Things to be Learned About Bitcoin From Living On It For A Week

Alan Zibluk Markethive Founding Member

This has been a big week for Bitcoin. On Monday, the Senate Committee on Homeland Security and Governmental Affairs held the first-ever Congressional hearing on Bitcoin. Later in the day, the currency's value reached an all-time high of more than $800. That has left a lot of people scratching their heads. What's Bitcoin? How do you use it? And why would anyone want to? Read on for answers. (Inspired by Max Fisher's classic explainer on Syria)

What's Bitcoin?

Bitcoin is an online financial network that people use to send payments from one person to another. In many ways, Bitcoin is similar to conventional payment networks like Visa credit cards or Paypal. But Bitcoin is different from those and other payment networks in two important ways. First, Bitcoin is decentralized. For-profit companies own the Visa and Paypal networks and manage them for the benefit of their respective shareholders. No one owns or controls the Bitcoin network. It has a peer-to-peer structure, with hundreds of computers all over the Internet working together to process Bitcoin transactions.

Bitcoin's decentralized architecture means that it is the world's first completely open financial network. To create a new financial service in the conventional U.S. banking system, you need to partner with an existing bank and comply with a variety of complex rules. The Bitcoin network has no such restrictions. People don't need anyone's permission or assistance to create new Bitcoin-based financial services. The second thing that makes the Bitcoin unique is that it comes with its own currency. Paypal and Visa conduct transactions in conventional currencies such as the U.S. dollars. The Bitcoin network, however, conducts transactions in a new monetary unit, also called Bitcoin.

That seems really weird! Why would anyone use a payment network based on an imaginary currency?

It is weird. Almost everyone who encounters the idea for the first time (including me) has the same reaction: That can't possibly work. But so far the market has proved the skeptics wrong:

 

This graph shows the price of one Bitcoin since the start of 2011 when the currency began to adopt mainstream attention. The price has been extraordinarily volatile — it lost more than 90 percent of its value between June and October 2011, for example. But there's also been an unmistakable upward trend. Notice that the chart is on a logarithmic scale. It shows the currency's value rising from around $0.30 at the start of 2011 to around $600 today. There are almost 12 million bitcoins in existence, so the Bitcoin "money supply" is now worth around $7 billion.

Bitcoin has captured the imagination of venture capitalists. A startup called Bitpay, which processes Bitcoin payments on behalf of vendors, raised more than $2 million earlier this year. Coinbase, a startup that helps consumers buy and sell bitcoins, has raised $5 million. And last month, a Bitcoin startup called Circle raised $9 million. Why are people so excited? Bitcoin enthusiasts believe that Bitcoin's peer-to-peer architecture and low barriers to entry will allow the creation of a new generation of innovative financial services, in much the same way that the Internet's open architecture led to innovative new online services. There are also many Bitcoin fans who see the currency as an antidote to the inflationary tendencies of central banks, though, as we'll see later, this argument for Bitcoin is misguided.

This just sounds like a bubble. Do people use the currency for anything besides speculation?

I just mentioned Bitpay. It provides a good sign of Bitcoin's growing popularity for "real" transactions. In September 2012, the company announced that it had signed up 1,000 merchants to use its service for accepting Bitcoin payments. Just a year later, the company said, it passed 10,000 merchants. Bitpay works with a wide variety of merchants. Some sell online services like Web hosting or virtual private networks. Others sell jewelry and electronics. There are even restaurants and cupcake shops that sell their wares for bitcoins.

And yes, Bitcoin has significant illicit uses. Programs like Satoshi Dice allow people to gamble online. Until recently, a Web site called Silk Road helped dealers sell millions of dollars of illicit drugs. It's hardly unusual for new payment technologies to attract illicit use. Pornography was a big draw for both the first VCRs and the early consumer Internet. New payment technologies often attract criminals looking for new ways to move their funds without government scrutiny.

Another application for bitcoins that is expected to become more important in the future is international payments. Right now, wiring money internationally involves slow, expensive and inconvenient services like Western Union. Bitcoin is international, and its fees can be much lower than conventional wire transfer services. There's still work to be done to make such a system affordable and user-friendly. But it has the potential to disrupt the international payment industry.

Who created Bitcoin?

No one knows for sure. The currency was created by a person who identified himself as "Satoshi Nakamoto." While the name sounds Japanese, Bitcoin's creator never provided any personal details. He collaborated with other early Bitcoin fans through online forums but never met with other members of the Bitcoin community face to face. Then, starting in 2010 he gradually reduced his involvement in the currency's development. His last known communication came in 2011.

We don't know who Satoshi Nakamoto is, but we do know that if he ever surfaces, he will be an extremely wealthy man. Millions of bitcoins were created in the currency's first two years, and Satoshi likely owns hundreds of thousands of them. At today's prices, he would be a millionaire many times over. Before leaving the scene, Nakamoto passed his torch to a mild-mannered developer named Gavin Andressen, who is currently the project's lead developer. Andressen now works under the auspices of the Bitcoin Foundation, the closest thing the anarchic Bitcoin community has to an official public face.

Where do bitcoins come from?

In a conventional financial system, new money is created by a central bank, such as the Federal Reserve. But the Bitcoin network doesn't have a central bank. So the system needed an alternative mechanism for introducing currency into circulation. Bitcoin's designer solved this problem in a clever way. As I said above, hundreds of computers scattered around the Internet work together to process Bitcoin transactions. These computers are called "miners," and Bitcoin's transaction-clearing process is called "mining." It's called that because for every 10 minutes, on average, a Bitcoin miner wins a computational race and gets a prize. Currently, that reward is 25 bitcoins, worth around $12,500. These prizes provide a strong incentive for more people to join in Bitcoin's transaction-clearing process, helping the currency to remain decentralized.

