By Ashley Lannquist, MBA Student at Haas School of Business, UC Berkeley. Original article published in Medium and accessible here: http://bit.ly/2B1zPR3

The blockchain technology ecosystem is building a future that will be more decentralized and democratic, whose beneficiaries will range widely from Syrian refugees to investment banks. The World Economic Forum estimates that by 2027, 10% of global GDP will be stored on blockchain technology.

Rapidly evolving blockchain technology and startups are poised to fundamentally change entire business models, fundraising models, business operations, payments systems, and more. Despite the importance of this emerging technology, much unfamiliarity surrounds the topic.

The purpose of this essay, divided into three parts, is to 1) explain blockchain, cryptocurrency, and recent trends, 2) describe blockchain applications, or “decentralized apps” (DApps) and their tokens, and 3) elucidate how blockchain technology will be used to redesign the Internet and economy of the future.

1.1 Blockchain & Cryptocurrencies Explained!

The Bitcoin blockchain launched in 2009 as a peer-to-peer (P2P) digital payment system. Its creator ingeniously derived a system, using computer networks, cryptography, and game theory (now collectively called “cryptoeconomics”) for parties around the world who do not know each other to conduct and record transactions without an intermediary.

The bitcoin “cryptocurrency,” which can also be called a “token,” is the digital currency that users send to transfer value in this payments system. By circumventing intermediaries, users can send value across borders using the Bitcoin blockchain for extremely low fees (less than 50 cents per transaction, regardless of the amount sent).

Blockchain’s game theory component is essential: It establishes incentives and disincentives based on pure economic rationality and self-interest for participants to validate transactions in the network and to play by the rules. It underlies the self-regulating mechanisms in decentralized networks and applications. Game theory also informs the robustness of the network to malicious activity from harmful or adversarial actors within its system. This robustness is usually described in terms of “byzantine fault tolerance” (BFT) or “fault tolerance” and is based on the Byzantine General’s Problem that states that no more than 33% of the network participants can be malevolent to maintain the system’s integrity (in practice, the Bitcoin blockchain’s threshold for fault tolerance is 50%).

The result is that, entirely from the bottom-up and with no centralized coordinator or guarantor, the P2P network runs smoothly and honestly in a “trustless” environment where participants are self-interested and do not know one another. In fact, during the week ending December 5, 2017, 2.6 million transactions were sent over the Bitcoin network without interruption.

In the years after 2009, several less anonymous, but brilliant engineers have developed alternative blockchain technologies that modify and enhance the original Bitcoin system. The most noteworthy example is Ethereum, which is the second-largest system by market capitalization (defined as the number of tokens in circulation multiplied by their market price).

Cryptocurrencies are the “native” digital currencies that exist in blockchain systems or applications. Whereas the Bitcoin system’s native cryptocurrency is bitcoin, Ethereum’s is called ether. All blockchains use their own native cryptocurrencies or require the use of major ones such as bitcoin and ether. There are slightly more than 1,000 cryptocurrencies in circulation as of December 5, 2017.

Cryptocurrencies are necessary to operate blockchain systems, because they are the incentive mechanism for computers (“nodes”) in the network to conduct (“validate” or “verify”) transactions. Indeed, they are the reason you only pay a tiny fee to send a bitcoin transaction. The Bitcoin blockchain system compensates the nodes maintaining the network 12.5 bitcoins every time they successfully validate a set of transactions in a process called “mining.”

1.2 Mechanics

All blockchains or similar “distributed ledger technologies” (DLT) have a common set of characteristics.

Blockchains are digital ledgers or logs that record electronic transactions that occur between two parties. The two parties do not know each other and directly engage in a peer-to-peer network of connected computers. Rather than relying on a third-party middleman (ex. PayPal, a bank, etc.), the network collectively reaches agreement (“consensus”) on which transactions are legitimate using a consensus mechanism. By “legitimate,” we mean that, for example, Alice sends money to Bob and does not spend the same digital currency twice (called a “double spend”) or do anything else malicious.

There are several types of consensus mechanisms, each with pros and cons. The main types are “proof-of-work” (the basis for Bitcoin and Ethereum), “proof-of-stake” (eventually the basis for Ethereum), and “proof-of-authority” (the basis for private chain setups). Proof-of-work is very wasteful of electricity, which is one reason people want to adopt other mechanisms.

