Open It Up

Blockchains are networks. Like all networks, their value comes from the people.

Today’s most powerful companies—Facebook, Tencent, Apple—are network companies. Even companies like Tesla are building networks of charging stations. Networks are valuable because they have network effects: for every user that joins a network, the network becomes more valuable for all users, as shown in Figure 3-1.

Network effects: As every new user joins a network, the network becomes more valuable for all users.

Figure 3-1. Network effects

Imagine a world in which only 12 people use Twitter: not very useful. Now imagine a world in which all of your friends are on Twitter: extremely useful. Now imagine a world in which all of your friends, plus celebrities, politicians, and you yourself are on Twitter: most useful.

Successful networks build their own momentum, generating a kind of magnetic force that attracts even more users, making the network grow even bigger and more useful. Like a growing snowball, the more people who join, the more people who want to join.

Put simply, the more people who use a blockchain, the more powerful that blockchain becomes. We call this the Blockchain Network Effect, and the wise technology leader will write this rule on a sticky note and keep it on his or her desk.

Blockchain Network Effect: For every user who joins a blockchain, the more valuable that blockchain becomes.

The fundamental question is this: How will you get people to join your blockchain?

CZ saw that the technology for Binance was important to get right, but he saw that user adoption was even more important. He had to get users buying and selling on his platform.

One way in which he rapidly attracted new users was to quickly offer many different altcoins on the Binance exchange, attracting a new community of users with each one. Competitor exchanges were slow to add new altcoins; consequently, they were slow to add new users.

Thanks to network effects, networks that are more open are generally more successful. Note that “more open” does not mean “completely open”: Apple allows developers to create apps for the iPhone, but it famously protects the quality of those apps through extensive review. The sweet spot is somewhere between “wide open” and “invite only,” as shown in Figure 3-2.

Figure 3-2. The sweet spot between “permissioned” and “permissionless”

This decision about “open” versus “closed” is an important one for the enterprise technology leader. We call open blockchains permissionless (you don’t need permission to join), and closed blockchains permissioned (invite only).

• In a public or permissionless blockchain, as envisioned by Satoshi Nakamoto, there is no central authority controlling or restricting access to the system. Anyone is free to participate in the system, even anonymously. But users have no authority in the governance or decision-making of the system, because those rules were “hardcoded” into the system in the beginning.

• In a private or permissioned blockchain, a central authority figure—usually the owner or company—controls or restricts access to the system. Therefore, we generally know the identities of the people using the blockchain. And although the blockchain is still trusted, it is not transparent to those on the “outside.”

This is not just a theoretical argument. Let’s imagine we’re creating a blockchain for the airline industry, where users can buy and sell frequent-flyer reward points with each other. At the beginning, we’re simply trying to convince airlines to join our blockchain. Table 1-1 shows two possible pitches: which approach is more likely to succeed for the industry as a whole?

Table 1-1. More openness leads to more adoption.

Type	Pitch	Likely result
Permissioned (private)	“Only the Big Three airlines will be invited. Their miles will be compatible.”	More likely to end up with a handful of incompatible blockchains. Consumers are likely to have a mishmash of blockchain-based rewards points, many of which go unredeemed (in other words, like frequent-flyer systems today).
Permissionless (public)	“Any airline can join. All airline miles will be compatible.”	More likely to lead to a single frequent flyer standard, as airline miles become interoperable (like the one-stop listings of Google Flights today). Consumers will save and spend frequent-flyer miles more, well, frequently, buying companion tickets and flying more often.

Assuming that the pricing mechanics are designed correctly (so that airlines aren’t losing money), the permissionless approach—the public approach—benefits the industry as a whole. More openness leads to more adoption.

But “open” can be a hard sell for a private company. Indeed, research from the World Bank IFC shows that most enterprises are currently choosing permissioned (private) blockchains.³ However, the more permissioned (or closed) a blockchain becomes, the more it opens itself up to threats of disruption from a permissionless (or open) alternative.