This reward declines on a fixed schedule: Every four years the reward falls by half. So, from 2009 to 2012, it was 50 BTC, now it's 25 BTC, and starting in late 2016 it will fall to 12.5 BTC, and so forth. If you do the math, you'll find that there will never be more than 21 million bitcoins in circulation. Right now, there are almost 12 million bitcoins in circulation, so the Bitcoin money supply will never be more than twice its current size.

Isn't that a huge problem? I learned in economics class that deflation can cause economic problems.

It's true that deflation has traditionally been associated with economic problems, but there's little reason to think this will be a problem for Bitcoin. That's because deflation is only a problem if it is what economists call a "unit of account" for a nation's economic system. Right now in the United States, salaries, mortgage payments, rents and other long-term financial commitments are priced in U.S. dollars. As a result, if the value of the dollar rises unexpectedly, these "sticky prices" can cause severe economic distortions. Unable to cut wages, employers have trouble making payrolls. Unable to renegotiate their debts, homeowners have trouble making their mortgage payments. Tenants get stuck with rents they can't afford. The result is a recession.

Hardly anyone uses Bitcoin as a unit of account. You'd be insane to sign a contract promising to repay a loan of 100 BTC in 10 years or to take a job where your salary was priced in bitcoins. Even the Bitcoin Foundation, which pays its employees in bitcoins, still sets its employees' salaries in dollars, converting employees' dollar-based salaries into the corresponding number of bitcoins on each payday. As a result, fluctuations in the value of bitcoins don't cause the kinds of economic disruptions that fluctuations in the value of traditional currencies do.

How do I get bitcoins?

One option is to mine them yourself, but that's not a good choice for beginners. For everyone else, your best bet is to purchase them with a conventional currency. Web sites known as exchanges will let you trade bitcoins for conventional currencies with other users. Even more convenient are companies like Coinbase, which will withdraw cash from your bank account and convert it to bitcoins at the current exchange rate. A few Bitcoin ATMs are popping up, which will directly trade paper money for Bitcoins. Here's a video of someone using a Bitcoin ATM in Vancouver:

Okay, I bought some Bitcoins. Now what?

Next you'll need a place to store them. Bitcoins are stored in "wallets," which in this case are just files that contain encryption keys, or secret codes that allow you to transfer your bitcoins to other people. There are several options. One is to store them yourself using one of the Bitcoin programs available for Mac, PC and Android. Another option is to entrust them to a third-party Web site known as a "online wallet." A third option is what's known as a "paper wallet," where you print out your encryption keys and store them in a safe place, such as a safe deposit box.

Each has risks. If you choose to store your bitcoins yourself, then you could lose them to a hacker, a hard drive crash or a lost mobile device. But if you choose to use a third party, you need to worry about that third party swindling you or becoming bankrupt. The Bitcoin market is largely unregulated, so there are few legal protections if you happen to choose the wrong online wallet service. Paper wallets avoid the pitfalls of other methods, but they're tricky to set up correctly, and of course you're out of luck if you lose the piece of paper.

Okay, I have some bitcoins and found a secure way to keep them. What do I do with them now?

There are thousands of Bitcoin merchants online who will sell you everything from jewelry to electronics to illegal drugs. You can also spend bitcoins in "real life." To spend them in person, you need a Bitcoin mobile app. Generally, the store you're buying from will show you a QR code representing the Bitcoin transaction. You then scan that QR code with your phone, and the mobile app will send the required number of bitcoins to the store. Then you walk out the door with your purchases.

Of course, right now the options for face-to-face Bitcoin transactions are rather limited. Earlier this year, Kashmir Hill of Forbes lived on Bitcoin for a week. Because she lived in tech-savvy San Francisco, she was able to find enough Bitcoin-accepting merchants to get by, but just barely. So Bitcoin is far from being a practical currency for day-to-day use.

Should I buy bitcoins?

Probably not. There are two reasons you might want to buy bitcoins: to purchase goods and services or for speculation. Right now Bitcoin isn't a very practical payment technology for ordinary users. The software is too complicated, and the risk of loss due to hackers, forgotten passwords, hard drive failures and so forth are too large. Also, Bitcoin is extremely volatile right now, so your wallet could go from having $100 worth of Bitcoins one day to $50 the next. And right now, as Hill discovered, the technology just isn't used widely enough to make it a useful option to have in your pocket or purse. For most people, conventional payment technologies like credit cards are going to be more convenient.

What about speculating on Bitcoin? Once again, the currency probably isn't a good choice for ordinary users. The security and reliability risks of Bitcoin loom much larger if you invest thousands of dollars in the currency. You don't want to run the risk of losing thousands of dollars because you forgot a password or had an unexpected password failure. And the currency is extremely volatile. It might keep going up, but it could also lose 90 percent of its value next week. In other words, you should only jump on the bandwagon if you have a strong stomach.

If people shouldn't buy bitcoins, then what is all the fuss about?

Once again, the analogy to the Internet is instructive. Until the 1990s, the Internet wasn't a practical technology for ordinary folks to use, either. It used complicated text-based programs, and you had to be a computer expert to use it effectively. But it would have been foolish for an observer in 1990 to dismiss the Internet as too nerdy for mainstream use. Over time, entrepreneurs took the basic infrastructure of the Internet and built innovative and user-friendly online services such as Google, Facebook and YouTube.

Bitcoin boosters are betting that the same will happen with Bitcoin. The "raw" bitcoin network isn't very accessible, but startups like Coinbase and Bitpay are slowly fixing that. Some day soon, someone may develop Bitcoin's "killer app," a program that provides a financial service that has clear advantages over conventional banking. That might be an international money-transfer network with lower fees, a practical system for online micropayments, or something else that no one has thought of before.

