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Blockchains, Cryptocurrencies & the New

Decentralized Economy: Part 1 — A Gentle


Introduction

Blockchain is the most important technology you might not yet understand.

It is building a future that will be more decentralized and democratic, whose beneficiaries
will range widely from Syrian refugees to investment banks. The World Economic Forum
estimates that by 2027, 10% of global GDP will be stored on blockchain technology.

Rapidly evolving blockchain technology and startups are poised to fundamentally change
entire business models, fundraising models, business operations, payments systems, and
more. Despite the importance of this emerging technology, much unfamiliarity surrounds the
topic.

The purpose of this essay, divided into three parts, is to 1) explain blockchain,
cryptocurrency, and recent trends, 2) describe blockchain applications, or “decentralized
apps” (DApps) and their tokens, and 3) elucidate how blockchain technology will be used to
redesign the Internet and economy of the future.

Blockchain & Cryptocurrencies Explained!

The Bitcoin blockchain launched in 2009 as a peer-to-peer (P2P) digital payment system. Its
creator ingeniously derived a system, using computer networks, cryptography, and game
theory (now collectively called “cryptoeconomics”) for parties around the world who do
not know each other to conduct and record transactions without an intermediary.

The bitcoin “cryptocurrency,” which can also be called a “token,” is the digital currency that
users send to transfer value in this payments system.

By circumventing intermediaries, users can send value across borders using the Bitcoin
blockchain for extremely low fees (historically less than 50 cents per transaction, regardless
of the amount sent).

Blockchain technology’s game theory component is essential: It establishes incentives and


disincentives based on pure economic rationality and self-interest for participants to validate
transactions in the network and to play by the rules. It underlies the self-regulating
mechanisms in decentralized networks and applications.

Game theory also informs the robustness of the network to malicious activity from harmful or
adversarial actors within its system. This robustness is usually described in terms of
“byzantine fault tolerance” (BFT) or “fault tolerance” and is based on the Byzantine
General’s Problem that states that no more than 33% of the network participants can be
malevolent to maintain the system’s integrity (in practice, the Bitcoin blockchain’s threshold
for fault tolerance is 50%).

The result is that, entirely from the bottom-up and with no centralized coordinator or
guarantor, the P2P network runs smoothly and honestly in a “trustless” environment where
participants are self-interested and do not know one another.

In fact, during the week ending June 21, 2017, 1.8 million transactions were sent over the
Bitcoin network without interruption, constituting $4.4 billion of value (at a $2507 bitcoin
price).

In the years after 2009, several less anonymous yet still brilliant engineers have developed
alternative blockchain technologies that modify and enhance the original Bitcoin system. The
most noteworthy example is Ethereum, which is the second-largest system by market
capitalization (defined as the number of tokens in circulation multiplied by their market
price).

Cryptocurrencies are the “native” digital currencies that exist in blockchain systems or
applications. Whereas the Bitcoin system’s native cryptocurrency is bitcoin, Ethereum’s is
called ether.

All blockchains require the use of a digital currency, whether it be their own native
cryptocurrencies or an existing one such as bitcoin and ether. There are about 718
cryptocurrencies in circulation as of June 27, 2017.
Cryptocurrencies are necessary to operate blockchain systems, because they are the incentive
mechanism for computers (“nodes”) in the network to conduct (“validate” or “verify”)
transactions.

Indeed, they are the reason you only pay a tiny fee to send a bitcoin transaction. The Bitcoin
blockchain system compensates the nodes maintaining the network 12.5 bitcoins every time
they successfully validate a set of transactions in a process called “mining.”

Mechanics

All blockchains or similar “distributed ledger technologies” (DLT) have a common set of
characteristics. This is how they work:

1. Blockchains are digital ledgers or logs that record electronic transactions that occur
between two parties.
2. The two parties do not know each other and directly engage in a peer-to-peer
network of connected computers.
3. Rather than relying on a third-party middleman (ex. PayPal, a bank, etc.), the network
collectively reaches agreement (“consensus”) on which transactions are legitimate
using a consensus mechanism. By “legitimate,” we mean that, for example, Alice
sends money to Bob and does not spend the same digital currency twice (called a
“double spend”) or do anything else malicious.

There are several types of consensus mechanisms, each with pros and cons. The main types
are “proof-of-work” (the basis for Bitcoin and Ethereum), “proof-of-stake” (eventually the
basis for Ethereum), and “proof-of-authority” (the basis for private chain setups). Proof-of-
work is very wasteful of electricity, which is one reason people want to adopt other
mechanisms.

If you can remember 3 more things, remember these:

1. Once the network approves the transactions, the transactions get posted to the digital
log. In Bitcoin, attempted transactions are first grouped together in a block, which
then gets verified all at once (by the proof-of-work mechanism) and added to a long
chain of blocks. This is why it’s called a “blockchain”!
2. The blocks are linked together using cryptography, so that you cannot
surreptitiously edit or tamper with the transaction data on a block once the block is
added to the chain (or more precisely, once a subsequent block is added to the chain
after it).
3. The transaction details are transparent and verifiable by the public. However, the
identities of the buyers and sellers are hidden behind their public usernames, which
are long alphanumeric addresses. Here’s a window into the Bitcoin blockchain. The
simultaneous transparency of transactions and masking of identities is why
blockchains can be used to both anonymously buy drugs and obediently report to
regulators.

