Why the blockchain matters Why the blockchain matters Why the blockchain matters

Reid Hoffman

This article was taken from the June 2015 issue of WIRED magazine. Be the first to read WIRED's articles in print before they're posted online, and get your hands on loads of additional content by subscribing online.

At least one global cryptocurrency will achieve mass-market adoption. That cryptocurrency will either be Bitcoin or a derivative inspired by it. The chance that it will be the former is so strong that in 2014 I invested in Bitcoin startups Xapo and Blockstream. And yet, perhaps surprisingly, when one of the very smart people I know in Silicon Valley recently told me he's a major "Bitcoin sceptic" who has not yet seen "many real use cases" for the technology, I considered it a good sign.

Why? Because in my experience, the most transformative ideas are not the ones that achieve broad consensus early on. Instead, they're the ones that are so uniquely out there, so contrarian, that even informed observers have wildly differing opinions regarding their potential value.

The internet itself was like this. It started as a strange new parallel universe called "cyberspace" and then became a part of everyday life. LinkedIn, eBay, Twitter and Airbnb were all bizarre concepts at first, offering services that many observers felt would achieve fringe adoption at best. Now, they're all part of the daily lives of millions of mainstream users.

Bitcoin is still so new it seems bizarre to most people. Yet consider how far it has come since November 1, 2008, the day that someone using the name Satoshi Nakamoto posted a white paper to a cryptography mailing list describing a "peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution."

A couple of months later, when the system went live, adoption was slow. "The real trick will be to get people to actually value the Bit Coins [sic] so that they become currency," an observer posted on a thread a week or so after Nakamoto released the first version of the Bitcoin software. "It might make sense just to get some in case it catches on," Nakamoto replied to the poster.

And now, just six years later, more than 100,000 merchants accept Bitcoin. You can also use it in direct transactions with the currency's seven-million-plus users. Venture capitalists have invested more than $500 million (£340m) into Bitcoin-related startups.

Even in the face of such traction, however, there are concerns whether Bitcoin, and cryptocurrencies in general, are just a fad, an asset class that might fail entirely once the irrational exuberance wears off, and leave the world as Bitcoin-free as it was on October 31, 2008.

Just as the internet inspired a whole new era of fast and unanticipated innovation, so, too, will Bitcoin -- or its inspired derivative

Certainly Bitcoin has been an unpredictable store of value to date. But while people often focus on the volatility of its market price and performance as a speculative commodity, Bitcoin isn't just a commodity or asset. It's a cryptocurrency -- it does all of the things that a traditional currency does. It functions as a medium of exchange, a store of value and a unit of account.

But Bitcoin doesn't just duplicate or even optimise the functions of traditional currencies -- it adds new digital, cryptographic, distributed server functions to currencies. Because it functions simultaneously as a currency, an asset and a platform, Bitcoin is better described as a global cryptoCAP (currency, asset, platform) -- or even as a synergistic form of "cryptocapital" that can help unleash the full economic power of the networked age.

There are many ways to understand platforms, but here are two attributes by which Bitcoin moves from cryptocurrency to cryptocapital system:

First, it distributes transaction-clearing responsibilities across a broadly distributed network of computers known as "miners", eliminating the need for expensive centralised third parties such as banks and payments processors to authenticate and verify online exchanges of value. Anyone with the appropriate software and hardware can function as a miner on the network. To compensate miners for the resources they commit to the system, Bitcoin issues 25 newly "minted" bitcoins approximately every ten minutes, and miners compete for this reward. (In the Bitcoin system, each unit of account is called a bitcoin, with a lower-case "b".)

Second, Bitcoin makes money programmable. With Bitcoin, the world's smartest and most creative software developers have an open platform on which to build products and services that will allow individuals, organisations and even machines to do business with each other more flexibly, more efficiently, more frequently and more productively.

As my friend the Bitcoin sceptic suggests, it's hard to imagine exactly what manifestations of cryptocapital are going to resonate most with its users. In 1995, even most internet zealots had not yet begun to fully envision a world in which people would routinely buy used cars at the touch of a button, rent their sofas to strangers, view new learnings on their genetics or trade quips with TV stars in real-time as the latest episodeof their shows aired.