Could bitcoins ever replace conventional money?

It's possible, but it doesn't seem very likely. People want to use the currency that most other people use, and in the United States that's going to be US dollars for the foreseeable future. And that's a good thing: if Bitcoin became the standard currency of the US economy, then its fixed money supply would create a serious risk of the next economic downturn snowballing into a depression.

However, there could be a lot of room for Bitcoin to complement conventional financial networks. After all, Paypal gained traction because the conventional financial networks of the day weren't meeting all of users' needs. Bitcoin's open architecture could allow it to be even more disruptive. People are unlikely to ever eschew conventional financial networks altogether, but there could be a substantial market for Bitcoin-based services that perform certain services more effectively or affordable than conventional alternatives.

Chuck Reynolds
Contributor

Alan Zibluk Markethive Founding Member

Whether we consciously think about it or not, banks are intertwined with our lives. We need them, but more importantly, they need us. It’s something to consider, given that there are times the banking industry can sometimes be frustrating, to say the least. Although startups like Simple are trying to bring a friendlier face to banks, it is the underlying system itself that is resistant to change. When faced with the emergence of something like bitcoin, it is worthwhile paying attention to how the banking industry behaves. Many who are working towards building a bitcoin economy believe that banks will need to change.

Risk versus reward

Banks by their nature are always looking to reduce their exposure to risk while balancing out profits from making loans as well as investments on their clients’ behalf. As it stands right now, bitcoin must seem infinitesimal compared to a bank's regular business operations that it is probably not worth contemplation.

Gareth MacLeod, who is a co-founder of Canada-based Tinkercoin, has been able to convince a bank to do business with his company.

“Banks are conservative institutions”, MacLeod says. “From their perspective, they stand to gain very little from working with bitcoin businesses, and stand to lose a lot. Even the largest bitcoin businesses would represent only a few hundreds of thousands of dollars of revenue to a bank, which is pennies to them.”

Global credit card fraud is on the rise. For payment processors, bitcoin could just complicate things. Tinkercoin has experienced rejection by a major credit card company, which is not surprising given that fraud protection is a standard accouterment to possessing plastic. “Their potential losses are in the tens of millions if the business is subject to fraud, or the business runs afoul of the regulators.” MacLeod’s experience with banks and financial companies gives an outsider some perspective on the challenges working hand in hand with the savings & trust down the street.

The onus is on bitcoin companies

The case for bitcoin may be that the companies building bitcoin businesses will simply have to find ways to comply with financial regulations before regularly interfacing with banks. Coinsetter, a bitcoin-based trading platform that bears more resemblance to currency trading than that of Mt. Gox, is geared towards that view. The CEO of Coinsetter, Jaron Lukasiewicz, has had numerous conversations with banks and is certain that the path forward is complete compliance from the start.

Coinsetter’s trading platform, still in beta, allows for investment strategies like margin trading.

“Bitcoin companies, especially exchanges, can succeed by creating strong AML programs before entering into discussions with banks”, says Lukasiewicz. “The more they can guarantee that bitcoins aren’t being sent to bad places, the better.”

In terms of entrepreneurship, this is a vastly different strategy to employ when compared to a regular startup. As anyone who has started a business or worked in a bootstrapped entity, it’s all about doing whatever it takes to get off the ground. With bitcoin, it’s going to be different: if you don’t have the right rules in place from the beginning, there is a risk that you will get shut out of the system and possibly fail.

A guaranteed market

Again, a bank’s propensity to do business with a particular person or entity comes down to risk. It may be that a maker will need to guarantee a market for bitcoins. Remember when Mt. Gox couldn’t handle the trading on its own platform and had to shut down for 12 hours? Banks do not want something like that to happen. Ever.

On April 11, 2013, Mt. Gox suspended trading on its exchange for 12 hours. Banks do not want something like this to occur. John Paul Engel, who runs the boutique management consulting firm Knowledge Capital, believes that a big player in finance is going to have to get involved in decentralized currencies. Only then will bitcoin become legitimized in the eyes of credit card companies, payment processors, and the local thrift. A respected market maker would have to step up and guarantee a market in bitcoins.

Engel believes some institutions will need to “effectively provide a bid (buy) and an ask (sell) spread on a constant basis. The organization would need to have the credibility and the resources to guarantee it. Someone like a Goldman Sachs or Berkshire Hathaway. Someone with deep enough pockets to ensure the float.” Goldman Sachs being a bitcoin market maker? It sounds like something from fiction, but it’s probably closer to reality than ever before.

Banks have two choices

Banking innovation in financial services as a result of bitcoin is likely to take some time. The process that the banking industry goes through to enact any sort of change is slow and calculated. It all goes back to that risk versus reward proposition. Financial institutions have little incentive to “fail fast”, a common method of moving forward in an entrepreneurial or startup scenario. It's what bitcoin startups would prefer to go through in order to develop products and services, but is not realistic.

Many banks are fearful that the sector is about to go through wrenching change. At this point, it appears that banking may have reached a fork in the road. They likely have two choices. Institutions could begin to work within the new, continuously evolving framework of digital money. That would require them to start by recognizing that there is a shift in financial technology and embrace that movement.

Or, they could put a friendly face on an old system. That would be the route that is being put forth with products like Simple. This is whereby a contemporary type of interface masks the traditional, antiquated banking system that is running in the background. We’ll probably end up seeing different banks choosing different routes depending on their attitude of disruptive tech like bitcoin. What do you think about banks working with bitcoin companies? Is it fair that banks don’t want to do bitcoin-based business? What do you expect banks to do when faced with the proposition of decentralized virtual currencies?