Note that some blockchains can restrict transaction visibility and participation to designated
parties; these are called “permissioned” or private blockchains. Many large companies are
very interested in these private blockchains, in part because they do not want proprietary or
competitive data to be public. The R3 Consortium of most major banks in the world (which
raised $107 million in funding in May) has developed a private blockchain system called
Corda that just entered beta phase — so has the Linux Foundation (with major support from
IBM) with the Hyperledger Fabric.

Another exciting innovation is Zcash, which allows you to hide details of transactions such as
the sender, receiver, and amounts (using zk-SNARKs) while operating on a public
blockchain. JPMorgan just announced a big partnership with Zcash.

Robust and Secure Networks

In addition to offering a mechanism for peers to transact directly for free without knowing or
trusting each other, data held in blockchains are robust and secure. This is because:

1. Using cryptography, transaction information is recorded in a way that is permanent


and tamper-evident. As a result, we can call the blockchain “immutable.” System
attacks are extremely difficult. For Bitcoin and other “byzantine fault tolerant”
networks, the most prominent way that data on the blockchain can be manipulated is
with a concerted attack by a majority of the network participants, called a “51%
attack” (there are different types of attacks requiring different levels of participation
to succeed). Further, experts agree that the quantum computers of the future will be
able to break today’s cryptography schemes.
2. The blockchain record is downloaded on thousands of computers around the world
that are participating in the network. These computers constantly sync, or update, the
record for new transactions. As a result of this wide data distribution, data storage is
robust and there is no single site of failure that attackers can target. To delete the
blockchain you would need to destroy the thousands of computers in the system all
around the world.

In summary, data are not stored in concentrated sites, but rather on a log that is downloaded
on thousands of nodes and constantly syncing. New data locks onto the log in blocks that are
connected by cryptographic hash pointers referring to preceding and subsequent transactions
on the ever-growing “chain” of transactions.

Ethereum

Ethereum is an extremely promising and exciting blockchain technology due to some crucial
features and advancements over the first-generation Bitcoin system.

Whereas Bitcoin has very limited programming leeway (some compare programming
capabilities to that of a graphing calculator) and is essentially a ledger of payments between
parties, Ethereum’s programming language can be used to quickly build new applications.

Ethereum’s programming language, Solidity, is easy to use and versatile. It is “Turing


complete,” meaning that it is capable of approximately simulating the computational aspects
of any other real-world general-purpose computer language, which leads to more
sophisticated applications.

As part of the Turing completeness of Ethereum’s Solidity programming language, anyone


can build conditional contracts (using “if/then” and other logic statements) that execute
autonomously. The coded contracts are called “smart contracts” and can execute previously
agreed upon terms.

Smart contracts are a big deal: They can be considered legally enforceable and can benefit
countless industries by removing time and human error from contract processes.

Note that because the contracts are on the Ethereum blockchain, their code is open-sourced;
public visibility motivates developers to be extremely cautious about their code so that it is
not exploited by hackers to attack the program.

In combination with high quality developer tools and core components (Truffle, Metamask,
uPort and others) and substantial industry support (Ethereum Enterprise Alliance, along with
Brooklyn-based venture studio ConsenSys), Ethereum shows great promise and popularity
within the community.

Ether cryptocurrency is required for the execution of code and smart contracts on the
Ethereum blockchain. Users must spend a small amount of ether, called “gas,” to incentivize
the network to conduct and verify transactions and run smart contracts. These “gas”
transaction execution fees are the intrinsic use of ether.

Most cryptocurrencies have an intrinsic use, which is to access or employ the blockchain
system or application (discussed in greater detail in Part 2).

For more background on blockchain, see this article by policy research and advocacy group
Coin Center and this textbook by professors at Princeton.
Blockchain Today

Numerous non-governmental, governmental, and for-profit institutions are actively investing


in blockchain R&D to power the future. Institutions spanning the United Nations, IMF, EU
Commission, U.S. Dept. of Homeland Security, and National Science Foundation are
investing in blockchain research initiatives.

Furthermore, many governments and central banks are interested in introducing digital
currencies; Vladimir Putin, the Monetary Authority of Singapore, the People’s Bank of
China, Bank of Canada, Bank of Japan, and more have been investigating digital currencies.

It is likely that nearly every major multi-national corporation has begun looking at or
investing in blockchain technology, from Walmart to Western Union. In brief, using
blockchain allows businesses to remove the need for central parties or brokers in
various processes, eliminating the fees, human error, time, and security risks that they
entail.

IBM and Microsoft have established “Blockchain-as-a-Service” businesses, while major


consulting firms including Deloitte, Accenture, and KPMG are building blockchain practices.
BCG’s 2016 report “Thinking Outside the Blocks” smoothly summarizes the relevance of the
technology while guiding readers through its potential corporate uses.

