Bitcoin 2.0: Bringing Us Back to the Village

NEW YORK—Bitcoin was supposed to propel us far into the future. Instead it is taking us back to a preindustrialized world, as the bitcoin technology has applications far beyond its use as a virtual currency.

“We have developed technologies that have enabled us to go back to the village,” said Joseph Lubin, COO of Ethereum, a leader in developing applications and services based on bitcoin technology.

Lubin is talking about the rule of consensus of ancient times as opposed to the top-down hierarchical organizations that rule our world today. But how can the futuristic bitcoin system of solving mathematical puzzles to validate transactions achieve that?

If we take a financial transaction as an example, one application would be to pay for software online in bitcoins. Now, instead of one party such as Visa or MasterCard saying the transaction is valid, because it fulfills all the requirements of their systems, the whole network of participants has to agree it fulfills the requirements set forth in the initial protocol, which is open source.

Fairness

The beauty of this consensus-based approach is its inherent fairness and resistance to corruption.

“There will be ways to manipulate people to make bad decisions, but there won’t be ways to manipulate the system itself,” says Lubin.

The system under development by Ethereum and a couple of other companies is fair because the protocol and the rules of the game are open source and cannot be changed arbitrarily. Every transaction gets logged on a centralized ledger, the so-called blockchain, for everybody to see and validate. Of course, only the code is visible, whereas the details of the transaction are hidden and the identities of the users unknown by default.

The system cannot be corrupted because “there is no central point of control or weakness,” according to Lubin.

Given the peer-to-peer network consists of thousands or millions of different so-called miners—they get paid in virtual tokens like bitcoin to validate the transactions—no single actor has control over the data, which is always encrypted.

This is the exact opposite of monolithic entities, like Visa or MasterCard, which in the past have been pressured into stopping transactions to WikiLeaks for example.

Other bad examples of the abuse of central decision-making power include the likes of Facebook and Google, which handed over private data wholesale to the NSA because an individual company can be put under pressure.

Thousands of different actors cannot. “There are 50,000 miners out there, go talk to them. None of them can decrypt the data, only the people with the secret key can decrypt things,” said Lubin. Because the keys are in the hands of private individuals and companies, only they can decrypt data belonging to them.

Everything Goes

In terms of potential applications, the possibilities are endless.

“We could transmit any type of value back and forth. The whole world of possibilities is open, and we’re just starting to imagine it,” said Gil Luria, an analyst at Wedbush securities, one of the first investment firms to publish research on bitcoin.

“Pretty much anything you can imagine will be reimagined as a distributed system. A lot of things will move to blockchain technology,” said Lubin.

The Ethereum system, for example, will be able to host decentralized applications such as online payments, messaging, and decentralized marketplaces replacing the centralized systems of eBay or Amazon, and even stock exchanges.

Efficiency

One big area where the efficiency of the technology could come into play is real estate.

“Real estate transactions are some of the most cumbersome illiquid transactions that we could possibly have designed,” said Luria. According to him title and escrow companies as well as brokers make a lot of money facilitating the trust between buyer and seller.

“When you have a centralized asset ledger [the blockchain] that everybody has a visibility to, and is completely auditable, you can do multi-signature transactions, you could change that process,” Luria said, thereby cutting out the middlemen and reducing transaction costs.

“At some point in time, this isn’t tomorrow, but ultimately, ten years from now we could get to a point where real estate transactions could be done within an hour, as opposed to over a month,” said Luria.

Lubin agrees that real estate transactions will be improved by blockchain technology, and also adds insurance.

“People are pooling their own capital to self-insure and this could be done on any scale,” he said. According to him, any number of people could enter into a contract on the blockchain and deposit money to be paid out in the event of damage.

In case of damage, you would still need a real world validator to confirm the specifications set forth in the online contract. But then the claims could be paid instantly, without insurance company employees or shareholders taking a share.

Vulnerability

Despite the decentralized design of the current bitcoin system, there is one major flaw, which still could be exploited according to Lubin.

“If the Chinese government wants to kill bitcoin, they can produce an enormous amount of [specialized mining computers] and suddenly have more than 50 percent of the computing power of the network.”

Consensus means your solution has to be accepted by more than 50 percent of the network. If you control more than 50 percent, you make the decisions.

“It’s possible. It would be politically extremely unpopular. Bitcoin is still very small, so it doesn’t make a lot of sense for governments to attack it that way,” said Lubin.

Because of this issue, Ethereum is designing its system in a way to avoid some of the problems bitcoin faces.

“Ethereum mining will be centralization hard. We will create a proof of work algorithm which makes it extremely difficult and cost-ineffective to create [specialized mining computers],” he said.

The algorithm itself might also be subject to change. “I don’t think bitcoin should be more than the fat-pipe financial infrastructure for the crypto industry. Ethereum, because it’s computer software, it will have to get better and better like normal applications as well,” he said.