Chuck Reynolds
Contributor

Alan Zibluk Markethive Founding Member

Hard Fork Will Slow Bitcoin Price Down

  

With the ETF decision out of the way, the focus in the Bitcoin community has turned back to the scaling debate. While some proponents of an increase in block size are in favor of a hard fork, South African Bitcoin entrepreneur Vinny Lingham feels that this would negatively impact Bitcoin.

Scaling arguments

The Bitcoin network seems to be choking at the moment, with unconfirmed transactions piling up, transaction fees shooting through the roof and a general sluggishness across the network. Microtransactions have more or less ended, with high transactions fees making them unviable. Everybody agrees that there is a problem but unfortunately, consensus eludes the Bitcoin community on what the solution should be. The Core team believes that retaining block size at 1 MB is crucial to maintaining the distributed nature of the Bitcoin network, while others advocate increasing the block size to increase the network capacity.

Bitcoin Unlimited

Bitcoin Unlimited (BTU), which seeks to transfer power to decide on the block size to the miners, has emerged as a frontrunner to handle this problem. The proportion of nodes who have “signaled support” to Bitcoin Unlimited has increased steadily to over 30 percent. It has overtaken SegWit, currently backed by the Bitcoin Core team, which has 28 percent of nodes supporting it.

The increasing support for Bitcoin Unlimited has had some unintended consequences, with a bug in the software (since rectified) resulting in a number of codes crashing and doomsday scenarios being predicted if Bitcoin Unlimited becomes successful. Once the number of miners signaling support for Bitcoin Unlimited crosses 50 percent, it is possible for a miner to generate a block size greater than 1 MB, thereby forking Bitcoin.

Why is Vinny Lingham against a hard fork?

Vinny Lingham believes that Bitcoin has the potential to reach $3000, only if there is no hard fork.

“Danger on the horizon. If Bitcoin forks, all bets are off and we can kiss $3k BTC in 2017 goodbye…”

Vinny believes that Bitcoin’s greatest asset is its brand awareness, which will get diluted if there is a hard fork. It could lead to confusion for the common man of which Bitcoin is the real one. Merchants might avoid both BTC and BTU because of the confusion. It could also result in rival factions dumping both versions of Bitcoin at exchanges, thereby depressing the price.

Vinny points out to what happened to Ethereum Classic when the Ethereum Foundation sold off their coins. Moreover, the network effect would decrease with users divided between BTC and BTU, thereby lowering the overall value of Bitcoins in circulation. While the block size debate has sharply polarized the Bitcoin community, working together would be the only way to ensure that Bitcoin’s value is not destroyed.

Bitcoin Price Shrugs Off Bitcoin

 

Bitcoin’s price remained stable as news surfaced of a bug in Bitcoin Unlimited (BU) shutting down half of its nodes. On Tuesday, BU’s node numbers dropped suddenly from around 800 to 400, with developer Andrew Stone and investor Roger Ver subsequently confirming that an attacker exploited a bug in the protocol.

 

Stone wrote on Tuesday:

“We are seeing an abnormal, hard-to-create input result in a negative outcome so we are classifying this as a network attack.”

The events unleashed a frenzy of social media activity which even engulfed some of cryptocurrency’s best-known names. Core developer Peter Todd took to Twitter to deny any involvement in the bug, about which he tweeted an hour after the malicious episode began. Responding to Todd, tech blogger Avatar X alleged that fellow developer Greg Maxwell had said that two further bugs were present in BU which had “yet to be fixed.” Meanwhile, received hostility. One BU node operator accused him and other responsible parties of “plain incompetence” as panic gripped a community to whom Ver had only last week unveiled a brand new mining pool.

Chuck Reynolds
Contributor

Alan Zibluk Markethive Founding Member

Someone Wants to Stick a Fork in Bitcoin

 

Which bitcoin will prevail?

A dispute among the people involved in bitcoin is revealing a paradox of the digital currency: The same resistance to human meddling that drove its popularity may also be its greatest limitation. It seems that the only way to get anything done is to split the currency in two.

At issue is the size of blocks, the batches in which transactions are processed and that make up the links in the so-called bitcoin blockchain. Currently, they’re so small that the whole system can handle only about seven transactions per second — nowhere near enough to compete with, say, Visa network’s 24,000 transactions per second. Some people think that’s a good thing! Bitcoin relies on thousands of internet-connected volunteers, and their operating costs should be kept as low as possible.

On the other hand, many are unsatisfied with the system’s speed. A faction known as Bitcoin Unlimited has released a new version of the software that can create bigger blocks and is now rallying the support of bitcoin miners, who process transactions in return for new currency. The plan is to gain enough minor support to build its own branch-off the chain. Meanwhile, the computer geeks who develop the core bitcoin software have offered their own solution, which not only increases capacity but also enables the creation of low-value payment channels adjacent to the main network — the idea being that people might not need every coffee purchase immortalized on a globally distributed ledger.

Bitcoin and the Blockchain

The standoff illustrates a vulnerability. Because bitcoin relies on a worldwide network of individual computers to maintain the blockchain, one group can — intentionally or not — become separated from the rest. The two networks will thus accumulate different information, creating competing chains. If the “fork” is unintentional, the networks eventually reconnect and discard the lesser chain. But if the fork is intentional, as in the case of Bitcoin Unlimited, it can continue forever.

The insurgents’ software will eventually disconnect from anyone who doesn’t support their blockchain. The most troublesome part is that both sides want to assume the identity of bitcoin. This would be like the Confederate states seceding from the Union, then insisting that they were the real United States and that the northern states had voluntarily left. Ultimately, it will be up to individual users to either choose one chain or recognize both as legitimate currencies.