Meanwhile, remarkable (although very volatile) returns in cryptocurrencies such as bitcoin


and ether are driving public attention to the assets as speculative investments:

Year-to-date as of June 27, 2017, the price of one bitcoin has risen 148% to about $2400,
while the price of one ether has risen an astonishing 2900% to about $240. The total market
cap of cryptocurrencies is about $98 billion. These figures vary widely with the volatile
pricing dynamics.
Market Cap of Cryptocurrencies Approximately $100 Billion

Source: http://coinmarketcap.com/charts/
Cryptocurrencies have also been grabbing headlines as a new source of startup financing.
Total fundraising to blockchain startups from “ICOs,” or initial coin offerings (discussed
below), has exceeded $600 million so far this year, surpassing levels of investment funding
raised from venture capital (VC) firms. This figure includes the staggering $150 million
fundraising round by Israel-based startup Bancor on June 12, 2017, which was filled in less
than three hours.

Initial Coin Offerings: Democratized Fundraising

ICOs have proven to be an incredibly rapid new means of fundraising, as evidenced by


multiple strong issuances this year. They democratize fundraising, allowing non-traditional
upstarts without traditional equity and with open-source production to raise millions of
dollars.

Impressively, ICOs draw on the community of blockchain enthusiasts and cryptocurrency


investors to crowdfund projects. In this way, they democratize the venture capital process.

In fact, while ICOs are completely open to the public, most VCs are not legally able to
participate due to agreements with LPs that limit the types of securities in which they can
invest.

As industry thought-leader Jamie Burke put it, “The day when VCs were the elusive elite and
primary source of capital for startups has ended. When a startup (Brave) can raise $35m in 30
seconds without any dilution, the genie is out of the bottle and it isn’t going back in.”

Note that strong demand for ICOs in May and June 2017 has led to a “crowding out” of small
investors in favor of large “whale” investors who can receive priority allocations. Some
challenge whether this undermines the democratic nature of ICOs.

Strong ICO interest has also led to complications and volatility in the price of ether.
Many ICOs require investment in the form of ether, which drove unprecedented demand for
the asset in May and June 2017. The price of ether reached new highs (above $410) in the
week of June 18 during the Status token ICO, until congestion and service disruptions on
exchanges led to downward price pressure and even a “flash crash” of ether on the GDAX
exchange to $13. These pressures may have also exposed limits in the current Ethereum
network. In the final week of June, the price of ether fell to the $200-$300 range.

Regulation and Investment Risk

As of June 27th, cryptocurrencies are not considered public or private “securities.” They are
not yet regulated by the SEC, and they do not have standardized features. Some offer features
similar to distributions or coupons, some offer voting rights, and most offer neither.

The SEC would like to ultimately regulate ICO participation, as it does with other forms of
crowdfunding, to protect retail investors from scams and losses. Currently, ICOs and tokens
are not required to provide disclosures or a prospectus. Some are also not based on sound
business models. With escalating hype and public awareness, more industry outsiders are
investing in ICOs and tokens. Without the safety measures and transparency normally
demanded by SEC regulation, investors are at risk.
Conclusion

Blockchains and other distributed ledger technologies have a variety of positive features and
can be applied to countless industries and uses to improve efficiency, security, and
operations. Cryptocurrencies such as bitcoin and ether are required to execute transactions
and operate the networks. They are also investable assets and sold to the public to raise
capital. As such, they constitute a new form of crowdfunding and startup fundraising.
Blockchain cryptocurrencies are also a new type of alternative investment, one that is not
yet SEC-regulated and that can pose risks to imprudent investors.

Most industry observers agree that we are in the early days of a complete restructuring of
numerous processes and operations to be decentralized and on the blockchain. “This is like
the Internet in the 1990s” is commonly exclaimed.

Blockchain VC and thought-leader Olaf Carlson-Wee has stated, “We’re absolutely still in
the infrastructure building phase. But I do think within one to two years, we’ll start to see the
first viral applications that are user facing.”

In Part 2 of this essay, we explain “decentralized applications,” which are apps built on
blockchain technology that redesign the delivery of products and services in the interest of
the user and the public.

 Update: Here is Part 2!


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Blockchains, Cryptocurrencies & the New


Decentralized Economy: Part 2 —
 Blockchain-Based Apps
Blockchain startups are building the apps of the future.

In Part 2 of this series, we develop the concept of decentralized applications, called “DApps.”
These new, open-source applications are built using blockchain technology. They
decentralize the delivery and operations of app-based products and services, which can
have positive implications for users.

Decentralized apps have a low level of control and ownership by a centralized authority.
They have less ownership over user data and product content, often charge lower fees, and
are built in an open-source manner by a community of contributors. This stands in contrast to
the centralized apps we currently carry on our cell phones such as Google, Uber, and
Facebook, which own (and sometimes sell) our data, can charge high fees (e.g. to advertisers
or users), and are built with a higher degree of proprietary software.

Decentralized apps also use their own digital currencies (app-coins, cryptocurrencies, or
tokens) or a major digital currency such as the Ethereum blockchain network’s “ether,” as
introduced in Part 1. The digital currencies support a new type of business and revenue
model.
Many of the apps of the future could be built on a blockchain, funded by a new method of
capital-raising (token sales and ICOs), and monetized by a new revenue model based on
tokens. But above all, they are propelled by the ideal of decentralization.

A New Business Model

A decentralized application begins life as follows: A startup has an idea to build a


decentralized version of some product or service in the form of a new application. The
creators then write an academically oriented white paper explaining to the world the
underlying technical details and use cases. They create and issue their own cryptocurrency to
support the transactions of the product or service and to raise money. They hire more
developers who believe in the mission, and they establish an online community of
contributors and users who help implement and grow the project.