A useful analogy is the “closed” network of taxi companies, with their regulatory protection, medallion system, and specialized networks of drivers and dispatchers. Taxis were disrupted by the “open” networks of ride-sharing companies like Uber and Lyft, which allowed anyone to drive after passing a background check. Although Uber is still a centralized company, it is more “permissionless” when compared with the taxi industry’s “permissioned” system. (We mean this literally, given that Uber usually did not ask for permission before taking over a new market.)

When considering where your blockchain project falls on the continuum, push for permissionless. That’s how you attract the most users and become an industry standard. Open it up.

Eliminate the Intermediaries

Let’s imagine that you’re biting into a crisp, juicy Fuji apple. Now, take a moment to trace that apple backward in time, like watching a movie in reverse, to the store where you bought it. Before the store, it was shipped on a truck from a warehouse. Before that, a distribution center. Before that, it was put into a box, harvested, and picked from a tree in a farmer’s sunny orchard.

Of course, you could have just driven to the farm and picked the apple yourself. But we have developed these complex delivery and distribution networks to make life easier. Few of us have time to drive around to a dozen different farms to pick up the week’s groceries.

The downside to this convenience is that each person who handles our apple drives up the cost: the driver, the distributor, the delivery person; each add on a few cents. You and I get squeezed—and so does the farmer. And so do the apples—to make juice.

Now compare your store-bought Fuji with a Community Supported Agriculture (CSA) share, where local residents each buy a “share” of the farm’s harvest. Throughout the summer and fall, you get a big delivery of whatever is in season: apples, corn, and usually kale. Lots and lots of kale. Seriously, you will run out of uses for kale.

What you give up in control over your kale supply, you gain in variety (you get to try a lot more things) and savings (it’s a lot cheaper). By eliminating the “go betweens” that go between the farm and the store, you get cheaper, fresher food.

The second principle of blockchain is eliminate the intermediaries. The network of middlemen, middlewomen, managers, agents, resellers, jobbers, agents, managers, brokers, dealers, and broker-dealers—with all the accompanying paperwork and markup—drive up costs and drag down efficiency. Blockchain can help eliminate these “in-betweeners.”

Ask yourself: where do we have inefficient intermediaries? Who can we eliminate from our supply chain? “Going direct to the customer” has always been a way to save money for both producers and consumers. With blockchain, this can be done with code, resulting in improved performance and lower costs. We call this process disintermediation.

Disintermediation: Eliminating an intermediary, someone who drives up cost while not adding much value.

By issuing its own altcoin, Binance raised initial funds directly from users, disintermediating the usual Silicon Valley VC network. By offering a “Binance Coin” that investors could buy and sell on the Binance exchange, CZ created his own “digital money” that other entrepreneurs can now use to launch their own projects on Binance: in essence, a mini-economy that disintermediates dollars.

Ask yourself: where can we eliminate steps in our supply chain? Where can we replace a centralized record keeper with a decentralized ledger? Where can we eliminate an intermediary? That’s where a blockchain solution is often hiding.

But what if you are the supply chain? Take the Depository Trust and Clearing Corporation (DTCC), a company that clears and settles transactions for large financial markets such as the New York Stock Exchange. The DTCC acts as an intermediary for $1.85 quadrillion in annual transactions—yet over two years ago, it made a sizable investment in blockchain to prepare for the future. It intends to move its annual $10 trillion credit derivatives tracking onto a blockchain, enjoying significant savings and efficiency improvements from the elimination of redundant procedures. By embracing change, even intermediaries do not need to be displaced in a blockchain world.⁴

Code, Not Contracts

Think back to the sweet crunch of that Fuji apple. Again, follow that apple backward in time: from your hand back to the grocery store, the warehouse, the distribution center, and finally back to a tree in a sun-dappled orchard.

At every step of that journey was paperwork: invoices, receipts, bills of lading, and so forth. Even though much of the paperwork is computerized, a surprising amount is still done using physical paper (just check your grocery store receipt, which is probably the length of a small child).