And just as the internet inspired a whole new era of fast and unanticipated innovation, so, too, will Bitcoin -- or its inspired derivative.

Substantial capital investment in Bitcoin has only been happening for a couple of years now -- and it takes time to bring software products to market. But thousands of the world's most creative programmers and technologists recognise the possibilities that it presents. In time, we are going to see the emergence of Bitcoin Googles, Bitcoin Facebooks, Bitcoin Alibabas -- massively valuable companies for which no contemporary analogues exist -- built on the platform's foundations of decentralised trust and programmable money. And there's a very good chance it will happen faster and less predictably than anyone currently imagines.

Bitcoin as a currency and an asset

Some people doubt Bitcoin's status as a currency because it's not backed by a government. Others say it's not an asset, like gold or stocks, because it has no physical state and doesn't even correlate to equity in a company or some other physical property.

But the truth is Bitcoin functions pretty well as a currency -- a medium of exchange that you can use to purchase a wide range of goods and services. And it is an asset as well. When you own bitcoins, or even portions of bitcoins, you own equity in the overall Bitcoin system.

And while bitcoins don't exist in any physical form, scarcity is literally coded into the Bitcoin system. Every day, the Bitcoin system "mints" new coins and distributes them in a contest-like way to miners to incentivise their efforts. This in turn gives the individuals or organisations engaged in mining a way to cover the costs of their equipment and the electricity they consume, and potentially make a profit. But the rate at which Bitcoin mints and distributes bitcoins is fixed and terminal. Eventually, such distributions will decrease and then stop altogether -- the overall number of bitcoins in the system will top out at 21 million.

In its roles as asset and currency, Bitcoin is similar to gold. In fact, Wences Casares, 41-year-old founder of Xapo, a Bitcoin wallet provider in which I've led the Greylock Partners investment, says Bitcoin is effectively gold 2.0. As Casares notes, first, Bitcoin is scarcer than gold, making it a great store of value. Second, in a networked world, Bitcoin is more useful than gold, because it's more divisible, more portable and more verifiable.

Bitcoin is also more divisible, portable, and verifiable than traditional currencies such as the pound or the dollar. Each bitcoin can be divided into 100 million satoshis. And once you have bitcoins, you can exchange them with merchants and other users through simple electronic transactions that clear in approximately ten minutes. In contrast, credit-card transactions can take days to clear.

In addition to being easily divisible and portable, Bitcoin also eliminates the need to convert currencies when individuals or entities from different countries transact with each other. And most importantly regarding its utility as a global currency, Bitcoin doesn't need highly centralised and expensive third parties such as banks and payments processors to ensure that a transaction is legitimate.

Instead, it relies on the blockchain. This a digital ledger that resides on computers that run Bitcoin's software. Every time one party exchanges some amount of bitcoin with another party, information about this transaction is checked against previous entries in the blockchain. If a party tries to spend counterfeit bitcoins, or bitcoins it doesn't own, these checks will reveal that. If the transaction's recipient isn't a legitimate Bitcoin account holder, that would also be revealed.

With its "distributed consensus" approach, in which multiple public copies of a shared single ledger are constantly evaluated to prevent fraud or error from entering, Bitcoin offers a high degree of security. In contrast, a bank's proprietary ledgers offer more centralised and private points of attack for hackers and criminals to target and potentially corrupt.

When you combine Bitcoin's global scope, its extreme divisibility and its ability to verify transactions without third parties, you end up with a system where engaging in exchanges of economic value becomes nearly as friction-free as tweeting or texting.

With Bitcoin, you can ask a colleague to add their two cents to a discussion you're having on Quora -- and pay them appropriately when they do. You can accept a payment worth $100,000 from a guy you know only as gulliver@alilliput.com and be absolutely confident that the money is really there. You, as a resident of Manchester, can send money just as easily and cheaply to New York, Tokyo, or Timbuktu as you can to Leeds, Leicester or London.

Bitcoin doesn't eliminate the need for transaction fees, but it does reduce the overall cost of the transactional infrastructure that's needed to fulfill financial transactions. In the more virtualised Bitcoin system of economic record-keeping and exchange, there is much less need for buildings, vaults, vehicles and personnel. So, ultimately the system can operate much more efficiently than traditional banking and credit systems do.