These projects are built either on their own blockchains or on top of a blockchain protocol
layer such as Ethereum (which, unlike Bitcoin, can support the development of complex
applications, as discussed in Part 1). We explain this architecture in Part 3.

There are a number of products and services that could be reinvented with a decentralized
business model. These could include cloud storage, computer processing power, video game
streaming, poker, gambling/predictions markets, crowdfunding, commodity investing, hedge
funds, and media content distribution.

Existing blockchain-based startups providing these services include, respectively (with their
corresponding cryptocurrencies): Storj.io (SJCX) and Sia (SC); Golem (GNT); First Blood
(1ST); Virtue Poker (token not yet launched); Augur (REP) and Gnosis (GNO); WeiFund
(token not yet launched); Digix (DGD); Melonport (MLN) and Numer.ai (Numeraire); and
Steem (STEEM) and SingularDTV (SNGLS).

To illustrate a use case, Storj.io is an Ethereum-based decentralized cloud storage application;


it allows users to rent storage capacity at a fraction of the cost of Dropbox by connecting
them with users who have excess capacity. It brokers the peer-to-peer (P2P) exchange. Users
can pay and receive payment for storage capacity in Storjcoin (SJCX).

A second interesting example is Brave, a web browser developed by the creator of JavaScript
and Mozilla Firefox, Brendan Eich. It can block web trackers and ads, improving privacy,
browsing speed, and the user experience. It intends to dis-intermediate middlemen from
Internet advertising, instead establishing a decentralized digital ad exchange (based on
Ethereum). Brave will pay publishers its Basic Attention Token (BAT) when users view ads.
It will also pay users, in BAT, who elect to view ads.

Importantly, startup Lisk (LSK) has developed a sophisticated platform that helps DApp
developers build and launch their programs more easily, lowering barriers to entry and
supporting the creation of new DApps.

Not Your Parent’s Company

Even at an organizational level, DApps and blockchain projects are significantly more
decentralized and democratized than traditional apps and companies.
Software development and leadership teams are often either spread across the world or based
in urban co-working spaces. Within and beyond this core team, additional programmers and
product developers contribute to software development as freelancers that are part of the
community and ecosystem.

Communications with internal teams and the ecosystem are via Slack and Reddit.
Announcements and communications to the broader public are via Medium and Twitter.

If you want to learn more about any of these DApps, I recommend following them on these
platforms.

The startups pay developers and other contributors in either cryptocurrency or fiat currency.
Note that the term “fiat currency” is widely used to differentiate traditional, government-
issued currencies such as euros and U.S. dollars from cryptocurrencies.

Each month, dozens of new DApps launch and offer their tokens to the public, proliferating
and decentralizing numerous use cases.

A New Product Delivery Model

How does this new decentralized organization deliver products and services? Notably, it
retreats from owning, storing, or selling the product or service itself. Instead, it often simply
either:

1. Brokers the product or service between peers, or


2. Retrieves, verifies, and delivers content to users without storing or owning the content
or user data

In a DApp, content and user data are typically stored on the blockchain infrastructure layer
rather than on a company’s proprietary platform, database, and servers (explained in Part 3).
In this model, users retain ownership of their data.

A Platform for True P2P Applications

The blockchain infrastructure could enable a true “sharing economy” with a more direct peer-
to-peer exchange of goods that is not brokered by a middleman extracting large rents.

In the case of decentralized cloud-storage DApp Storj.io, parties connect and exchange cloud
storage capacity and payment for very low costs via the DApp. DApps like Storj.io provide a
front-end interface for the parties to connect, and may or may not take a fee for providing the
service.

Forthcoming DApps could attempt to replace Uber and AirBnB, allowing for more direct
peer-to-peer transactions and obviating the need for a centralized platform.
“Blockchains are ideal as a shared database in which every user can read everything, but no
single user has control over who can write what. This allows for the disintermediation of
third-party trust brokers in networks, their monopoly rents and an increasing level of
transparency and efficiency.”
- “Blockchain-Enabled Convergence,” Outlier Ventures
In these P2P transactions, terms can be negotiated and executed on smart contracts (written
on Ethereum) so that parties can comfortably transact without knowing one another or having
a guarantee from a central entity. The buzzword for this type of engagement is “trustless.”

Note that smart contracts require indication of real-world events (e.g., the home was
damaged) by an “oracle,” who connects and feeds data or information about events that occur
in the external world. Prominent oracles include Oraclize and Reality Keys. An oracle’s
accuracy and trustworthiness needs to be well-founded, which is easier said than done. For
further information, you can read this article.

Even a payment process for a P2P exchange DApp can occur over blockchains. Because of
their very low transaction fees, the right kind of blockchains can enable micropayments,
which are currently too costly when using traditional payments processors ($0.30 + 2.9% for
PayPal and 1–4% for credit card processors).

A decentralized app can also foster a marketplace for the direct P2P exchange of goods.
OpenBazaar illustrates this example; it allows users to buy and sell a variety of goods online
with no marketplace or brokerage fees.

OpenBazaar FAQs

Source: http://openbazaar.org/
A New Token-Based Revenue Model

The cryptocurrency is the basis for the new decentralized revenue model.