This paperwork—whether it’s literally paper or not—is what we might call a contract. You buy the apple from the store, you get a receipt verifying the transaction: a mini-contract of your transaction. As you follow the apple through its journey from farm to food, visualize every step involving a contract: a buyer, a seller, and a signature.

Contract: Any “paperwork” that records a transaction between two or more parties.

Any business traveler knows the hassle of managing a mountain of receipts: they’re often misplaced, miscategorized, or missing. Now multiply that times millions of apples, millions of shipments, millions of buyers and sellers, and you see the magnitude of the mountain.

This is where blockchain comes in. A smart contract is computer code that establishes agreements between parties and then executes the transaction when certain conditions are met, without the need for a third party. The contract is maintained on the distributed ledger (our massive P2P Google Sheet), and it is automatically “signed” when both parties have fulfilled their end of the bargain.

Smart contract: Computer code that establishes an agreement between two or more parties, without the need for a third party.

As an example, Alice wants to pay one unit of Ethereum to Farmer Bob in exchange for a bushel of apples (Figure 3-3).

Figure 3-3. The smart contract

She sends one ETH to a smart contract that “holds” the ETH until Bob has delivered the apples. This smart contract functions like an escrow account, except that it doesn’t require a third-party escrow company; it’s all handled through code, as demonstrated in Figure 3-4.

Figure 3-4. Loading up the smart contract with ETH

When Bob delivers the apples, he holds out a QR code, which Alice scans on her phone. This clears the one ETH to be delivered to Bob’s account, as shown in Figure 3-5.

Figure 3-5. Everybody’s happy

As Figure 3-6 makes clear, if Bob doesn’t deliver the apples, Alice can just “withdraw” the money back into her account.

Figure 3-6. Stupid contract

Smart contracts are potentially more efficient than paper contracts because they can be used to coordinate transactions between multiple parties. A real-life example is supply chain management: now imagine the entire life cycle of the apple being tracked on a smart contract. Talk about farm-to-table: blockchain will let us see the entire journey from farm to table, as depicted in Figure 3-7.

Figure 3-7. From farm to warehouse to delivery to Alice’s restaurant

An example: today, the international shipping giant Maersk has partnered with IBM to create a global shipping supply chain service called TradeLens.⁵ In keeping track of items as they move through ports from their source to their destination, Maersk saves money anytime shipments need to be screened or checked. Instead of keeping track of all the “receipts,” Maersk has only one record for each item, stored on blockchain.

We call this idea “Code, Not Contracts.” Although each shipment still involves contracts, they are code-based smart contracts, not paper-based contracts issued by third parties. CZ’s Binance exchange operates exclusively on smart contracts—not on old-fashioned paper contracts of a traditional exchange. With blockchain, we are eliminating the intermediaries.

Work It Out, Don’t Fork It Out ⁶

In 1517, a German academic professor wrote a paper that would change the course of history. According to legend, he dramatically nailed his paper to the door of a local church—which might or might not be true, but definitely makes for a better story.

That professor was Martin Luther, and his paper, Ninety-five Theses, is generally recognized as the start of the Reformation. His paper outlined a different vision for the way the Catholic church should be run, and that vision eventually became a division: the Protestant church.

In blockchain terms, we call this a fork: a new project splitting off from the primary project, like a fork in the road. Forks come about when developers have fundamental disagreements on how to move forward: because most blockchain projects are open source (the Catholic church), it’s easy for a subgroup of developers to start their own competing project (the Protestant church).

Fork: A new blockchain project splitting off from an existing project.

Forks are abundant in the blockchain world: bitcoin itself has been forked over a dozen times,⁷ creating altcoins like Bitcoin Cash (faster transactions), Bitcoin Gold (easier to mine), and Bitcoin Private (better privacy).

To be clear, this is not creating a brand new altcoin, as in the early days of bitcoin. This is making a copy of an existing blockchain—like copying an accounting ledger—and then going your own way with a new blockchain, as shown in Figure 3-8.

