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Blockchain Economy 101 – An actuary’s attempt to wade through BCE

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Quite overwhelming sea of articles out there – links for quick learning – Highly recommend Mastering Bitcoin: Programming the Open Blockchain”  by Andreas M. Antonopoulos

What constitutes Blockchain Economy (BCE)? Key ingredients are (and why they are so transformative):

1. Distributed Ledger (or Database) Technology

2. Peer-to-Peer Transmission

3. Transparency with Pseudonymity

4. Irreversibility of Records

5. Computational Logic

It can pretty quickly get overwhelming for a starter to wade through tons of information about Blockchain on the web. This space has grown exponentially; when I started digging around, it gave me a sense that a tectonic shift had happened right under my feet, and I am blissfully caught unaware. There are myriad ways of explaining the BCE, as this is not just a couple of new concepts, but multiple interlinked principles evolved into a very potent phenomenon. 

This blog is my attempt to describe the BCE. Of course, there are hundreds of articulations out there, but every effort to articulate this fascinating phenomenon hopefully makes it richer!

Some links that helped me are: – Comprehensive but convolutedly long. Mixes concepts of money and wealth, and touches briefly on what Blockchain is, explaining why it is so fundamentally innovative. But mixes up with lengthy explanations on how each fundamental change waves evolve, losing focus on Blockchain.

Starts with trust need in the economy but quickly gets into some of the complicated cryptographic stuff of Blockchain. Then gets into smart-contracts and broader application ideas. Heads-up – has too many links, which can be distracting!

This has the plainest English explanation – but only creates more questions of how for those who are moderately tech-savvy.

A long but one of the must-go-through sources for a serious pursuer is “Mastering Bitcoin: Programming the Open Blockchain” by Andreas M. Antonopoulos. Even if you are not familiar with any coding, this book is still readable to get an excellent deep primer. I would read anything from him!

BCE Five fundamental principles underlying the technology:

1. Distributed Ledger (or Database) Technology

 A ledger is the sequential blocks of data or blocks, each linked sequentially over time. You can think of them as traditional books of entries in digital form, each having verifiable but immutable (not changeable) links to the previous one. 

Essential in Distributed Ledger are ‘nodes”. These nodes are programs determining what data in what formats should be in the ledger, which is a series of blocks, rules of validation of data, and rules of consensus. These are the digital soldiers who carry out the distributed task of ensuring the fidelity of the Blockchain by comparing the data with their own individual copies of the blocks (or ledger). That is the trust for you; one soldier can’t compromise and fudge the data; that takes altering ledger copies with every one of these soldiers. These nodes are developed (or new soldiers created) by consensus, and the majority of existing nodes need to agree on any changes in the rules.

Each node keeps the entire database from day 1 (or like the beginning of the time!). That’s right, it is massive data like your passbook has details of all of the transactions from your bank from all of its customers! So how does this even begin to make sense? Enter hashing technology, which conveniently packs the largest of information into a uniform, compact hexadecimal output. 

No single party controls the data or the information. Every party can verify the records of its transaction partners directly, without an intermediary. Like I pay you by recording transactions directly in my passbook, which is reflected in everyone’s passbook! No need for tellers of bank guys to validate that. Of course, the data is not public; you will have access to control whom you want to share the details.

This structure enables a framework for trusting a total stranger, with solid features of neutrality, the immutability of timestamped records or forgery protection, auditability, and integrity. Obviates the need for a central repository and authenticator/arbitrator.

What does this mean? Very potential disruptive implications. Like drastically reducing margins for savings/credit banks or any market maker exchanges, look at the income of the top financial institutions. It kind of breaks away physical boundaries and potentially threatens macro-financial policy decision powers that the Governments yield now (Governments have sole control over the flow of financial transaction information). With the automatic trust that comes with the BCE structure, the need for Regulators will reduce. 

This leads to broader political landscape disruption. The first proof-of-concept for Blockchain Economy is Bitcoin, and surprisingly it more than meets the criteria required to be fiat (Government-issued) money! Actually, it beats the US dollar by a long margin if you sit down and tick off desirable qualities for investing over a 20-year horizon! 

2. Peer-to-Peer Transmission

Communication occurs directly between peers (or nodes) instead of via a central repository. Each node stores and shares information with all other nodes. Hence the transactions can almost be instantaneous. 

