corners of the web by criminals, drug dealers, etc. Unidentified bad actors poisoned the well for the rest of the community. What could have been a utopian peer-to-peer distributed currency became a tool for criminals. The lack of central authority and inability to quickly track identity are enormous regulatory hurdles that need to be cleared. Regulators are fearful of criminal activity and see the above issues as reasons to shut down marketplaces, exchanges, and platforms. What is being done to address these problems?
Enter The Winklevoss Brothers
Tyler and Cameron Winklevoss are best known as the founders of the social networking platform, HarvardConnection, later named ConnectU. The brothers successfully sued Facebook for $165 million in 2004, claiming that Facebook stole their intellectual property. In 2013, the twins became interested in Bitcoin and built several ventures in the space including their latest venture, Gemini, a fully regulated Bitcoin exchange.
Gemini’s value proposition is derived from full platform regulation (currently the only fully regulated exchange in New York). Playing the long game, the twins believe that Bitcoin is here to stay and requires a fully transparent and fully regulated Bitcoin exchange platform to build trust with users over time.
In a recent SXSW 2016 talk, the brothers acknowledged problems with Bitcoin’s legacy image issues and criminal associations; however, they think that these issues will be rendered mute in a regulated environment. Simply, it does not make sense for criminals to use blockchain based platforms because each and every transaction is recorded, published, and unchangeable. While it is theoretically possible to hack in and steal coins from an individual user account or wallet, there would still be a record of the theft and a record of the sale of the coin published in the distributed double-ledger. If the identity of each and every platform participant is registered, and, each transaction is recorded and unchangeable, any thief would be registering their crime and advertising it for all eternity…not the ideal criminal technology platform. Sunlight is a great disinfectant and Gemini expects regulatory transparency to regenerate a trusted reputation for Bitcoin and the Gemini exchange moving forward.
To Ethereum And Beyond!
While Gemini hopes to solve a piece of the cryptocurrency trust issue, Bitcoin still faces some big technical hurdles. Regarded as Bitcoin 2.0, Ethereum entered the scene aiming to address Bitcoin’s structural issues, add smart contracts, and improve platform clearing speed. Up until early April 2016, Ethereum was booming – in March passing a $1B market cap. The Ethereum associated cryptocurrency “Ether” was also growing rapidly. However, on the week ending April 15th, Ether took a massive tumble, dropping 50% in value. According to market analysts, Ether technicals had been deteriorating for months but it is too early to tell what effect the market drop will have on future platform performance.
What is Ethereum?
Ethereum describes itself as a “decentralized platform that runs smart contracts; applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference.” As you may remember from the introductory links, smart contracts are, “computer protocols that facilitate, verify or enforce the negotiation or performance of some sort of agreement (e.g. a legal contract emulating the logic of contractual clauses or a financial contract specifying responsibilities of the counterparts and automated flows of value).”
Ethereum and Bitcoin both operate on blockchain which means that a user does not need to trust a third party to correctly maintain data that is contained in the blockchain.
Differences Between Ethereum and Bitcoin
“While Bitcoin is created as an alternative to regular money and is thus a medium of payment transaction and store of value, Ethereum is developed as a platform which facilitates peer-to-peer contracts and applications via its own currency vehicle (Ether).” In fact, using Ethereum code, anyone can design and issue their own cryptocurrency.
Ethereum also differs from Bitcoin in two key technical ways. First, is clearance speed (aka Block Time). Bitcoin takes approximately 10 (or more) minutes to clear transactions, Ethereum takes about 12 seconds. Second, Ethereum has its own Turing complete internal code. This means that given enough computing power and enough time, anything can be calculated. Bitcoin is limited in comparison.
As Ethereum grows in scale and computing power, it is evident that the transaction clearing speed improvements offer a strong technological advantage (at a lower cost) that could soon disrupt banks and electronic payments/clearing platforms.
So, is Bitcoin dead, on life support, or in a new phase of regulated growth? Will Ethereum replace Bitcoin, banks, lawyers, and electronic payment providers, or continue its recent tumble? Most importantly, is cryptocurrency or the “smart contract” the blockchain killer app? Stay tuned.
Header image from Namecoin.