Illustration by TheDigitalArtist
New technologies often cause polarization between their supporters and critics. In this article I will outline five common misconceptions about Blockchain and Decentralized Applications (dapps) looking at both the skeptics’ and the proponents’ views. To conclude, I will summarize the key findings from my research and reflections on the different topics outlined in this article (jump directly to the “wrap-up” section if you are short on time).
Three widespread misbeliefs among Blockchain critics
Blockchain skeptics often tend to either not fully understand or purposefully downplay the technology’s significance. In this section I present three popular claims from critics which I believe to be problematic:
“A Blockchain is nothing more than a distributed database” The concept of Blockchain, which received growing public attention after the publication of the Bitcoin Whitepaper in 2008, consists of a distributed ledger at its core.
There is one crucial technical characteristic which differentiates a Blockchain from a conventional shared ledger or database — the use of cryptography: A Blockchain consists of a sequence of blocks. Each block holds a batch of transaction information. Every new block (i.e. new entry in the distributed ledger) is being verified by the network nodes based on cryptographic rules. Following the genesis block, every new block in a Blockchain also contains encrypted transaction information from the previous block. Agents interacting with a Blockchain like Ethereum do so on the basis of ‘Public-key cryptography’ — consisting of a ‘private key’ that ultimately regulates the ownership of and access to a certain digital asset and a ‘public key’ which is used to transact with other agents on the Blockchain.
It is through this system of ‘cryptographic proofs’ that Blockchain technology lays the foundation for a so-called ‘trustless’ system: Agents that otherwise might distrust each other can transact with each other on a cryptographically secured basis. This is crucial as it paves the way for all kinds of ‘decentralized systems’ in which value needs to be exchanged in one way or another.
At the same time, Blockchain is often not the right technology choice for use cases where different players naturally trust each other. Some companies made this experience when implementing so-called ‘private’ or ‘permissioned’ Blockchains through which a consortium of different players stores and shares data — whenever trust and transparency are no issues within such a consortium a conventional, shared database is usually a cheaper, simpler and more performant solution.
“Blockchain technology is not scalable”
At the time of writing, the Bitcoin network can process around five transactions per second (tps), Ethereum ~15, Tezos ~40. Those are very low numbers when compared with the transaction throughput of conventional payment providers which is in the thousands in terms of tps. It is therefore fair to claim that the currently most established (and up and running) public Blockchains would not be fit to process a significant share of all global financial transactions.
However, as with most new promising technologies, the growing Blockchain community continuously develops the technology further: With Ethereum’s 2.0 version the contributors are aiming for a tps of 100,000 — community members of other Blockchains (e.g. Cardano) even look at a future maximum tps of 1,000,000 for their network.
The theoretical foundation for such a sharp increase in tps has been layed with innovations like ‘Sharding’ — an approach by which a certain number of nodes are combined into a shard and where each shard is responsible for a partition of the Blockchain. This differs from the current Blockchain design where each node needs to store the entire state of the Blockchain. So-called ‘Layer 2 solutions’ which use ‘State channels’ and similar technologies in order to take a significant share of calculations “off-chain” are other paths towards a much more scalable Blockchain architecture. Those technologies, especially if applied in conjunction, make it possible to achieve an increase in tps by factor 10,000 or even higher when compared with today’s numbers.
It would be overly optimistic to claim that the solution to the scalability problem is just around the corner. Still, in my view it is highly probable that it will be overcome within the next five years — certainly within this decade.
“Blockchain technology is not being used”
Almost three years ago, a few weeks before the peak of the “Initial Coin Offering (ICO) bubble”, an Ethereum-based game called “CryptoKitties” reached a maximum of ~15,000 daily users. At that time, this might have been the most popular Ethereum dapp. In December 2017, the game received a lot of media attention because this usage levels led to a heavy congestion of the Ethereum network by temporarily consuming 20% of the entire network’s computational power. How has the number of Blockchain and dapp users developed since then?
In Q2 2020, the total number of active users of Ethereum-based applications has risen to 1.25 million according to dapp.com. This number grew by 300% when compared with Q2 2018. At the time of writing (October 15th, 2020), Glassnode counted approx. 500,000 individual addresses that were active (i.e. have sent or received a transaction) on the Ethereum network over the course of the past 24 hours, and over 1 million active addresses on the Bitcoin network. MetaMask, probably the most famous Ethereum browser wallet, recently communicated that it has exceeded 1 million monthly active users — a number that grew by more than 300% over the past 18 months.
In short, the argument that Blockchain technology is not being used is simply untrue. In general, one could also witness growing dapp user numbers over the past two years. Nevertheless, the same numbers suggest that Blockchain technology is still far away from mainstream adoption. Current users can be seen as ‘innovators’ — not quite yet ‘early adopters’ — using the terminology of the often cited ‘Technology adoption life cycle’.
Two controversial but popular views among Blockchain proponents
The same way skeptics sometimes tend to bad-mouth Blockchain technology and downplay positive developments, proponents are generally leaning towards an overly optimistic view of the technology’s future — not seldom ignoring important risk factors. Here are two controversial but popular claims that I would like to challenge:
“Decentralized = no legal constraints apply”
There seems to be a dominant view among certain groups of Blockchain supporters which suggests that public Blockchains are not subject to national laws due to their decentralized nature. The argument often goes something like this: “Blockchain XYZ is a decentralized protocol which is not owned or operated by a specific legal entity. It can therefore not be shut down by the regulator — just like the Internet cannot be shut down by anyone.”. At times this argument is being taken ad absurdum by using it as a sort of implicit legal protection for almost any Blockchain-based product or service — no matter how decentralized it might or might not be.