As Fred Wilson at Union Square Ventures expresses, “The token that you sell in your ICO is
the atomic unit of your business model. You are selling some of it to raise capital but the
main purpose of the token is to monetize your product or service.”

This is big: A DApp effectively derives revenue when its cryptocurrency increases in
value. The DApp’s leaders retain a percentage of the supply of the cryptocurrency that they
create. As users consume tokens in exchange for receiving the product or service on the
DApp, they boost the token’s demand, and the token rises in value. This effect increases
the value of the organization’s retained tokens, effectively increasing the value of its
assets.

It is important to note that the token must continue to be held in accounts, whether by users,
investors, or others in the community. If the coin is simply spent or sold immediately when
no longer in use, any appreciation in token value will not be sustained.

The founding team and developers can use the cryptocurrency, either directly or by
converting it to fiat, to pay employees, developers, and contributors. Similar to offering
equity shares, compensating employees in cryptocurrency incentivizes effort at work, since
employees have “skin in the game” and benefit from the token’s price appreciation.

What’s more, even the DApp’s users who hold the token also participate in its upside; in this
way, the DApp business model is considered better than free for users!

Further, the leadership team may pay external contributors from tokens set aside in an
“ecosystem fund.” Finally, it can also convert its cryptocurrency to fiat to pay business and
office expenses. Note that a crucial downside of a token-based compensation scheme is
volatility and losses if the token value falls.

Who Buys Tokens?

Two types of people buy a DApp’s tokens: The first is users of the DApp platform who
spend cryptocurrency as a medium of exchange to buy and sell its products and
services. For example, when people want to rent excess cloud storage capacity with Storj.io,
they can spend Storjcoin in the DApp.

The access that tokens provide leads to the perspective that they are analogous to API keys,
or any type of access keys. Tokens grant access to the use of the application (DApp) or
blockchain network (e.g., Ethereum). In this way, cryptocurrency has an intrinsic use and
value, elevating it from intrinsically valueless fiat currency.

Thus, a token, or cryptocurrency, is both a medium of exchange like a standard currency and
an access key like a paid API key.

The second type of buyer is speculators who want to invest, either in a primary issuance of
tokens (ICOs), a pre-sale of new tokens, or in a secondary market on cryptocurrency
exchanges. They hope the value of the token will rise, either from its use as a medium of
exchange on the DApp or from interest by other speculators around the world.

Investors are attracted to cryptocurrencies because, in addition to this year’s headline-


grabbing returns, they provide exposure to high-growth start-ups at attractive valuations and
with the potential for excess risk-adjusted returns that are uncorrelated with other asset
classes.

Expressed otherwise, “The particular value of any token will depend on a variety of factors
described in the application code that created it (e.g. the total supply of tokens), as well as the
market demand for the token, which could be driven by a desire to use the tokens (e.g. desire
to attend the token-ticketed event or buy the token-denominated cloud storage) or by
speculation over future use-value.”

Conclusion

Decentralized apps, or DApps, are an entirely new type of application with a redesigned
business and service model that favors decentralization, or the devolution of control and
monetary interest from a “centralized” company.

Notably, user data is stored on the blockchain infrastructure level, not within the application,
leaving it in the hands of its true owners, the users. Prices for goods and services are also
lower, as the application removes the middleman that may exist in a current service model.

DApps can be created for numerous business cases, such as for creating marketplaces for
the direct exchange of goods in a peer-to-peer environment. Other examples of products and
services that have already been decentralized on apps include web browsers and a peer-to-
peer exchange of cloud storage capacity.

Cryptocurrencies, or tokens, are a novel method of monetizing a product or service.


DApps issue native, unique currencies that are employed in the applications. They are then
rewarded by the appreciation of their currencies when the application is used, in addition to
any other fees they may charge. The cryptocurrency, rather than content, product sales, or
brokerage fees, is the main driver of firm revenue.

If you are excited about DApps and want to start using them on your own, you can begin by
exploring the ones listed in this article.

In Part 3 of this essay, we discuss the new Internet architecture and the decentralized “Web
3.0.” We explain how data is stored and shared on blockchains and decentralized storage
layers, rather than within applications, and how this data openness promotes interoperability
and interaction between users and applications with widespread and never-before-possible
benefits.

 Update: Here is Part 3!


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Blockchains, Cryptocurrencies & the New
Decentralized Economy: Part 3 — The
New Internet

Blockchain technologies and decentralized applications can together build a new Internet and,
more broadly, a new economy.

In Part 1 of this post, we introduced blockchain mechanics, digital currencies, and key trends
such as enterprise adoption and ICO financing. In Part 2, we developed the concept of
decentralized applications, called “DApps,” and their new token-based business models.
In the 3rd and final part, we explain the role of data openness and interoperability in
blockchain technology and how they support the new era of heightened interaction,
decentralization, and efficiency that makes up the “Web 3.0.”

The New Internet Architecture

The Old System

The current Internet and World Wide Web transmit information via traditional “protocols,”
namely IP/TCP, HTTP, and HTTPS. These were developed in the late 1960s and 1970s by
the DARPA and other U.S. research institutions. The protocols are the foundational layers
upon which today’s centralized applications such as Facebook, Bank of America, Uber,
Google, and others operate. The World Wide Web uses HTTP and HTTPS, which is why
URLs read “https://www.facebook.com.”