This is one reason it’s so hard to tame bitcoin by, say, creating an exchange-traded fund so regular investors can get a piece of the action. The ETF filing for the Winklevoss Bitcoin Trust actually includes a provision specifying which bitcoin network it will support in the event of a split. Another ETF filing for Grayscale’s Bitcoin Investment Trust acknowledges that the fund will end up with equal values of two types of bitcoin, and must select one to keep in the fund. Thus far, Bitcoin Unlimited has secured support from the world’s largest mining operation, as well as adoption from about 10 percent of the bitcoin network. Unfortunately, the campaign suffered a minor setback this week thanks to a software bug:

Past rebellions have eventually faded. To make a credible attempt at a coup, Bitcoin Unlimited must recruit major exchanges, wallets, and other service providers. It’s not easy: People who treat their digital currency as real money tend to be risk-averse when it comes to new software. Even the developers of core bitcoin have not yet gained enough support to activate their upgrade. While the impasse might be aggravating for those who find bitcoin transactions too sluggish, it’s far better than a blockchain that is too easily modified. After all, immutability is supposed to be a feature, not a flaw.

1. Incidentally, larger block sizes increase the risk of such partitions because nodes need to transmit more data to make sure everyone has consistent information.

2. After a fork, the chain that is kept is the one that took more computational effort to create. It’s often the longer one, but not always.

3. From the Winklevoss Bitcoin Trust S-1: “In the event of an upcoming modification to the Bitcoin Network that could potentially result in a hard fork with two separate and incompatible Bitcoin Networks, the Custodian, in consultation with the Sponsor, will elect to support the Bitcoin Network that has the greatest cumulative computational difficulty for the forty-eight (48) hour period following a given hard fork, in order to engage in bitcoin transactions and the valuation of bitcoin.”

   From the Bitcoin Investment Trust S-1: “If a permanent fork, similar to Ethereum, were to occur to bitcoin, the Trust would hold equal amounts of the original and the new bitcoin as a result. In consultation with the Index Provider, the Sponsor would select a Bitcoin Network (and therefore a single version of bitcoin). The Sponsor would simultaneously isolate the bitcoin on the Bitcoin Network that it did not select to segregate it from the Trust’s Bitcoin Holdings. The Sponsor’s intention would be to distribute to its Shareholders the bitcoin on the Bitcoin Network that it did not select.”

Chuck Reynolds
Contributor

Alan Zibluk Markethive Founding Member

What Blockchain Means for the Sharing Economy

Look at the modus operandi of today’s internet giants — such as Google, Facebook, Twitter, Uber, or Airbnb — and you’ll notice they have one thing in common: They rely on the contributions of users as a means to generate value within their own platforms. Over the past 20 years, the economy has progressively moved away from the traditional model of centralized organizations, where large operators, often with a dominant position, were responsible for providing a service to a group of passive consumers. Today we are moving toward a new model of increasingly decentralized organizations, where large operators are responsible for aggregating the resources of multiple people to provide a service to a much more active group of consumers. This shift marks the advent of a new generation of “dematerialized” organizations that do not require physical offices, assets, or even employees.

The problem with this model is that, in most cases, the value produced by the crowd is not equally redistributed among all those who have contributed to the value production; all of the profits are captured by the large intermediaries who operate the platforms. Recently, a new technology has emerged that could change this imbalance. Blockchain facilitates the exchange of value in a secure and decentralized manner, without the need for an intermediary.

How Blockchain Works
Here are five basic principles underlying the technology.

Alan Zibluk Markethive Founding Member

Google’s DeepMind has a plan for protecting private health data—from itself

As part of its projects with Britain’s National Health Service, Google’s artificial intelligence unit DeepMind announced last week it’s developing a new way to protect confidential health data—from itself. Its problem: How to assure hospitals, and the public at large, that patient confidentiality isn’t compromised as it processes the sensitive medical health records entrusted to it.

DeepMind’s proposed solution is to create an indelible data log that can’t be tampered with. It would show when a piece of data was used, and for what purpose. Importantly, DeepMind itself wouldn’t be able to modify logs to use the data nefariously. The solution bears resemblance to the “distributed ledger technologies” or “private blockchains” that the financial world has been trying to create in recent years. While loathe to call it “blockchain”—DeepMind prefers the term “verifiable append-only ledger” to describe its health data system—it is interested in one property that the technology can confer upon its users: trust.

While the banks want blockchains to slash back-office costs while staying compliant, DeepMind needs blockchains to shore up public trust. Last year, DeepMind’s work with the UK’s health service was dragged into the public by a New Scientist investigation. The publication found that 1.6 million patient names, addresses, and other information from three London hospitals had been shared with Google’s artificial intelligence subsidiary. It triggered an investigation by the UK’s privacy regulator that is ongoing. DeepMind and the hospitals say they followed the rules.

Huge data sets are what make artificial intelligence work. For DeepMind, access to a trove of national heath data could give it a significant advantage in the race to develop AI techniques for healthcare (although it says the Streams app that it’s devising with the three London hospitals doesn’t involve AI). Nonetheless, DeepMind needs to assure the hospitals—and the public—that it’s handling sensitive medical data safely. “We hope that by building tools like this in the open, we’ll improve the level of trust that patients have with respect to this data access,” DeepMind co-founder Mustafa Suleyman says.

But for all its talk of transparency, letting patients access their own data logs isn’t part of DeepMind’s plan. Suleyman says it might happen one day, but that his firm’s obligation is to the hospitals. DeepMind is the data processor to the hospitals, which are the data controllers. “Our job is to help them do a better job of their own governance. In the long term, you can see the potential patient benefit … but it’s a bit early,” Suleyman says. This is a crucial distinction because under European data protection laws controllers bear heavier responsibilities (pdf).

