Bitcoin: the business of blockchain October 2017

By KATHRYN MITCHELL, Published in Financial Law

Part 1: Foundational technology

In the late 2000s, Bitcoin was counter-culture; revolution; anarchy; cypher-punk. It was anti-government, anti-control and commonly understood as the currency of the dark web and shady cyber-criminal organisations. It was, in short, a dangerous adventure.

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But it was also opportunity. Slowly but surely bitcoin has been shuffled into the mainstream – firstly domesticated as "blockchain" and, then, civilised, as "distributed ledger technology". The jargon and folklore which surround the technology make it seem like a craze. People have speculated that it too will pass into the digital ether along with planking and the ice bucket challenge.

However, bitcoin and blockchain have proved more robust than other internet "crazes". Experts and critics have gone so far as to say it might, in fact, be a revolution.

Introducing the blockchain

Blockchain is the technology which underpins Bitcoin, the first cryptocurrency launched in 2009 by an unknown programmer who went by the name of Satoshi Nakamoto. Bitcoin is only relevant to this discussion insofar as it is the technological innovation which saw the introduction of the blockchain. Blockchain is the foundation on which bitcoin was built.

There are three critical features of the blockchain which make it a powerful piece of technology:

1. De-Centralised

The blockchain is a decentralised network. This means that the network is distributed among all the participants in the network. Power is not concentrated at a central point. This means that the network cannot really break – if a computer leaves the network, the network continues to function. This is critical for the following two features of the blockchain to be possible.

2. Secure

Data distributed along a blockchain is secure. This is due to the sophisticated encryption protocols which are built into the system. It is very difficult – almost impossible – for someone or something to corrupt the information stored along a blockchain.

3. Comprehensive

A blockchain provides a comprehensive record of all transactions which have occurred along a particular blockchain. Theoretically, a person can trace a digital object's history through the blockchain.

These three elements make the blockchain groundbreaking because they allow the network to record and verify participant's identity and transaction history.

The impact of blockchain on business

Identity and transaction history are two essential features of modern commerce, law, politics and economics. Identity coupled with transaction history makes it possible for an individual to own an object. Ownership makes change of ownership possible. This allows reliable commercial transactions to occur. Contracts are also predicated on identity and transaction history.

Marco Lansiti and Karim R. Lakhani argue in their article "The Truth about Blockchain", which appeared in the Harvard Business Review, that blockchain is a foundational technology rather than a disruptive technology. This means it is not the kind of technology that will simply shift the manner in which something is typically done, but it will fundamentally alter the way in which our institutions are constructed. The internet is another example of a foundational technology. Foundational technologies typically take longer to be adopted than disruptive ones because of how profound their influence tends to be.

This is good news because it gives business time to prepare.

Blockchain has endless capacity for application limited only by entrepreneurs' imaginations and, at some point in the future, we must assume regulation. This article will address two which are gaining traction in the market and require consideration by business from a strategic as well as a practical perspective. These are smart contracts and radically altered reputational systems.

1. Smart contracts

Smart contracts are defined by Don and Alex Tapscott in their book Blockchain Revolution as "computer programs that secure, enforce and execute settlement of recoded agreements between people and organisations". At a smart contract's simplest, it can be described as follows:

I bet you that the Springboks are going to beat France in June this year. In order to stop you from weaselling your way out of the bet, we decide to conclude a smart contract. We code a contract which provides for the following:

the Springboks beat France;

then

you pay me R1 000.

the Springboks lose to France;

then
nothing.

The computer programme or smart contract monitors the condition and upon the fulfilment of the condition, the result is automatically executed; your account is debited R1 000 and that money is transferred to my account.

Smart contracts have far reaching implications and applications in areas where there are lots of intermediaries. A good example is in the field of security transactions. Smart contracts have the potential to eliminate brokers and other intermediaries who increase transaction costs and add to inefficiency in the system.

2. Reputational systems and organisational structure

Ronald Coase, a Nobel-prize winning economist, developed an economic theory of the nature of the firm (by "firm", he meant any organisation). He posited that firms exist to minimise transaction costs. A firm is a collection of individuals operating as a single entity sharing in a brand and identity with a centralised system for administration, amongst other things. A firm's size is limited by the costs of transactions. The moment there is too much friction within an organisation it will become too expensive to run and should, economically speaking, splinter into smaller more efficient firms.

Blockchain has the potential to change this because it has the capacity to dramatically reduce transaction costs. The blockchain can act as proof of competency or a reputational monitor. Hypothetically, every individual becomes a node and their interactions are recorded in the blockchain.

A potential application of this is that a decentralised searchable database of talent and skill is developed. The database will contain a history of individuals' track records – a "transaction history" in essence.

A user of the database will be able to view every transaction to which a specific individual has been a party and use this to evaluate their competency and fit for a specific job. In a dystopian twist, these records may be ranked in accordance with users' ratings on the database.

This vision of the blockchain future will profoundly alter the manner in which human capital is distributed in an economy. It has the potential to collapse borders as the database will cross jurisdictional lines. Additionally it will democratise knowledge and facilitate the transfer of ideas.

These are two of so many potential applications of blockchain that have the potential to radically alter the manner in which we do business. Blockchain is a brave new world which will favour the prepared.

Mitchell is an Associate with Fasken Martineau (South Africa).

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