Here are three more features of blockchains:

Once the network approves the transactions, the transactions get posted to the digital log. In Bitcoin, attempted transactions are first grouped together in a block, which then gets verified all at once (by the proof-of-work mechanism) and added to a long chain of blocks. This is why it’s called a “blockchain!” The blocks are linked together using cryptography, so that you cannot surreptitiously edit or tamper with the transaction data on a block once the block is added to the chain (or more precisely, once a subsequent block is added to the chain after it). The transaction details are transparent and verifiable by the public. However, the identities of the buyers and sellers are hidden behind their public usernames, which are long alphanumeric addresses. The simultaneous transparency of transactions and masking of identities is why blockchains can be used to both anonymously buy drugs and obediently report to regulators.

Note that some blockchains can restrict transaction visibility and participation to designated parties; these are called “permissioned” or private blockchains. Many large companies are very interested in these private blockchains, because they do not want proprietary or competitive data to be public. The R3 Consortium of most major banks in the world (which raised $107 million in funding in May) has developed a private blockchain system called Corda that just entered beta phase — so has the Linux Foundation (with major support from IBM) with the Hyperledger Fabric.

Another exciting innovation is Zcash, which allows you to hide details of transactions such as the sender, receiver, and amounts (using zk-SNARKs) while operating on a public blockchain. JPMorgan has a partnership with Zcash and is incorporating its capabilities in its own internal blockchain network, called Quorum.

1.3 Secure Networks

In addition to offering a mechanism for peers to transact directly for free without knowing or trusting each other, blockchains are extremely secure. This is because:

Using cryptography, transaction information is recorded in a way that is permanent and tamper-evident. As a result, we can call the blockchain “immutable.” System attacks are almost impossible, except potentially by quantum computers in the future or in a concerted attack by a majority of participants in the network (there are different types of attacks requiring different levels of participation to succeed). The blockchain record is downloaded on thousands of computers around the world that are participating in the network. These computers constantly sync, or update, the record for new transactions. As a result of this wide data distribution, there is no single site of failure that attackers can target. In other words, to delete the blockchain you would need to destroy the thousands of computers in the system all around the world.

In summary, data are not stored in concentrated sites, but rather on a log that is downloaded on thousands of nodes and constantly syncing. New data locks onto the log using cryptographic hash pointers referring to preceding and subsequent transactions on the ever-growing “chain” of transactions.

1.4 Ethereum

Ethereum is an extremely promising and exciting blockchain technology due to some crucial features and advancements over the first-generation Bitcoin system. Whereas Bitcoin has very limited programming leeway (some compare programming capabilities to that of a graphing calculator) and is essentially a ledger of payments between parties, Ethereum’s programming language can be used to quickly build new applications.

Ethereum’s programming language, Solidity, is easy to use and versatile. It is “Turing complete,” meaning that it is capable of approximately simulating the computational aspects of any other real-world general-purpose computer language, which leads to more sophisticated applications. As part of the Turing completeness of Ethereum’s Solidity programming language, anyone can build conditional contracts (using “if/then” and other logic statements) that execute autonomously. The coded contracts are called “smart contracts” and can execute previously agreed upon terms.

Smart contracts are an important innovation: They can be considered legally enforceable and can benefit countless industries by removing time and human error from contract processes. Note that because the contracts are on the Ethereum blockchain, their code is open-sourced; public visibility motivates developers to be extremely cautious about their code so that it is not exploited by hackers to attack the program.

In combination with high quality developer tools and core components (Truffle, Metamask, uPort and others) and substantial industry support (Ethereum Enterprise Alliance, along with Brooklyn-based venture studio ConsenSys), Ethereum shows great promise and popularity within the community.

Ether cryptocurrency is required for the execution of code and smart contracts on the Ethereum blockchain. Users must spend a small amount of ether, called “gas,” to incentivize the network to conduct and verify transactions and run smart contracts. These “gas” transaction execution fees are the intrinsic use of ether. Most cryptocurrencies have an intrinsic use, which is to access or employ the blockchain system or application.

1.5 Blockchain Today

Numerous non-governmental, governmental, and for-profit institutions are actively investing in blockchain R&D to power the future. Institutions spanning the United Nations, IMF, EU Commission, U.S. Dept. of Homeland Security, and National Science Foundation are investing in blockchain research initiatives. Furthermore, many governments and central banks are interested in introducing digital currencies; Vladimir Putin, the Monetary Authority of Singapore, the People’s Bank of China, Bank of Canada, Bank of Japan, and more have been investigating digital currencies.