In this scheme, which can also be called client-server architecture, data is stored within
applications. Specifically, the companies owning the applications (e.g., Google) store user
data in their data centers and servers. As a result, they control and benefit most from the data.
We can call them “centralized,” as explained in Part 2.

The Economist recently called these tech titans “giant centralized databases” whose “value
derives from the fact that they control the entire database and get to decide who sees which
part of it and when.”

Another excellent article entitled “Mapping the Decentralized World of Tomorrow” further
criticizes, “The problem with centralized systems is that they lack transparency, allow for
single points of failure, censorship, abuse of power and inefficiencies.”

The New System: New Protocols and Networks

The forthcoming blockchain-based Internet runs on new protocols and has a new architecture
that supports more decentralized systems to the benefit of users.

Firstly, blockchains such as Bitcoin, Ethereum and others are their own new protocols.
Additionally, developers have created complementary decentralized protocols and networks
that operate alongside or in conjunction with blockchain protocols. They provide services
such as efficient data and file storage/management (IPFS, Sia, Storj, BigchainDB/IPDB) or
rapid payment transactions (Lightning Network, Raiden Network).

The simplified visualization of the blockchain application stack below is taken from Joel
Monegro’s article “The Blockchain Application Stack”, which I highly recommend, along
with his “Fat Protocols” article. You can see the Bitcoin blockchain at the bottom. The
additional decentralized protocols named above are represented by the green rectangles (they
are considered “middleware”).
Source: “The Blockchain Application Stack”

New Protocols: Decentralized Payments!

Needless to say, since their early days, blockchains such as Bitcoin have focused on enabling
cheap and efficient money transfer across borders.

Blockchain protocols will continue to promote an “Internet of Value,” as Ripple calls it, with
the nearly free flow of capital. Ripple uses its own private blockchain and native currency,
XRP, to help banks send money overseas more efficiently.

New Protocols: Decentralized Data Management!

Importantly, the new system also shifts user data (content and files like documents, large
datasets, mp3s, images, etc.) from applications run by companies to the decentralized, shared
data storage protocols and systems named above.

Rather than stored in applications, user and product data are stored in decentralized
file and data storage systems, whether they be blockchains like Bitcoin and Ethereum or the
more efficient and specialized “middleware” layers (IPFS, Storj, Sia, BigchainDB/IPDB,
etc.). Note that Storj is introduced in Part 2 of this series.

Protocol Labs’s IPFS is a leading decentralized file storage and management system. It is
specifically designed to support the peer-to-peer storage of various types of files (images,
audio and video files, documents, etc.), and it is cheaper and more efficient for this purpose
than Bitcoin and Ethereum.

As stated in Part 2, decentralized apps, or “DApps,” are commonly built “on top of”
blockchains (notice them on the top of the stack above). The DApps call, verify, and then
deliver the user and content data from where they are stored on shared protocol layers lower
in the stack. They connect to these layers with commercial or open-source APIs.

The decentralization of data and file storage and ownership, from centrally managed
applications to shared protocol layers lower in the stack, has important implications for
data ownership, accessibility, and interoperability.

Power to the User

What this all means is that in the blockchain-based Internet, users regain control and
ownership over their data. Their data is stored in decentralized storage layers, where they can
keep control of it, rather than in central databases owned by big tech companies.

For more detail on how this works, in the case of IPFS, the content is stored on nodes in the
IPFS network, and then a cryptographic hash, which is a type of unique fingerprint of the data
in a small and secure form, is recorded on a blockchain to prove that the data existed at a
specific time and place. That hash is referenced in order to retrieve and deliver the full
content from the IPFS system.

Shifting user data to decentralized data layers allows for self-sovereign data ownership.
Potentially, users can monetize their own data by selling it to interested third parties. They
can also easily share their data with other applications.

Data and Transaction Interoperability

Because open protocol layers store user data, they allow for the sharing of data across
applications and protocols.

In other words, blockchain, or more broadly, distributed ledger technologies (DLT) can be
the shared data layers where multiple applications connect. They can also be the shared
money transmission layers.

Data openness and interoperability, coupled with blockchain-based payment channels, allows
for sophisticated integrations that can improve user experience.

As the same Joel Monero of Union Square Ventures wrote, “Applications built atop this
architecture will, in most cases, work very similarly to the ones we have today — just like
Coinbase works similarly to PayPal. The big difference to consumers, however, is that
because they are built on decentralized protocols, they will be able to talk to each other, just
like different e-mail applications and bitcoin wallets can interoperate.”

Data interoperability paired with the token-driven revenue model creates new business
model opportunities, such as more direct or truer peer-to-peer (P2P) markets for the more
efficient exchange of goods or information. This mechanism is explained in Part 2.
As an example, a media and content-sharing platform could allow users to spend the DApp’s
native token to view or download content, which is stored in IPFS. The token value is sent
directly to the owners and publishers of the content, who have shared it selectively with the
DApp. Meanwhile, the DApp is rewarded via the token’s price appreciation when users
spend tokens to access content through the application.

Interoperability Across Blockchains

In the future, decentralized apps operating on different blockchains will also be able to
communicate and transfer value to one another. Interoperability will not be limited to
applications on the same blockchains, just as e-mail communication is not limited between
users of Gmail, Microsoft Outlook, or other programs (which use different protocols). There
may even be thousands of blockchains for various purposes, all interoperable.

