What investors, innovators and entrepreneurs get wrong about distributed ledger technology and blockchain

I’ve been looking at distributed ledger technology since 2012; I’ve tried to mine bitcoins and ethereum; I’ve made several bets, participated in ICOs and tried to comprehend some of the underlying mechanisms. After seven years, I figured I would summarize what I see most investors, innovators and entrepreneurs get wrong about this technology.

1.           Comparing it to the Internet (as the next big thing)

The Internet was not something “new” in every sense of the word. But It linked the underlying computer base and in fact existing LAN networks together into one super wide area network. The origins are from the 60s (DARPA funded as a means for communications to survive a nuclear attack) and while crypto enthusiasts rightfully point out that it took 20 years until we saw some meaningful applications in the late 80s and finally commercialization in the mid-90s, blockchain projects are nothing like the Internet. A whole lot of things had to come together for the Internet to work:

a) Scalability in network technology (from copper cables to fiber optics, from switches to routers) led to continuous increases in necessary bandwidth (the actual driver for innovation).

b) Interoperability and a protocol standard that even Microsoft couldn’t diffuse (I’m talking about TCP/IP, TCP/UDP etc.)

c) Killer application(s) in the user space with the Web and HTML (also standardized and interoperable) to gain critical mass (the actual driver for adoption).

d) Commercialization of network traffic was there almost from the beginning, you had to pay for access and that transcended between massive Internet exchanges all the way to your dial-up access. In short, a market was created.

e) No regulation - a true greenfield situation. In that sense the Internet is much easier to compare to the development of the airline industry (regulation came later)

2.           Banking, financial services-  and payment transformation (digital or otherwise)

The topic of revolutionizing banking and the financial service industry at large has great allure. However, there are several  areas where blockchain and DLT more dectract than actually help:

a.           Regulatory and compliance: The financial service industry is complex not because the business is complex but because every minutiae of it is regulated. And only national banks or government entities have the authority to create FIAT money and regulate the industry - we have seen this play out yet again with the recently “failed” Libra project and their use of “stablecoins”. Alternative “currencies” are legally challenged before they hit critical mass, likewise transparency is required by legislator.

b.           Legacy and process: I saw how some crypto projects tackle the opportunity for more real-time transaction processing. This too is a detractor because the underlying challenges for real-time transactions have a lot more to do with the core banking legacy systems (the batch mindset vs. the API mindset) and our “outdated” processes than blockchain or DLT. In fact, I would go so far and argue that DLT solves nothing at all here and instead makes this even more complex - while in theory it’s true that in a decentralized system you wouldn’t need a clearing house, it’s also true that you would have to propagate that transaction onto every node in the system. And to underscore this point even more, the NEO banks are doing near-real time on top of legacy processors without the use of DLT or blockchain technology just fine.

All industries are undergoing a digital transformation that focuses on changing our legacy processes since we’re still doing a lot of “manual work that simply got digitized”. The irony is that especially the financial service industry is not a good blockchain industry precisely because there is no lack of “trust”. Which brings me to my third point:

3.           Trust - or the true application of blockchain

Finally we enter the most important use case of blockchain or distributed ledger technology and that is the trust factor because it solves the “Byzantine Generals Problem”. As Marc Andressen himself pointed out so eloquently in a NYTimes write-up in 2014 (excerpt):

“The practical consequence of solving this problem is that Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.

What kinds of digital property might be transferred in this way? Think about digital signatures, digital contracts, digital keys (to physical locks, or to online lockers), digital ownership of physical assets such as cars and houses, digital stocks and bonds … and digital money.”

I believe the technology is indeed groundbreaking, just as Marc Andressen describes it, however, so far, and especially since this article was published in 2014, I have mostly seen attempts by crypto enthusiasts that target existing frameworks and there is no clear path to interoperability between the various DLT and blockchain efforts nor is there a path to scaling up any of these efforts. The energy consumption of distributed ledger makes its application suboptimal especially in areas where greenfield opportunities would exist (such as the emerging economies).

One could argue that with blockchain technology you start on a green field precisely because you don’t have to worry much about contractual agreements or compliance aspects because that’s all baked into the protocol(s). Thanks in part to the immutability of the blockchain, these things would solve many problems. But what people forget is that you’re trying to solve a mindset and culture problem with technology and unless there is a killer-app for it, it will become really hard to change culture.

In short, a) the blockchain enthusiasts and industry need to come together and create a broad set of foundational rules; not unlike TCP/IP, before they hope to create the necessary foundation (interoperability, standard protocols etc. - yes, there are some efforts underway) to allow something to grow beyond the hype. Then, b) there has to be a killer-app that ties into our world seamlessly and is not constantly challenged by regulators for being just a tool for fraudsters and gangsters and lastly, c) too many startups are focused on areas for which DLT and blockchain is not even good technology nor would it really solve a problem; instead they should go back to the roots and look for use cases where the Byzantin General Problem represents a barrier to overcome.