It is likely that nearly every major multi-national corporation has begun looking at or investing in blockchain technology, from Walmart to Western Union. In brief, using blockchain allows businesses to remove the need for central parties or brokers in various processes, eliminating the fees, human error, time, and security risks that they entail.

IBM and Microsoft have established “Blockchain-as-a-Service” businesses, while major consulting firms including Deloitte, Accenture, and KPMG are building blockchain practices. BCG’s 2016 report “Thinking Outside the Blocks” smoothly summarizes the relevance of the technology while guiding readers through its potential corporate uses.

Meanwhile, remarkable (although very volatile) returns in cryptocurrencies such as bitcoin and ether are driving public attention to the assets as speculative investments: Year-to-date as of December 5, 2017, the price of one bitcoin has risen 1200% to about $12,600, while the price of one ether has risen an astonishing 5500% to about $450. The total market cap of cryptocurrencies is about $370 billion. These figures vary very widely with the volatile pricing dynamics.

Market Cap of Cryptocurrencies Approximately $370 Billion

Cryptocurrencies have also been grabbing headlines as a new source of startup financing. Total fundraising to blockchain startups from “ICOs,” or initial coin offerings (discussed below), has exceeded $4.3 billion so far this year according to Token Data’s weekly newsletter.

1.6 Initial Coin Offerings: Democratized Fundraising with a Dark Side

ICOs have proven to be an incredibly rapid new means of fundraising, as evidenced by multiple strong issuances this year. They have the potential to democratize fundraising, allowing non-traditional upstarts without traditional equity and with open-source production to raise millions of dollars. Impressively, ICOs draw on the community of blockchain enthusiasts and cryptocurrency investors to crowdfund projects. In this way, they can democratize the venture capital process.

In fact, while ICOs are completely open to the public, most VCs are not yet legally able to participate due to agreements with LPs that limit the types of securities in which they can invest. In order to participate in cryptocurrency, many VCs are launching new funds. As industry thought-leader Jamie Burke put it, “The day when VCs were the elusive elite and primary source of capital for startups has ended. When a startup (Brave) can raise $35m in 30 seconds without any dilution, the genie is out of the bottle and it isn’t going back in.”

Over the course of 2017, strong demand for ICOs has led to a “crowding out” of small investors in favor of large investors who can receive priority allocations. Some challenge whether this undermines the democratic nature of ICOs. Furthermore, the opportunity for easy fundraising has attracted low-quality and sometimes fraudulent teams to issue ICOs, defrauding or taking advantage of unsophisticated investors. In response to the ICO trend and prevalence of fraudulent issuances, regulators around the world including the SEC have begun forming views about the legality of issuances and how they should be classified. They have also begun charging fraudulent or maleficent token projects for misrepresenting return potential or attempting to defraud customers.

Voracious ICO interest has also led to complications and volatility in the price of ether. Many ICOs require investment in the form of ether, which drove unprecedented demand for the asset in May and June 2017. The price of ether reached a new high (above $410) in the week of June 18, 2917 during the Status token ICO, until congestion and service disruptions on exchanges led to downward price pressure and even a “flash crash” of ether on the GDAX exchange to $13. These pressures may have also exposed limits in the current Ethereum network. In the final week of June, the price of ether fell dramatically to the $200-$300 range.

Blockchains and other distributed ledger technologies have a variety of positive features and can be applied to countless industries and uses to improve efficiency, security, and operations. Cryptocurrencies such as bitcoin and ether are required to execute transactions and operate the networks. They are also investable assets and sold to the public to raise capital. As such, they constitute a new form of crowdfunding and startup fundraising. Blockchain cryptocurrencies are also a new type of alternative investment, one that is not yet SEC-regulated and that can pose risks to imprudent investors.

Most industry observers agree that we are in the early days of a complete restructuring of numerous processes and operations to be decentralized and on the blockchain. “This is like the Internet in the 1990s” is commonly exclaimed. Blockchain VC and thought-leader Olaf Carlson-Wee has stated, “We’re absolutely still in the infrastructure building phase. But I do think within one to two years, we’ll start to see the first viral applications that are user facing.”

Credits:- The Future Society

Original Source:- http://www.thefuturesociety.org/blockchains-cryptocurrencies-new-decentralized-economy-part/