Cosmos and Polkadot, and Ripple’s Interledger Protocol (ILP) are among the projects
addressing interactions between multiple blockchains. “Cross-chain solutions” vary in how
they contribute to interoperability; Cosmos specializes in the transfer of value (sending
money) across different blockchains, ILP specializes in the exchange of value, and Polkadot
allows for a variety of interactions across smart contracts and blockchains.

Towards a Web 3.0


Distributed ledger technologies support a “Web 3.0”, where users own their content or
data, and where users, applications, and connected devices interact with one another in
new and exciting ways.

“Blockchains are far more than a technical solution to solve the double-spend in digital
cash; they change the balance of power in networks, markets and even the relationship
between the individual and state, all characteristics of Web 3.0”
-“Blockchain-Enabled Convergence — Understanding the Web 3.0 Economy” — Outlier
Ventures Research

While the buzzwords “Web 1.0,” “2.0,” and “3.0” lack conclusive definitions, they can be
briefly summarized as follows:

 In the Web 1.0, centralized media and content sites provided information to readers.
For example, MSN published the news for readers with little reader interaction. It is a
“static web.”
 In the Web 2.0, social media sites (YouTube, Medium, Facebook) and collaborative
websites and services (Wikipedia, Google Docs, Dropbox) allowed users to publish,
share, and collaborate on content themselves. It is the “social web.”
 In the Web 3.0, applications, users, and connected devices interact directly with
each other. Decentralized apps can call and share the same user-owned data
stored on blockchains’ open data layers. Additionally, connected devices (such as
home devices or autonomous cars) can transmit their data and transfer value over
blockchain layers to users and other devices via smart contracts (discussed below). It
is a “user-owned, decentralized web.”

In a 2001 article entitled “The Semantic Web,” Tim Berners-Lee (the creator of the World
Wide Web) and his co-authors envisioned a system where computers are able to comprehend
“semantic” data on websites, “better enabling computers and people to work in
cooperation.” Data is encoded with specific machine-readable meaning and logic, allowing
software to understand it and perform sophisticated tasks automatically. Software can then
engage across applications or websites (and the users that employ them) on a vast scale. The
“Semantic Web” is an early expression of a Web 3.0 system where software, applications,
and users interact with one another.

Today, Protocol Labs’s IPLD is building a data model for the decentralized web that lets data
structures across blockchain and web protocols be more interoperable.

Perhaps future Web 3.0 applications will combine machine-readable logic, data
interoperability technology such as IPLD, and modern machine learning methods to
intelligently understand and traverse data from across the Internet. From there, they could
intelligently interact with users, other DApps, and devices, and make recommendations or
take actions (based on smart contracts and other code).

Web 3.0: Identity & M2M Transactions

The forthcoming “Internet of blockchains” supports new capabilities that are only recently
becoming possible. Here are two high-impact examples:

1. A Secure, Digital Identity


It may be possible to create digitized, self-sovereign user identities using blockchain
technology.

An individual could store relevant identifying and other personal information in a single,
“tamper-evident” (tampering and manipulation would be apparent) blockchain-based profile
or account. He or she could manage this information and send it to anyone, from
decentralized apps to government agencies. The entities would be able to read and
immediately verify the individual’s identity and information.

The Economist recently wrote, “if people’s identity is anchored in one or several blockchains,
this would give them more control over it and their personal data. If a potential tenant, for
example, wants to prove to a landlord that his income is high enough to pay the rent, he need
only disclose that bit of information, instead of allowing access to his entire credit history, as
is often the case today.”
Digital identities can be stored securely on a blockchain for a variety of uses and benefits,
from the humanitarian to the commercial.

They can provide much-needed identity documentation to millions of people around the
world who are unable to access banking, healthcare, and legal institutions for lack of this
documentation.

A blockchain-based identity can also securely link individuals to their assets, intellectual
property, and their financial, educational, and medical records. Users can be more protected
against identity theft. They can also more quickly and securely share medical or educational
information to a doctor’s office or employer. Banks may draw on the data for AML and KYC
compliance efforts.

Digital identities can also support more seamless and successful use of decentralized
platforms and applications.

Here are some prominent examples of blockchain-based identity projects.

 In June 2017, Microsoft and Accenture launched a prototype for a technology that
indexes biometric information that individuals can selectively share with different
agencies, organizations, and companies. The prototype, which has been deployed by
the UNHCR to register 1.3 million refugees, runs on Microsoft’s Ethereum-based
Azure blockchain service.
 uPort, built on Ethereum, seeks to provide a mobile-based service for self-sovereign
identity management. Users create a composite of credentials and identity information
that they can selectively send to confirm their identity. It can also serve as a
KYC/AML attestation system. uPort uses IPFS to store user identification data.
 Civic is another platform for secure management of digital identities. Personal
information is encrypted and stored on a mobile device, and users can share it with
companies and agencies through a QR code.

We are in the very early days of exploring the use of blockchain for a universal and secure
identity. Challenges abound, and industry leaders are rightfully cautious and skeptical.

2. A Machine-to-Machine World
Distributed ledger technologies can serve as the backbone to a more connected physical
world.