Figure 3-8. Forking blockchain

Forks are generally undesirable, for two reasons:

You lose users

As we’ve seen, the value of a blockchain relies on the number of people that use it. When you split a project, you reduce your user base significantly because users and developers generally must “choose” between one project or the other.

You are more likely to fork again

Just as Martin Luther’s Protestant church would eventually splinter into hundreds of denominations, blockchain forks often fragment into smaller and smaller projects. Once you’ve forked, you tend to keep forking.

This is not to say all forks are doomed to fail. Two famous forks—Bitcoin Cash (BCH) and Ethereum Classic (ETC)—have each prospered while maintaining a separate vision from the “one true faith” of bitcoin and Ethereum, respectively. In 2019, in fact, Bitcoin Cash returns doubled those of bitcoin.⁸

Even though a fork demolishes your user base and sets a dangerous precedent, you have a chance of survival if you’re really able to build a better blockchain. (Just accept that your bitcoin spinoff will never be considered the “real” bitcoin.)

Forks come about when each side is convinced that it holds the one true solution to a problem, usually with a kind of fervent zeal. Because the industry is young and immature, blockchain developers typically hash out these hashing debates on message boards and Twitter.

What’s needed is a face-to-face forum, like the United Nations. What’s needed is global governance standards, like those used by the World Bank. What’s needed are international events where developers can meet in person to discuss new approaches and come to compromise.

As a blockchain technology leader, be prepared for disagreement down the road. Before it becomes a crisis, decide how you’ll deal with disagreements, whether that’s off-site workshops, team-building exercises, or quarterly face-to-face meetings. Work it out, don’t fork it out.

Build Your Own Government

One of the earliest political cartoons, the “Unite or Die” graphic shown in Figure 3-9, offered a powerful message to the early American settlers: this disunited collection of colonies, all looking out for their own self-interest, needed to pull it together in order to survive as “The United States of America.”

Figure 3-9. Unite or Die

But there were problems with working together. The states were independent and free; why would they want to subject themselves to a powerful national government? In other words, how could this collection of states come together as a centralized nation, while still maintaining a measure of decentralized control?

These are the same problems playing out in the blockchain industry today. As we’ve seen, it’s difficult enough for a group of independent developers to agree without forking. So how do we possibly balance the needs of all these other players: nodes, miners, altcoin investors...not to mention your boss?

Governance: The system for organizing blockchain effort, made up of code (like laws) and code developers (like lawmakers). Although blockchain (the technology) is decentralized, governance (like government) is more centralized.

Just as government is a system for organizing human effort, governance is the system for organizing blockchain effort. Just as we can break down government into the two broad categories of laws and lawmakers, we can break down governance into the two broad categories of code and codemakers.

The codemakers (i.e., developers) make decisions by coming to consensus or compromise, then turning those decisions into code.

The code itself—in the form of smart contracts—then carries out those decisions, effectively “enforcing the law.”

Here’s a real-world example. Miners who maintain the Ethereum blockchain need to be paid for running this global network of computers, so developers decided to charge a little Ethereum—a service fee, or gas—for each Ethereum transaction.⁹ They wrote this “law” into code, in the form of a smart contract that sits on top of our initial contract (Figure 3-10).

Gas: A transaction fee on Ethereum. Also, another unfortunate blockchain term.

Figure 3-10. Passing gas

Code is now law: you can’t send Ethereum without paying for gas. If Ethereum users complain loudly enough, developers need to get involved again, figuring out a way to make everyone happy. Like the process of government, this governance process never ends.

The challenges posed by blockchain are not so much technological as political. Large alliances quickly form, and smaller players can find themselves excluded from the governance process. For the technology professional, this is why forming these alliances is so critical at this early stage of the industry.