Internet of Things (IoT) further enables tracking and monitoring information flow of brick-and-mortar industry supply components, for example, shipment tracking. With the instant transparency and real-time information, current significant margins/costs in the supply chain and distribution will evaporate quickly. Think of this, any lag in transaction and settlement is a target for malpractices! Our Regulators spend tons of money and effort to govern this lag, hence the costs like auditors, financial consultants, regulators, etc. 

Another angle is the absence of a centralized repository, which reduces the hacking and loss of data. This seems contradictory as now you have more than one repository to hack; hence should be easy to break in, but the same hashing I mentioned earlier makes it improbable to access majority nodes and then manipulate data simultaneously.

3. Transparency with Pseudonymity

Every transaction and its associated value are visible to anyone with access to the system. Each node, or user, on a Blockchain, has a unique 30-plus-character alphanumeric address that identifies it. Users can choose to remain anonymous or provide proof of their identity to others. Transactions occur between blockchain addresses.

This, coupled with the two above principles, is a powerful one. The availability of real-time – almost zero-cost trustworthy data that you control has the power to transform nearly any of our economic activity.

Specific one to Insurance, this enables you to monetize your information. You disclose your personal data to someone very specifically, for one particular purpose, for a specific period, and no more. We haven’t yet begun to comprehend the power of unlocking the monetary value of our personal profile data, which today we share in abandon now! P&C underwriting would be even more disrupted, as the very financial impact of an event being underwritten would undergo transition. Why? With BCE upsetting traditional economic structures, losses resulting from failure in traditional risk mechanisms will no longer be relevant. A good example is financial frauds or personal liability lines, where it is difficult to have transparent history. With BCE providing immutable records and better-articulated smart contracts, the frauds become difficult, or their financial implications become less severe. 

Even more fundamentally, BCE will trigger a wave of wealth creation that itself will change the financial consequences of risk events covered. 

4. Irreversibility of Records

Once a transaction is entered in the database and the accounts are updated, the records cannot be altered. This is achieved by linking a transaction to every transaction record before them (hence the term “chain”). Various computational algorithms and approaches are deployed to ensure that the recording on the database is permanent, chronologically ordered, and available to all others on the network.

This is the so-called immutability. Once confirmed (or linked), these transactions are there eternally, yes, eternally! This transcends time and generations – forever living records should enable a completely different economy! Like your great-grandson knowing how much you paid for your dating ring, assuming you could convert that into a successful marriage!

This also enables hard-to-monetize assets to monetize better, like 10 copies of a digital book. You get paid immediately every time someone accesses one of those ten copies. Similarly, a farmer can monetize his well-maintained but idle farming tool by lending out for a short period. 

The immutability of records is something very powerful. It can make corruption hard. The Chinese government recently killed a thriving industry of fake Government tax receipts used to claim duty exemption by putting them on a blockchain. Education and employment records on Blockchain can make pre/post employment verification totally redundant.

5. Computational Logic

The digital nature of the ledger means the Blockchain transactions can be tied to computational logic and hence can take execute programmed action. So users can set up algorithms and rules that automatically trigger transactions between nodes.

This is the Etherium world for you. Our legal framework is mainly developed to enforce transaction commitments between two parties. Currently, they are hindered by tortoise paced and prohibitively costly judicial systems, subject to geopolitical frictions. As a result, only a negligible percentage of contracts are enforced formally. Instead, standard recourses are arbitration and taking on some haircuts, posing a high drag cost in overall financial transactions.

Enter smart contracts. With no need for intermediaries to execute terms, they will disrupt the entire legal advisory/arbitration economy as known today. The future will belong to those subject matter experts who can develop digital contracts as mutually executable actions based on real-time information enabled by Blockchain.

Satoshi Nakamoto, no one yet knows him (her? them? Or SAmsung, TOSHIba, NAKAmichi, MOtorola ? @elonmusk ), but the person is aptly anonymous for this biggest ever wave of transformation, the foundation being pseudo-anonymity. 

Didn’t find anything new, but like Alchemist, this person has created a heady and potent potion from independent developments in cryptography, digital money, proof-of-work, and digital timestamping. Reminds me of the magic potion that druid Getafix is famous for; all of us now can potentially become data-drunk Obelix (one of my favorite cartoon characters, who doesn’t love him?? )!!

I currently work full-time at Swiss Re, Bengaluru. The blogs and articles on this website are the personal posts of myself, Balachandra Joshi, and only contain my personal views, thoughts, and opinions. It is not endorsed by Swiss Re (or any of my formal employers), nor does it constitute any official communication of Swiss Re.