So who owns what, when it comes to DeepMind’s health blockchain? The underlying data belongs to the hospitals, while the software belongs to DeepMind, says Suleyman. The data logs, created when the software processes the patient data, also remain under the hospitals’ control, DeepMind says. And what happens if there’s an error in logging the data since the records can’t be changed? The hospitals will have to figure that out, says Suleyman. “We provide that [data] set to the controller, namely the hospital. They already have a whole host of processes to deal with various degrees of error that may or may not have been made,” he says.

DeepMind says the system will be used sometime this year. It will be built on a foundation devised by Ben Laurie, its head of security and privacy. While at DeepMind’s parent company, Google, Laurie created a similar system to ensure security certificates issued by websites haven’t been tampered with, called the Certificate Transparency scheme.

For watchers of financial blockchains, DeepMind’s entry to it's space indicates progress for the technology powering these private blockchains. “It’s interesting, whatever it is,” says Simon Taylor, a co-founder of fintech consultancy 11:FS. “And in my opinion, a sign of where the market will move.” Not every business sector will need the sort of global, public, agreement on a ledger’s entries that cryptocurrencies like bitcoin require, he points out. Wall Street now has well-qualified company in the attempt to graft blockchain technology to existing industries.

Chuck Reynolds
Contributor

Alan Zibluk Markethive Founding Member

Congress Takes Blockchain 101

Congressman David Schweikert is determined to enlighten his colleagues in Washington about the blockchain. The opportunities the technology creates for society are vast, he says, and right now education is key to keeping the government from “screwing it up.”

Schweikert, a Republican from Arizona, co-chairs the recently launched Congressional Blockchain Caucus. He and fellow co-chair, Democratic Representative Jared Polis of Colorado, say they created it in response to increasing interest and curiosity on Capitol Hill about blockchain technology. “Members of Congress are starting to get visits from people that are doing things with the blockchain and talking about it,” says Polis. “They are interested in learning more, and we hope to provide the forum to do that.”

Blockchain technology is difficult to explain, and misconceptions among policymakers are almost inevitable. One important concept Schweikert says more people need to understand is that a blockchain is not necessarily Bitcoin, and there are plenty of applications of blockchains beyond transferring digital currency. Digital currencies, and especially Bitcoin, the most popular blockchain by far, make some policymakers and government officials wary. But focusing on currency keeps people from seeing the potential the blockchain has to reinvent how we control and manage valuable information, Schweikert argues.

A blockchain is a decentralized, online record-keeping system, or ledger, maintained by a network of computers that verify and record transactions using established cryptographic techniques. Bitcoin’s system, which is open-source, depends on people all around the world called miners. They use specialized computers to verify and record transactions and receive Bitcoin currency in reward. Several other digital currencies work in a similar fashion.

Digital currency is not the main reason so many institutions have begun experimenting with blockchains in recent years, though. Blockchains can also be used to securely and permanently store other information besides currency transaction records. For instance, banks and other financial companies see this as a way to manage information vital to the transfer of ownership of financial assets more efficiently than they do now. Some experiments have involved the Bitcoin blockchain, some use the newer blockchain software platform called Ethereum, and others have used private or semi-private blockchains. 

The government should adopt blockchain technology too, say the Congressmen. A decentralized ledger is better than a conventional database “whenever we need better consumer control of information and security” like in health records, tax returns, voting records, and identity management, says Polis. Several federal agencies and state governments are already experimenting with blockchain applications. The Department of Homeland Security, for example, is running a test to track data from its border surveillance devices in a distributed ledger.

The growing demand in the private and public sector for blockchain services has spawned a plethora of startups and enticed hundreds of millions of dollars of venture capital. But the nascent industry is handicapped by an uncertain regulatory landscape at both the state and federal level, says Perianne Boring, founder and president of the Chamber of Digital Commerce, a Washington, D.C.-based trade association.

Boring has argued that financial technology companies would benefit from a regulatory safe zone, or “sandbox”—like those that are already in place in the U.K. and Singapore—where they could test products without the risk of “inadvertent regulatory violations.” We don’t need any new legislation from Congress yet, though—that could stifle innovation, even more, she says. “What Congress should be doing is educating themselves on the issues.”

Chuck Reynolds
Contributor

Alan Zibluk Markethive Founding Member

Blockchain Will Transform Customer Loyalty Programs

Loyalty programs have proliferated across travel, retail, financial services, and other economic sectors. The average U.S. household participates in 29 different loyalty programs, according to the 2015 Colloquy Loyalty Census. The result is a maze of point systems and redemption options, with cumbersome processes for exchanging points among program partners. Loyalty programs are ripe for some kind of disruptive innovation that would make them easier to use.

Blockchain may just be the answer. Best known as the technology behind bitcoin, blockchain enables a ledger of transactions to be shared across a network of participants. When a new digital transaction occurs (for example, a loyalty point is issued, redeemed, or exchanged), a unique algorithm-generated token is created and assigned to that transaction. Tokens are grouped into blocks (for example, every 10 minutes) and distributed across the network, updating every ledger at once. New transaction blocks are validated and linked to older blocks, creating a strong, secure, and verifiable record of all transactions, without the need for intermediaries or centralized databases.

For consumers juggling an array of loyalty programs, blockchain could provide instant redemption and exchange for multiple loyalty point currencies on a single platform. With only one “wallet” for points, consumers would not have to hunt for each program’s options, limitations, and redemption rules.

All loyalty programs are vulnerable to a blockchain revolution, but the travel industry is perhaps the most at risk. Travel loyalty programs tend to be complex and multicurrency, making them different from retailers, which typically run simple discount programs, or from banks, which offer cash back or a single currency that can be spent easily across a range of merchants. In some cases, travel loyalty program points differ by journey component (flight, car rental, hotel, dining), leading to fragmented point collections, and a typical “breakage” rate (meaning the share of points not redeemed) of 10%–20%, in our estimation. Plus, it can be difficult for the average person to accumulate enough points to earn a meaningful reward.

