Trust is the most important commodity for people to be able to engage in business activity with others outside of personal relationships, in the company or privately. Today, trust is often provided in a variety of ways by common — very proven, but central — entities. The digital and global age is pushing these systems to their limits. Centuries of centralization have created abusive structures in society that inhibit the forces of innovation and have created a huge imbalance. One way out is to place the social order on a new decentralized foundation that, at its core, builds trust through the use of the world’s most recognized and universal language: mathematics.
The “dot-com bubble” of the 1990s is commonly viewed as a period of crazy excess that ended with the destruction of hundreds of billions of dollars in assets. What is less often discussed is how the cheap capital of the boom years helped finance the infrastructure on which key Internet innovations would be built after the bubble burst. It paid for the rollout of fiber optic cables, the research and development of mobile networks, and the construction of massive data centers. All of this, in turn, made possible the technologies that today form the foundation of the most powerful companies — such as Facebook, Google & Co: the beginning of the “information age” as we know it. The Internet as a basic infrastructure has thus revolutionized the access of “information”. Currently, a similar “dot-com” scenario is building up with the young crypto industry — first and foremost “Bitcoin”. It is yet to be predicted what the new “Googles” of this industry will look like, built on blockchain technology. Unlike the Internet and information processing, however, this is technologically about another commodity that could be completely revolutionized: Trust.
The Internet has revolutionized information processing — blockchain will revolutionize trust processing.
Modern capitalism has a long history and tradition — and yet it is perhaps a methodology that made growth and trade possible in the first place and provided a basis for trust that did not exist before: double-entry bookkeeping. In the 14th century, Italian merchants and bankers began using the method, rising to a new role of “intermediary” in the international exchange of goods and payments. Since then, “clean books” have been considered a sign of honesty and sincerity, which created trust and accelerated the circulation of money. The new system financed the Renaissance and paved the way for the capitalist explosion that was to change the world. But the system was not impervious to fraud. Bankers and other financial players often violated their moral duty to keep honest books, and they still do (#Enron or #Wirecard). In turn, to maintain trust, new industries have emerged to suggest trust through their processes and their names. In the context of companies, these are, for example, auditing companies. But in the social environment, too, there are many institutions that express trust and make economic behavior in its current form possible in the first place:
- Banks value the creditworthiness of their customers and thus demonstrate trustworthiness to third parties.
- Central banks are legitimized to put money into circulation and societies rely on these systems for exchange and trade.
- States issue identity cards, certifying to other states that the person enjoys the trust of the issuing state and is the person he or she claims to be.
- Seals (#FairTrade) are displayed on products to prove trust in the seller and their quality or delivery standards.
The trust issue is thus mostly a “centralized” issue — there is only one state that issues me a personal ID card, only one central bank that has sovereignty over the EURO or only one organization that issues #FairTrade seals. This centralization is highly efficient and well organized for its respective task — but also vulnerable to manipulation. Thus, we as a society have allowed centralized asset managers such as banks, stock exchanges and other financial intermediaries to become indispensable, transforming them from mere intermediaries to key players — high fees, limited access or lack of innovation are consequences of their dominance.
The 14th century accounting methodology described above may seem like a boring achievement, but it is a good model for the technical revolution on which the blockchains of today are based. For hundreds of years, double-entry accounting systems have formed the economic foundation. Every exchange of value, every ownership and property, every debt relationship. It’s all based on reliance on a common system to record and track those transactions. A system that gives definition and order to society itself. How else would we know who is the richest person in the world? However, this system of order has reached its limits in the information age. How, for example, can you determine ownership of digital stuff? A music file? A picture?
A blockchain — and Bitcoin as a prominent example — is an electronic file — a list of transactions. In principle, these transactions can represent almost anything: Money transactions, exchanges of other assets, or rights to digital works (e.g., music). They could include smart contracts, which are code-based instructions to do something (e.g., buy a stock) when something else is true (the price of the stock has fallen below €15). What makes a blockchain a special kind of digital file is that it is not managed by a single centralized institution such as a bank or government agency, but is stored in multiple copies on multiple independent computers within a decentralized federation. No single entity controls the file. Any of the computers in the network can make a change, but only by following the rules dictated by a “consensus protocol,” a mathematical algorithm that requires a majority of the other computers in the network to agree to the change. Once a consensus generated by this algorithm is reached, all computers in the network update their copies of the ledger simultaneously. If any of them attempts to add an entry or retroactively change an entry without this consensus, the rest of the network automatically rejects the entry as invalid. This creates an immutable, shared record of the “truth” that cannot be tampered with.
What they all have in common is that mathematical rules and unassailable mathematics (#cryptography), rather than trust in fallible people or institutions, guarantee the integrity of the file.
The benefits of this decentralized model become clear when weighed against the trust costs of the current centralized economic system. Example: In 2007, Lehman Brothers reported record profits all of which were confirmed by its auditor, Ernst & Young. Nine months later, a nosedive in those same assets led to the bankruptcy of the 158-year-old company and triggered the largest financial crisis in 80 years. Obviously, the valuations cited in the books of previous years were way off. The failure in the system of double-entry bookkeeping and a costly auditing company was a powerful reminder of the high price we often pay for trusting the internally compiled numbers of central agencies. The crisis was an extreme example of the cost of trust. But there is a more innocuous way: think of the cost of all those accountants and their IT systems. Their job, reconciling their company’s books with those of their business partners, is to ensure that neither party trusts the records of the other. It is a time-consuming, expensive, but necessary process. These costs are rarely acknowledged or analyzed by economists because practices like reconciling accounts are seen as an integral, unavoidable part of doing business.
The promise of blockchain technology, on the other hand, is to dramatically reduce these costs of trust through a radical, decentralized approach — creating a new way of structuring social organizations.
Trust is an important part of our society — an important part, a foundation. In the case of a profound and radical reorganization of the lowest mikado stone, there may still be many open questions that society wants answered. It may be clear — the previous economic order with many institutions to build trust (banks, insurance companies, …) and a new decentralized order are fundamentally different — and therefore cannot exist in parallel. Mass unemployment according to today’s understanding would therefore be a corresponding consequence. Conversely, however, this should not mean that we should keep the status quo and even defend it — quite the opposite. The blockchain — as a technology — offers a decentralized approach that enables trust through mathematics and power distribution and thus overcomes many problems of our time — which have been formed by centrality and abuse of power. A new, a better, a sustainable social system. The Internet has revolutionized “information processing” — the Blockchain will revolutionize “trust processing”.