Bitcoin doesn't eliminate the need for transaction fees, but it does reduce the overall cost of the transactional infrastructure that's needed to fulfill financial transactions. In the more virtualised Bitcoin system of economic record-keeping and exchange, there is much less need for buildings, vaults, vehicles and personnel. So, ultimately the system can operate much more efficiently than traditional banking and credit systems do.

Programmable money

As an asset, Bitcoin proves that gold is not all that glitters. As a currency, it stretches even further than the dollar. But its truly great transformational force lies in how it functions as a platform.

If we couldn't exchange money for goods and services, it would have little value to us. In essence, then, money is simply data, a simple way to measure and keep track of exchanges in value, or accumulations of wealth. But what makes Bitcoin unique is how it keeps all this information aggregated in a single global ledger that is accessible to anyone, and also accessible to software.

Bitcoin transactions are managed by a few lines of computer code written in script. At the most basic level, this code simply specifies what information from both parties is necessary to complete the transaction. But the programs governing these transactions can also be more complex, performing various functions if certain conditions are met.

Thus, developers can begin to create a wide range of potentially useful applications. And because no one single company or government controls this platform, these developers have a great deal of freedom to innovate. That means the greater Bitcoin ecosystem is capable of evolving just as rapidly and productively as the internet. It's the first open platform for financial services.

How developers will ultimately take advantage of this unprecedented opportunity is hard to predict. When the developers who created the protocols that underlie the internet and the web introduced them, they weren't envisioning LinkedIn, eBay, PayPal and Netflix. Instead, they created an open platform that gave developers the freedom to innovate. This eventually paid off in ways that led to the birth of new industries and the transformation of many old and entrenched ones.

As Bitcoin moves forward, enhancing the blockchain's capacity to function as an open and extensible platform will play a key role in its development. There are many different perspectives and projects regarding the best way to do this. One, for example, is the "coloured coins" standard, which introduces a way to use bitcoins to represent stocks, bonds, other currencies and properties as e-assets.

The approach that excites me most is one that incorporates a technology called "sidechains". Because Bitcoin is open source, anyone can propose a change to its primary code base, or Bitcoin Core. Before that change gets implemented, however, Bitcoin's core development team must approve it, and then Bitcoin miners must adopt it. There are benefits to this prudent approach that emphasises consensus, of course, but it can also impede innovations.

Sidechains allow developers to add features and functionality to Bitcoin through a process called "two-way pegging". This gives developers a way to modify Bitcoin without actually changing Bitcoin Core, and without creating an entirely new altcoin.

So sidechains offer a way to increase Bitcoin's flexibility while preserving its status as a single global open platform. That's why I invested in Blockstream, the company that is developing the sidechains technology.

Sidechains won't be implemented unless the Bitcoin community decides that the technology improves its utility as an open, decentralised platform. But whether it's sidechains or another approach, enhancing Bitcoin as a platform will create possibilities to build even more products and services around its central functionality of trustless trust and highly automated economic transactions.

For example, one of the most interesting things about Bitcoin is that the protocols it uses to exchange money, in the form of bitcoins, can also be used to exchange e-assets of all types. Everyone has assets that can be stored and exchanged in digital form. Think of the lease on your flat, the deed to your house, the title to your car, insurance policies, frequent flier points, stocks or the vast majority of money. These are all assets that you use in the course of making various transactions, and when you make those transactions, some party or mechanism has to verify these assets before a transaction can be completed. That's why we have lawyers, insurance claims specialists and notaries. But if the e-assets are entered in a Bitcoin-like ledger, proof of ownership becomes a matter of permanent and highly distributed public record. Any miner verifying blockchain transactions will know that you possess the asset in question, and can thus exchange or transfer it to other parties without additional verification. This in turn creates the possibilities of "smart contracts" -- instructions for performing transactions that automatically execute when certain conditions are met. If you die, for example, and this information is communicated to the Bitcoin system through a pre-established protocol, your assets could be distributed to your heirs according to your will, without further intervention from lawyers.