While it would certainly be an extremely difficult task for state regulators to entirely shut down a highly decentralized network like Bitcoin or Ethereum, there does not seem to be much that would hinder them legally from going against the principal creators of and contributors to a Blockchain network or application should it infringe specific national laws. The Blockchain space has witnessed this during the 2017 ICO boom when a number of high-profile ICO’s came under scrutiny from the US Securities and Exchange Commission for infringing securities laws.
It seems rather unlikely that the creators of the principle Blockchain protocols will be held accountable for what is being built on top — just as it would seem outrageous to sue Tim Berners-Lee, who first proposed the ‘WorldWideWeb’ in 1989, for all sorts of illegal activities taking place on the Internet today. The story becomes an entirely different one when looking at the ‘application layer’: As a founder of an Internet-based bank, state regulators will certainly hold me accountable for not complying with local AML rules. Why should the creator of a Blockchain-based application that basically replicates traditional financial services on-chain be treated any differently?
As a matter of fact, most dapps are only decentralized to a certain extent. Especially in the early stages of a project, its development usually depends on the actions of a few main contributors. While state regulators might not be able to “take down” a smart contract once it is deployed on a decentralized Blockchain network, they can target the smart contract (co-)creators with legal claims — eventually disincentivizing others from launching potentially law-abiding dapps.
It is clear that legal authorities first need to catch up with the technological developments. Of course, this takes time: National and supranational institutions around the globe are currently working on legal and regulatory frameworks to deal with Blockchain technology (see for instance the 2019 EUBOF report, a European Commission initiative). I hope that the innovators and founders of the space will use this time lag to catch up with legal requirements and thereby avoid potential troubles down the line.
“Blockchain technology is ready to be used by everyone”
The current state of Blockchain technology is sometimes being compared to the state of the Internet in the early 1990’s — the comparison seems to hold true not only in terms of performance deficits (to download a single picture from the Internet would take several minutes in the 90’s) and concerns over scalability (e.g. a BT internet customer in 1996 got 2.5MB of web space) but also with regard to user interaction: Before the launch of the Mosaic browser in 1993, only a small group of ‘innovators’ surfed the Internet as it was neither a very simple nor a particularly joyful experience.
I believe that we people who are in the Blockchain space often forget how cumbersome it still is for ‘outsiders’ to interact with Blockchain technology. As ‘insiders’ we got used to handle public and private keys, we are familiar with “Web 3 bridges” such as MetaMask, we know how to handle network fees, we can probably read and understand a fair share of the actual data that is being stored on a Blockchain and, most importantly, we understand the basic concept of Blockchain (I recommend “How Blockchain Works” by Anders Brownworth for readers who do not).
For Blockchain newcomers, especially if their background is not technical, it is quite a learning journey to reach this level of understanding. To interact with a Blockchain or dapp without having that knowledge can be not only difficult from a user interaction point of view (“How do I actually transfer funds from A to B? How do I interact with a smart contract?”) but also dangerous from a risk perspective (“How can I ensure to not lose access to my funds on the Blockchain — be it due to my own carelessness or the smart action of a malicious actor?”).
Hence, from a user’s perspective, there is one important difference between browsing the Internet in the early 1990’s and adopting Blockchain in 2020: with the latter technology one has usually a financial value at stake. This can dramatically increase the cost of failure — be it personal or technical.
And to be frank, quite a few potential points of failure exist when dealing with Blockchains today: Less so on a protocol level — at least the biggest Blockchain networks such as Bitcoin or Ethereum have proven secure and stable over time. But much more so on an application layer: Anyone can launch a dapp and try to lure speculators into sending funds to a certain smart contract address. Only few Blockchain experts are capable of auditing the security of a smart contract. Malicious actors abuse these circumstances by implementing back doors into their smart contract code that allows them to misappropriate the funds people have sent them over.
Another “point of failure” lies in centralized cryptocurrency exchanges: Most Blockchain newcomers use those to trade fiat currencies for cryptocurrencies or exchange between different cryptocurrencies and tokens. This is a convenient solution because the exchange takes care of handling the private keys. But often it is not a very safe one: Over the past years, the Blockchain scene has repeatedly witnessed hacks of centralized exchanges — the total value of stolen user funds lies in the billions (in USD).
It is therefore recommendable for so-called “hodlers” to keep the coins in their own wallets and thereby manage the private keys on their own. But this again comes with risks as private keys can be forgotten, lost, stolen or in some cases even worse — guessed by a computer. Along with the storage risks come other usage risks such as mistakenly sending a transaction to a wrong address on the Blockchain.
To conclude, I would like to briefly summarize this article’s key findings and arguments:
A Blockchain might be described as a “cryptographically enhanced” distributed ledger that enables a ‘trustless’ exchange of (digital) value. It is a groundbreaking innovation as it allows different actors that naturally may distrust each other to directly exchange value in a secure way.
The capacity of today’s widest adopted public Blockchains is very limited — as of today, they could only facilitate a tiny share of global financial transactions. Different solutions to the scalability problem are currently being developed. I believe there is a good chance this problem will be solved within the next five years.
The usage of Blockchain networks and applications has been steadily growing over the past two years: Today it seems fair to assume that there are over 1 million users globally that regularly transact on one or multiple Blockchain network(s). While this might be a respectable number, it also shows that the technology is still far away from mainstream adoption.
The Blockchain space is not (and most probably never will be) a lawless zone: While it can be difficult — at times impossible — for regulators to “take down” a smart contract once it is deployed on a highly decentralized network (and even more so to entirely shut down such a network), nothing stops them from taking legal action against the creator(s) of a Blockchain application that is believed to infringe certain laws.
People from within the Blockchain space tend to underestimate how cumbersome it still is for Blockchain newcomers to understand and eventually interact with the technology. For Blockchain to become fit for mass adoption, the user experience for the average (“non-techie”) user must become not only much simpler but also much more secure.