For technology leaders, a best practice is to form (or join) a nonprofit or consortium. For example, the Enterprise Ethereum Alliance and the Hyperledger Project are both professional organizations where competing companies set aside their differences to achieve a common technology goal. Like serving on the board of a nonprofit, member companies volunteer time and resources to help the industry move forward. In return, they are rewarded with a “seat at the table” of governance: a say in how the industry moves forward.

Enterprise Ethereum Alliance and the Hyperledger Project: Two industry groups that help guide the corporate development of the Ethereum and Hyperledger blockchain projects, respectively.

The best way to secure a seat at the table is to pull up a chair now, while there are still some left. If joining a consortium is too much of a commitment, attend local blockchain Meetups. Introduce yourself. Form friendships. Unite or die.

Free, Instant, Scalable, Trusted

The dirty secret about blockchain is that it still doesn’t work that well.

Satoshi Nakamoto’s vision was digital money that could be sent as quickly and easily as e-mail. Instead, bitcoin is expensive (we’ll call it $1.00 per transaction),¹⁰ slow (we’ll call it an hour),¹¹ and not scalable (we’ll call it five transactions per second, compared to the VISA network, which handles around 1,700 transactions per second).¹²

Towering over these is the issue of trust: for any financial system to be widely used, it must be widely trusted. Despite how far we’ve come, digital money is still new. We’re still working on trust.

Thus, we recommend four simple principles for your blockchain project: Free, Instant, Scalable, and Trusted:

Free

When it comes to consumer adoption, as Google has famously shown, the best price is free. Give away great products, and monetize the audience you build. Of course we need to pay the miners hosting our network nodes, which we generally pass back to the users of our network in the form of “service charges” or “convenience fees.”Consumers don’t care whether blockchain is the technology, they care about the convenience fees for transferring money, and the actual convenience. For this reason, free is the best price—and if not free, as low as possible. Like Google, strive for free.

Instant

In an age when it still takes three days to clear an international bank transfer, blockchain already offers a superior alternative. But consumers demand faster, better, cheaper. Email is instant; texts are instant; the web is instant. In a world of instant credit card purchases and One-Click shopping, blockchain developers must push for instant transactions (or even just the appearance of instant transactions) because that’s what consumers want and expect. Like Amazon, strive for instant.

Scalable

Like a plumber planning ahead, think carefully about the size of your “pipes”—your infrastructure—because bigger is usually better. CZ wisely built scalability into his Binance platform from the beginning, which allowed it to accommodate the flood of new traffic that accompanied each new altcoin trading on the exchange.Most beginning blockchains, like most beginning businesses, have the opposite problem: not enough users. They can’t get enough traction—enough new users or customers—to even worry about scaling. This is why most private/permissioned blockchains have trouble getting off the ground: there aren’t enough users to justify the project.On the other hand, if you suddenly get a burst of holiday traffic, your blockchain has to be able to handle the load. In thinking about scalability issues related to your blockchain, think of the “just right” amount of plumbing (not too little, but not too much) that you will need, and build it in from the beginning (see Figure 3-11). Like Binance, strive for scalability.

Figure 3-11. Speed and scalability as the key determinants in choosing a blockchain solution

Trusted

All monetary systems come down to trust, and blockchain—the Internet of Money—is no different. American money features the words “In God We Trust,” we name our banks “trusts,” and we transfer wealth between generations in “trust funds.” Blockchains must work to build this trust. How do we trust a blockchain? Like we trust a person. It needs to consistently demonstrate trustworthiness over a long period of time. This means technical aspects like reliability and uptime, but also political aspects like transparency and good faith. We also trust a person if they are affiliated with other people or institutions we trust (what economists call the “Halo Effect”).¹³ This is another reason to associate your blockchain with well-regarded people and brands: like Buffett, strive for trust.

Free, Instant, Scalable, and Trusted: four excellent blockchain ideals. And they’re as easy to remember as the back of your hand.

Regulation: Evolution versus Revolution

Blockchain regulation is one of the most important topics facing the industry today—and also one of the most complex. To simplify the story, let’s walk you through three seasons we’ll call Crypto Summer, Crypto Winter, and Crypto Spring.