Bitcoin's computational capacity will also enable machine-to-machine commerce. Driverless cars will automatically pay for toll roads, parking, insurance, electricity and cloud computing for navigation planning.

Bitcoin's future

Already, hundreds of alt.coins have emerged in Bitcoin's wake, and each one ostensibly boasts some virtue or characteristic that Bitcoin doesn't have. So it's still far too early to say whether Bitcoin will be joined or even replaced by other instances of cryptocapital that achieve substantial user bases.

But all the momentum resides with Bitcoin. At the beginning of 2014, around half of all the value of cryptocurrency stored in wallets could be attributed to it; the other half was distributed among 500 or so alternatives. By the end of 2014, Bitcoin's share of all wallet value had grown to 97 per cent.

So it's not just holding on to the pole position it achieved by being first to market -- in 2014, it actually increased its dominance. Network effects are kicking in. And for currency, network effects are even more powerful than they are for many other kinds of products. In the end, users are going to choose the currency that's handled by the most exchanges, accepted by the most merchants, and used by the greatest number of users.

However things play out regarding Bitcoin's specific future as the primary global cryptocapital, there are some high certainty predictions. Neither Bitcoin nor any other cryptocapital is going to replace national currencies and emerge as the world's sole global currency. There are a lot of useful attributes that national currencies have that will keep them necessary and in-demand. For example, economies tend to be naturally inflationary, so you need a currency that's inflationary too. Bitcoin is designed to resist inflation. A national currency, which can be regulated by national policymakers, is better for this purpose.

Credit cards aren't going anywhere either, because people are still going to want to make purchases on credit. But Bitcoin or some other global cryptocapital will disrupt many industries. Banks won't disappear, but cross-border transactions and wire transfers will be disrupted. And banks will focus on places where their high-cost resources can still add value, like initial public offerings and commercial lending.

Bitcoin has a strong shot at defining the cryptocapital space for years to come, at becoming a market-dominating force that will create massive value

Global cryptocapital will also bring access to electronic transactions to the billions of unbanked people in the world -- people who have so little money that it doesn't make sense for banks, with their high overhead costs, to try to serve them. In time, anyone with access to a smartphone or computer will be able to use Bitcoin or some analogue to store money, make transactions, maintain books of accounting and so on.

We'll also gain greater insight into how money flows through the world. Bitcoin is often characterised as a resource for criminals to exploit because it allows parties to engage in transactions with each other without explicitly identifying themselves. Ultimately, however, Bitcoin is a very transparent and persistent system. Every transaction that occurs is recorded and archived, and once again, kept in a single global ledger that is easy to search and analyse.

If governments were inventing a currency today, they might very well implement something like Bitcoin rather than cash, because Bitcoin is more secure, faster-moving and more easily connected to accounting systems. I anticipate over time that a wide variety of analytics services will evolve, for the purposes of market research, policymaking and big-data applications. In this regard, the more activity that occurs on a single platform like Bitcoin, the greater insights we'll have into how money flows through the economy, and into what we at LinkedIn call the Economic Graph: a comprehensive digital mapping of every job, company and economic opportunity on the planet.

With these insights and computational abilities we will see essential new services. Consider a platform like Facebook or LinkedIn where users get paid a satoshi every time they consume content and pay out other amounts when they want others to read something they've written. Or crowdfunding platforms that don't need a trusted third party to hold contributions until a threshold is tipped. Or an Airbnb-like platform for unused hard-disk space.

In the end, it's the possibilities of pervasive, global, high-volume cryptocapitalism, not Bitcoin's current market valuation, that makes it so interesting. Soon, a technology like Bitcoin will be creating value that may exceed what the internet has created to date. Of course, pioneers often disappear. Sometimes that idea that has venture capitalists reaching for their wallets and others taking a pass ends up being AltaVista. Sometimes, it ends up being Google.

Bitcoin has a strong shot at defining the cryptocapital space for years to come, at becoming a market-dominating force that will create massive value. It's already unleashing the power of software development and Moore's law on the evolution of the financial system. And the products and services that will be built on top of it will be so essential, we'll wonder how we ever lived without them.

This article was originally published here on May 15, 2015

Photo by Timba Smits