The Benefits of Disruption

Many industries have experienced disruption, due to technologies that successfully reduced inefficiencies and frictions, often disintermediating established players in the process. Large travel companies, such as airlines and hotel chains, know this from painful experience: They pay billions of dollars in commissions each year to Priceline, Expedia, and other online travel agencies (OTAs), which have transformed how consumers book flights, hotels, and rental cars. Blockchain-based loyalty platforms could be another such disruption.

Both small startups and large-scale technology companies are eyeing the possibilities this presents, and some are teaming up. IBM, for example, is partnering with startup Loyyal to develop blockchain infrastructure for loyalty and rewards programs. Travel companies with loyalty programs, whether stand-alone or part of a larger alliance, will have to figure out how to respond.

Early adopters could benefit considerably. First, blockchain could help relieve a large balance-sheet liability that many in the industry are facing. Loyalty programs have long relied on cobranded cards and partnerships to sell points and generate incremental revenue. But the number of airline seats and hotel rooms available for redemption in recent years has been limited by near-record occupancy and load factors. The result has been a growing volume of unredeemed points, which new accounting standards have turned into a headache: Revenue attributable to the value of loyalty points must be deferred until the miles are redeemed.

Adopting blockchain would enable companies to rapidly add and maintain loyalty partnerships without adding complexity to their programs. A robust, frictionless partner network could mean many more redemption options outside of the core travel product, thereby creating a much-needed release valve for these growing balance-sheet pressures.

Second, blockchain would enable businesses to break out of the loyalty program mold of narrowly defined, one-size-fits-all programs and redemption processes filled with customer hassles. Consumers increasingly expect personalized (not merely segmented) travel offerings and digitally enabled one-stop services; the growth of OTAs is in part a testament to that. Blockchain would allow both large and local partners to be added seamlessly, making the crafting of on-trend offers much easier, while virtually eliminating the back-end irritations of point redemption.

Caveats for Adoption

What shape are blockchain-based loyalty networks likely to take? Initially, each loyalty program might look to develop its own solution, but over time smaller loyalty programs might choose to band together to compete more effectively with larger ones. Ultimately, we expect to see the development of four to six blockchain-based loyalty networks, each anchored by a major airline, a major hotel chain, or a group of smaller travel companies. Options for building and maintaining the blockchain platform could include a joint venture with technology partners or with network providers such as banks or payment card processors.

Of course, the introduction of one or more blockchain platforms unifying multiple loyalty programs could pose a number of risks. Such platforms would add a transaction layer between consumers and program operators and merchants, likely generating a small per-transaction cost, which could grow over time, much like OTA fees. Customer data, a loyalty program’s most valuable asset, could become available to other network participants, even competitors. Currency devaluation is another risk in what is essentially an open marketplace for points trading.

To reduce these risks and avoid having their loyalty programs become commoditized, travel companies should get in on the ground floor of blockchain platform development. Participating in the initial structuring of commercial agreements and partnerships will be essential to protecting critical loyalty program components, including currency value, customer data and relationships, and transaction costs.

For any travel company considering an investment in blockchain, a few rules will be essential. First, they will want to participate in defining how currency is exchanged between programs — that is, how currency exchange rates are set, and any transferability rules. Second, they should seek to maintain exclusive control over their data, ensuring that only loyalty points, and not associated customer information, enter the transaction stream. Third, they should require guarantees that the platform is and will remain unbiased. Otherwise, traditional travel intermediary tools, such as paid search placements and exclusive promotions, could force companies into pay-to-play arrangements to ensure competitors don’t gain an advantage.

Travel companies, such as airlines and hotel chains, recognized too late the power of OTAs to disrupt the industry, and have been paying for that misstep ever since. The nascent state of blockchain for loyalty programs offers an opportunity to realize the value of disruption and shape its future impacts — if travel companies don’t wait too long.

Chuck Reynolds
Contributor

Alan Zibluk Markethive Founding Member

Global Supply Chains Are About to Get Better, Thanks to Blockchain

 

When an E.coli outbreak at Chipotle Mexican Grill outlets left 55 customers ill, in 2015, the news stories, shutdowns, and investigations shattered the restaurant chain’s reputation. Sales plummeted, and Chipotle’s share price dropped 42%, to a three-year low, where it has languished ever since.At the heart of the Denver-based company’s crisis was the ever-present problem faced by companies that depend on multiple suppliers to deliver parts and ingredients: a lack of transparency and accountability across complex supply chains. Unable to monitor its suppliers in real time, Chipotle could neither prevent the contamination nor contain it in a targeted way after it was discovered.

Now, a slew of startups and corporations are exploring a radical solution to this problem: using a blockchain to transfer title and record permissions and activity logs so as to track the flow of goods and services between businesses and across borders. With blockchain technology, the core system that underpins bitcoin, computers of separately owned entities follow a cryptographic protocol to constantly validate updates to a commonly shared ledger. A fundamental advantage of this distributed system, where no single company has control, is that it resolves problems of disclosure and accountability between individuals and institutions whose interests aren’t necessarily aligned. Mutually important data can be updated in real time, removing the need for laborious, error-prone reconciliation with each other’s internal records. It gives each member of the network far greater and timelier visibility of the total activity.

How Blockchain Works

Here are the basic principles underlying the technology.

Distributed Database
Each party on a blockchain has access to the entire database and its complete history. No single party controls the data or the information. Every party can verify the records of its transaction partners directly, without an intermediary.

Peer-to-Peer Transmission
Communication occurs directly between peers instead of through a central node. Each node stores and forwards information to all other nodes.