At the beginning of 2017, the price of bitcoin was about $1,000; by the end of the year, the same bitcoin was worth $20,000. Like the Summer of Love, “Crypto Summer” was a blockchain hugfest, with starry-eyed dreamers raising buckets of money for any blockchain project, no matter how far-fetched.

Almost overnight, bitcoin and altcoins became a $250 billion asset class, traded globally, 24 hours a day. Exchanges like Binance quickly rose up to handle the demand, creating a newer kind of New York Stock Exchange.

Then governments started asking, What are these things? Do we define them as securities? Currencies? Something else? In the United States, the Securities and Exchange Commission, which is charged with protecting investors, decided to proceed slowly. Wait and see.

But the lawyers began getting involved. And the lawyers, who urged timidity and caution, who were also not well educated on this new technology, mostly advised new blockchain projects to hold off. Wait and see.

And so this torrent of innovation slowed down to a trickle, and that trickle began to freeze. Thus began the Crypto Winter of 2018, as the price of bitcoin crashed from $20,000 down to $5,000, taking the entire digital asset market with it. These were dark days.

There was a great shakeout, not unlike the collapse of the dot-com bubble in 2000, where only the strong survived. But the companies that made it through Crypto Winter—like the internet companies that survived the early 2000s—grew even stronger. They survived to see the spring.

At the time of this writing, a new Crypto Spring is emerging, and the first buds of blockchain are bursting forth. Facebook is launching its own altcoin, called Libra. Countries like Switzerland and Malta are prospering, thanks to blockchain-friendly jurisdictions. And governments around the world are realizing they’ve got to figure this out.

The opportunity for governments—like the opportunity for business leaders—is to create fertile soil so this new technology can blossom. We don’t want to smother seedlings with heavy-handed regulation; the growth will just flourish elsewhere. Instead, we want a friendly regulatory “garden” where we can plant and nourish blockchain projects, allowing a thousand flowers to bloom.

For blockchain technology leaders, understand that you’re planting a garden on a wild frontier. Proceed carefully—but do proceed. You can’t wait for everything to be finalized. Listen to your lawyer, but take legal advice with a grain of salt, because your attorney probably knows less about blockchain than you do.

Blockchain is one money for one world, a global currency for a global economy. If governments are concerned that blockchain will usurp the US dollar, the Euro, and the yuan, that’s a valid concern. Just as business technology leaders must begin collaborating with other companies—grabbing a seat at the table—government leaders must begin collaborating with other countries.

In a sense, blockchain sits outside the jurisdiction of any one government, so no government can adequately regulate it. The best path forward is to put together an international consortium to create common-sense regulations for this new Internet of Money. Call it the “United Nations of Blockchain.”

In Summary

“So … what is blockchain?”

The biggest challenge faced by enterprise technology leaders is providing a clear and simple definition that builds blockchain passion and funds blockchain projects. We hope that our definition—the Internet of Money—and the stories you’ll read next will help you build that excitement and unlock those pocketbooks.

In our experience, the biggest motivator for most people is buying bitcoin. This is the “on ramp” to blockchain. Even purchasing a small amount for you or your boss is worthwhile: the experience turns you from an observer into an owner. You’ve got skin in the game, and that changes the game.

For most people, blockchain is a theoretical technology that’s difficult to explain and even more difficult to implement. When people see it as a new platform for sharing value—and they own a little of that value—everything changes. Once you use it, you can’t stop talking about it.

We encourage the technology leader to buy a little bit of these digital assets, which is the best way to understand how they work. Get hands on. You’ll quickly see the potential and also how much work needs to be done to reach that potential.

What an exciting time to be alive! We are building a new global financial system—a new internet for sharing value—and for our money, it’s the most exciting field today. We are building a new Internet of Money, and our efforts are likely to have an impact for the next 100 years. In building blockchain, we are building the future of the human species.

Now let’s turn to the real-world business leaders who are building this new Internet of Money.