They allow for the transfer of information or payments between connected “smart” devices
and machines, such as home and industrial utilities and hardware, autonomous vehicles, and
consumer wearables. They can also digitally connect users to those machines.

A device, for example an energy meter, washing machine, or autonomous car, has an
embedded chip that connects to a distributed ledger. By engaging with smart contracts, it can
buy or sell energy, or send data or payments, to and from users or other machines.

In the inter-connected and inter-networked future, much described in the Internet of Things
(IoT) paradigm, users and connected devices will be able to communicate and transmit
information or payments automatically between one another using smart contracts and
blockchain technology.

IOTA is a project that could potentially support the machine-to-machine (M2M) transfer of
data and payments. If the technology is successful, its distributed ledger, called The Tangle,
may be able to scale to millions of connected devices, operate with other blockchains, and
support fee-less payments.

Slock.it is another notable startup building blockchain-based IoT solutions. For connected
devices, it creates Ethereum-based identities and accounts to engage with smart contracts and
to send and receive payments. Both IOTA and Slock.it are members of a new Trusted IoT
Alliance.
When applied to automobiles, autonomous cars or trucks with DLT-based accounts could
seamlessly and cost-effectively pay tolls or refuel at electric vehicle charging stations. They
could also pay one another to pass each other on the highway, or to draft behind each other to
increase fuel efficiency in a process called “platooning.”

In the era of distributed ledger technology, we can reformulate science fiction writer William
Gibson’s famous statement to say, the future is already here, and it is widely distributed.

Challenges to an “Internet of Blockchains”

Challenges to Customer Adoption & Usability

DApps and other projects must develop more user-friendly interfaces for ease and
accessibility. Ideally, blockchain protocols will be hidden behind approachable front-end
interfaces and users will be unaware of the DLT underneath.

It is also important that the purchase, management, and storage of tokens becomes easier
for users. The process is currently confusing, difficult, and expensive. Cryptocurrency wallet
and exchange technology should continue to improve to reduce these frictions.

Decentralized browsers and browser plug-ins (to existing browsers like Chrome) are another
step in the right direction. They can also be considered decentralized application portals.
MetaMask, Mist, and Parity are Ethereum DApp browsers while Blockstack is a separate
decentralized browser platform. They have sleek and clean user interfaces, and in one portal,
they allow users to:

1) Securely store identity information (often in the form of profiles you may use for different
DApps)

2) Manage cryptocurrency (or token) accounts

3) Send identity information and tokens to a variety of DApps to access and use them quickly
and easily

Decentralized browsers can be seen atop a more developed Web 3.0 stack composed by
prominent Ethereum developer Stephan Tual:
Source: “Web 3.0 Revisited — Part One: “Across Chains and Across Protocols”

Challenges Related to Cryptocurrency Prices

It is hard for users to manage the costs and risks associated with cryptocurrency price
fluctuations. One way this manifests is the tendency for users to avoid spending tokens in
DApps when token values are rising. They prefer to hold the tokens in this case, anticipating
price appreciation. We saw this practice in the Spring of 2017 with ether and DApp tokens.

Challenges to Technical Implementation

Blockchain networks must mature; they are struggling to handle the volume of transactions
currently demanded in the network. They need to resolve their scalability challenges before
they can support widespread app adoption.

It is also very difficult to control access to private data, such as identity data discussed
above, without a centralized provider. Public-key cryptography, where a private key is
required to decrypt data, can help encrypt and secure information on the blockchain.
However, if the private key is lost, the data or assets tied to the account are lost forever —
 there is no password (or private key) recovery! Additionally, it is difficult to revoke access or
to grant temporary access to encrypted data. It is also hard to guarantee that someone who is
rightfully given a private key does not nefariously share it with others. uPort, mentioned
above, is employing smart contracts to improve key management.

While talented researchers and developers are addressing the aforementioned difficulties, the
nature and timing of implementation and widespread adoption is uncertain. No doubt, a
“killer app,” or a popular application such as those related to identity or M2M transactions
above, can accelerate consumer adoption (once scalability problems are resolved). On the
other hand, impediments such as severe and widespread attacks or strict government
regulation could derail adoption.

Conclusion

Blockchains and other distributed ledger technologies can lay the foundations for a
deeply connected and decentralized economy.

Enterprises, governments, and international organizations such as the IMF and UN are
currently researching and testing use cases and applications for this revolutionary technology.
Meanwhile, retail investors are flocking to cryptocurrency markets, allured by eye-popping
returns and exciting yet risky ICOs (Part 1).

Dozens of exciting blockchain-based startups are launching around the world. They are
building decentralized applications with completely open-source code and with the help of
external contributors. Each project has its own token (or cryptocurrency), which is both an
access key to the software and an investable alternative asset (Part 2).

Underlying these new apps are shared data and value transfer layers operating on
blockchains. They are the backbone to a new Internet, or Web 3.0, where applications, users,
and connected devices all inter-operate. Users and applications can interact, drawing on
selectively shared data and identities stored on decentralized protocol layers. Users and smart
devices can also interact with one another, sending micropayments or information across
networks.

While the success of a blockchain-based Internet and economy hinges on resolving


significant hurdles and avoiding impediments, the vision is both exciting and commendable.

As Arthur C. Clark stated, “The only way of discovering the limits of the possible is to
venture a little way past them into the impossible.”