Transparency with Pseudonymity
Every transaction and its associated value are visible to anyone with access to the system. Each node, or user, on a blockchain has a unique 30-plus-character alphanumeric address that identifies it. Users can choose to remain anonymous or provide proof of their identity to others. Transactions occur between blockchain addresses.

 Irreversibility of Records
Once a transaction is entered in the database and the accounts are updated, the records cannot be altered, because they’re linked to every transaction record that came before them (hence the term “chain”). Various computational algorithms and approaches are deployed to ensure that the recording on the database is permanent, chronologically ordered, and available to all others on the network.

Computational Logic
The digital nature of the ledger means that blockchain transactions can be tied to computational logic and in essence programmed. So users can set up algorithms and rules that automatically trigger transactions between nodes.

More on The Blockchain

In a nutshell, this is a global system for mediating trust and selective transparency. Its advocates say it will take the internet’s empowering potential to its next level. Although much attention and money has been spent on financial applications of the technology, an equally promising test case lies with global supply chain relationships, whose complexity and diversity of interests pose exactly the kinds of challenges this technology seeks to address. The technology can reveal hitherto hidden information and allows users to attach digital tokens — a unique, negotiable form of digital asset, modeled on bitcoin — to intermediate goods as they progress along the production, shipping, and delivery phases of a supply chain and as title to them passes between different players. This could give businesses far greater flexibility to find markets and price risk, by capturing the value that they have invested in the process at any point along the chain. What we end up with are dynamic demand chains in place of rigid supply chains, resulting in more efficient resource use for all.

Various endeavors have already started. Provenance, a UK-based startup, tells prospective clients they can use its blockchain-based technology to “share your product’s journey and your business impact on environment and society.” Walmart is working with IBM and Tsinghua University, in Beijing, to follow the movement of pork in China with a blockchain. Mining giant BHP Billiton is using the technology to track mineral analysis done by outside vendors. The startup, Everledger, has uploaded unique identifying data on a million individual diamonds to a blockchain ledger system to build quality assurances and help jewelers comply with regulations barring “blood diamond” products.

How technology is transforming transactions.

Advances in chip and sensor technology, which can translate data from the automated movement of physical goods, should greatly enhance these emerging blockchain systems. It could be especially powerful when combined with “smart contracts,” in which contractual rights and obligations, including the terms for payment and delivery of goods and services, can be automatically executed by an autonomous system that’s trusted by all signatories.

But this technology’s potential traceability and automation benefits don’t just pertain to things; it could also keep human beings in check. Staff and supervisors from different vendors can be granted special, cryptographic permissions, which, when placed into a blockchain environment, would appear as unique, traceable identifiers — preferably encrypted, to protect the employee’s personal information. This would allow all members of a supply chain community to monitor the activity of each other’s credentialed staff. Chipotle, for example, could see in real time whether a properly credentialed person in a facility owned by one of its beef suppliers is carrying out appropriate sterilization and disinfection procedures.

This kind of provable, transparent credentialing will be especially important for additive manufacturing, which is central to the dynamic, on-demand production model of the so-called Industry 4.0 movement. A team from precision parts manufacturer Moog Inc. has launched a service it calls Veripart, which seeks to overcome a challenge that the director of its additive manufacturing and innovation unit, James Regenor, described to us in these terms: “How can the maintenance crew on a U.S. aircraft carrier have absolute confidence that the software file they downloaded to 3D print a new part for a fighter jet hasn’t been hacked by a foreign adversary?” This underscores one of the most compelling arguments for blockchain technology: Without its solution to the trust problem, the sophisticated, decentralized, internet of things–driven economy that many are projecting might well be impossible.

These potential efficiency improvements, enabled by hitherto unavailable information, suggest blockchain technology could deliver vast savings for companies everywhere. But there are formidable obstacles to overcome first.

One challenge lies in the development and governance of the technology. Ideally, to encourage free access, competition, and open innovation, global supply chains would have the option to anchor to a public blockchain that no entity controls. In other words, data extracted from commercial and production activity would be cryptographically recorded in open ledgers. But, inevitably, private, closed ledgers run by a consortium of companies will also arise, as their members seek to protect market share and profits. Both imperatives pose challenges. For one, achieving global economic capacity for the most significant public blockchains, digital currency service bitcoin and smart contract platform Ethereum, is constrained by divisions in their open-source communities, making it difficult to agree on protocol upgrades. Second, there needs to be interoperability across private and public blockchains, which will require standards and agreements.

Another big obstacle: the law. A complex array of regulations, maritime law, and commercial codes governs rights of ownership and possession along the world’s shipping routes and their multiple jurisdictions. Marrying that old-world body of law, and the human-led institutions that manage it, with the digitally defined, dematerialized, automated and denationalized nature of blockchains and smart contracts will be difficult.

Even before governments can be convinced to support this effort, and to do so in a globally coordinated way industry must agree on best practices and standards of technology and contract structure across international borders and jurisdictions. In Hong Kong, the recently formed Belt and Road blockchain consortium seeks to bring order to this process by adopting internet governance approaches pioneered and tested by ICANN (Internet Corporation for Assigned Names and Numbers), the organization that manages domain names. As an international, private sector–led body, ICANN has already proven itself to be an effective global administrator and adjudicator.

These challenges must be weighed against the demands of a global economy that hasn’t properly recovered from the financial crisis of 2008 and is fueling disintegrating, isolationist forces in the U.S. and Europe. Any system that promises to counter those trends by removing the intercommercial frictions that curb trade while also enhancing transparency and control for businesses and their customers is inherently worth exploring. It’s why an increasing number of investors, businesses, academics, and even governments are starting to view blockchain technology as a much-needed platform for economic renewal.

Chuck Reynolds
Contributor

Alan Zibluk Markethive Founding Member