The invention of Bitcoin in 2008 marked the beginning of a new era in finance and economics. It removed the need for trusted human parties to operate financial systems. In this article we will attempt to understand the nature and significance of this transition. In doing so we strive to identify and articulate the impact blockchain technology can have on the future of society.

At the core of the notion of money are properties that stand in sharp contradiction with one another. There are things anyone should be able to do with money easily and at will — transfer it, exchange it, break it into smaller units, store it, transport it, and secure it. On the other hand there must be restrictions in place to prevent anyone from issuing money and from taking it away from others.

The contradiction between these two classes of actions — those that should be easy to do and those that should be severely restricted — leads to a situation where the creation and maintenance of a monetary system lands firmly in the hands of large entities that possess resources sufficient for the task, think FBI and Secret Service Counterfeit Department. Furthermore, the effort of ensuring the safety and validity of individual transactions is, similarly, one that can only be carried out by specialized organizations (such as banks) to whom we are all forced to lend our trust for lack of better options.

“Operating costs of human-enforced systems are inefficiencies that hamper down the whole system.”

In modern financial systems most of the tasks that underlie monetary transactions must rely on the goodwill of people performing them. When it comes to numbers and mechanical tasks people are notoriously unreliable. Additionally, when individuals find themselves in control of monetary flow they often tend to become corrupt by it. Moralism aside, this is human nature and we must deal with it the best way we can. Historically, this meant installing layers upon layers of additional control structures whose aim was to verify correctness of transactions and detect corrupt behavior.

We hope that, on balance, the cost of these additional layers together with the cost of mistakes and remaining corruption is manageable. Opinions are divided on this and in some places this process works better than in others. However, one thing is clear: these costs are significant whatever you do. They are inefficiencies that hamper down the whole system.

Consequently, today’s financial systems can only function when they reach a certain size. The reasons for this are two-fold. On one hand, the costs of these inefficiencies can only be absorbed by a sufficiently large economy of scale. On the other hand, some of the resources required to operate such systems (law enforcement, armies) are only available to sovereign governments.

“It’s a qualitative shift that can be equalled only to the most critical innovations in human history.”

Blockchain provides an alternative to this picture. In cryptofinance at least some of the tasks that were traditionally performed by people can now be delegated to decentralized computer networks that are highly reliable and to a large extent independent of human goodwill. This introduces not just a marginal increase in efficiency. It’s a qualitative shift that can be equalled only to the most critical innovations in human history.

To understand this, let’s pause to emphasize specifically the distinction between blockchain technology and traditional digital finance of the last three decades. Electronic banking is a significant advancement and has, similarly, eliminated many tasks which were previously performed by people. Yet, while making the process more efficient it did not address the agency problem which is the key issue in the overall inefficiency of modern finance. It is reliant on people’s goodwill just as much as paper finance. It involves trusted participants at every level.

The trust we lend to those who carry out modern financial transactions is two-fold. On one hand, we must trust that people will do the right thing. So, programmers are trusted to develop correctly functioning software, back-office personnel is trusted to perform reconciliations, traders and bank tellers are trusted to enter the numbers into their systems correctly. Correctness, of course, is ensured by additional expensive layers of controls and verifications.

But we must also trust that those involved will not do the wrong thing. So once a particular system is put in place, we trust that it will not change in material ways without us knowing about it. We trust that those who move our money do not take it away from us. This, again, requires layers of control, but more importantly, history shows that this trust is broken more often than one would hope.

“The blockchain deals with the agency problem completely.”

This is where blockchain systems make a qualitative shift. Unlike modern digital finance, if blockchain is functioning correctly it makes formal guarantees within some well-understood parameters (for example, the assumption that the majority of the nodes is honest) that no one can circumvent the rules with which it was coded. Not the participants of the network. Not the developers of the network. Not the users. Nobody.

In this sense, blockchain deals with the agency problem completely. It simply doesn’t require the layers of control and verification that prior financial systems necessitated. The resulting increase in efficiency is vast, not marginal. It spans orders of magnitude.

This transition makes possible innovations in two areas: accessible customized finance and mini-economics.

In customized finance the problem is that, traditionally, creating financial instruments with novel properties was an exclusive prerogative of large wealthy organizations with access to a staff of legal experts and qualified operational personnel. It is a mistake to think that the reason for this is overregulation. The expense of creating customized financial instruments is due mostly to the way these contracts and transactions are carried out — by people. To build the human control layers needed to transact custom financial instruments is expensive and complicated. Consequently, most of us are limited to well-understood models and a small number of instrument types.

Mini-economics refers to a new-found ability to create tokens of value with very small market capitalizations, even as small as a few thousand dollars. The properties of such instruments can be customized to needs of very small organizations and don’t require the scale that was previously necessary for them to function. These too become possible due to incredible improvements in efficiency that blockchain offers. Furthermore, decentralized exchanges and other infrastructural components of blockchain ecosystems make these instruments safe and accessible to a large community of participants.

“This is a recipe for a new wave of innovations of unimaginable scale”

Do you remember what happened when people were able to create small customized electronic devices after the invention of transistor? Small customized personal computers after the invention of microchips? Small customized software systems after the invention of compilers? History teaches us that when efficiency increases past a certain point, the innovation potential becomes truly incredible.

What I am describing here is an ability to create small, accessible, and customized economic systems. This is a recipe for a new wave of innovations of unimaginable scale. Economic transactions facilitate virtually every aspect of our lives, every aspect of every commercial organization, in governance structures, supply chains, transportation networks, payments, and on it goes. The key point here is not as some may claim that some hypothetical bad guys no longer have power over our finance. It is that individuals and small organizations can experiment and innovate in the area that was previously inaccessible to them.

I couldn’t possibly predict at this time all the forms this may take. However, some cutting edge business models are being explored as we speak. The social network called Steem turns user acquisition process on its head by issuing cryptocurrency in payment for posting content. Data storage network Sia allows people to rent disk space from each other using a blockchain-based assets, for a fraction of the price that DropBox charges for a similar service but with a guarantee of absolute privacy. Public blockchain is entering every industry from movies and digital content distribution to real estate and transportation networks.

“The tremendous increase in efficiency that blockchain brings will free up resources, both financial and cognitive, that will be needed to mitigate the risks it poses.”

In conclusion I’d like to use the vantage point of efficiency to address a question a lot of people are asking about blockchain. The question is whether blockchain can be used for illegal purposes (canonical examples being drug sales, assassination markets and child pornography) and whether that poses a real danger to society. While to give a complete answer to this question will require a whole other article, I want to point the reader's attention to the early days of the Internet and the similar questions that were being posed back then. Today the answer is obvious. We always adjust to innovation and find ways of mitigating its risks. But most importantly, in significant ways, the Internet today is a tool of law enforcement not just that of the criminals.

Same is true about blockchain technology. The tremendous increase in efficiency that it brings will free up resources, both financial and cognitive, that will be needed to mitigate the risks it poses. It is merely a matter of time and staying aware and realistic about the nature of the change that is taking place.

Welcome to the future.