3rd November 2024 > > Some musings on public vs private blockchains.

tl;dr

You have all had a couple of days off from reading the CCC, so today’s missive is a touch longer to make up for that lost time.

We have only one topic to discuss – public versus private blockchains, segueing into the immeasurable spiritual and practical benefits of decentralisation.

Market Snap

Market Wrap

Well, well, well. I leave you alone for just a few days with BTC threatening to post new all-time highs and look what happens in my absence. Am I the only one who takes my responsibilities seriously?

Glassnode has reported a large movement of short-term coins into exchanges, ramping up the sell-side pressure. This was accompanied by a net outflow from the spot BTC ETFs on Friday. Short-term holders tend to be more speculative in nature, so I guess we must wait for more committed investors to take their coins before the upward march continues.

Curious Cryptos’ Commentary – Public vs private blockchains

Several people have contacted me with questions about the fundamental differences between public and private blockchains.

I have clearly not been doing my job properly, for these two applications of blockchain tech are such widely differing beasts, a point I thought I had made clear in the past. The questions I have been fielding suggest that I have signally failed to do so. To try to rectify my own shortcomings, I thought a short precis may be in order, in the hope that I might clear up some of the misunderstanding.

We must start with the man himself, our Lord and Saviour, Satoshi Nakamoto, who described his vision in the very first sentence of the Bitcoin whitepaper (https://bitcoin.org/bitcoin.pdf):

“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending.”

Understanding Satoshi’s objective is key to understanding the limitations inherent in private blockchains compared to the peerless concept of public blockchains.

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This is neither the time nor place to revisit the cryptography that lies at the heart of bitcoin, but if you feel a little rusty you could do worse than hopping on over to some of the online modules that the research team at CC Towers has provided for you:

https://www.curiouscryptos.com/cccourses

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Public blockchains aim to be trustless, a description which sounds scary but counter-intuitively is safer than the process by which we place trust in centralised systems. The BTC ethos can be summed up as “Don’t trust, verify”.

Perhaps if we start in the centralised world, the one we know best and feel most comfortable in, this key concept at the heart of decentralisation will become clearer, by a process of defining what it isn’t.

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Your bank account is an entry into a large digital database, owned and managed by the bank.

A database is a very powerful tool. It can be set up to store data in a very specific format, with pre-determined criteria. It allows for easy interrogation of the data. For instance, it can be used to show the cash balance on your fiat account, or the number of MicroStrategy shares you have squirreled away in your ISA, showering you with over 400% returns for the last twelve months.

It is rare that anyone stops to think about how secure that data is, and the process by which its accuracy is determined. The administration of the controls over the data, and the database itself, is a vast undertaking, employing armies of back-office staff. There are procedures for the entry of data into the database, procedures for the validation of that data, procedures for the amendment of that data, procedures for the deletion of that data, a constant process of reconciliation, and the need to continually upgrade and improve all these security issues. And those are just the internal processes. External processes include the liaison with regulators, the quarterly audits, the constant need to respond to changing external threats, and a plethora of other activities.

This is how centralised systems work.

We put trust in them because of the infrastructure built around imperfect processes that are by their very nature susceptible to mistakes, omissions, and malicious activity.

Until our Lord and Saviour Satoshi came along, inspired by earlier thinkers who had already laid down some building blocks that enable us to get around these problems, the world simply accepted being dysfunctional, and very much less productive as a result.

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Public blockchains need none of the controls and administrative processes outlined above.

Implicit in the creation of the next block (again, you might wish to refresh your memory by referring to the course modules referred to above) is the proof of the accuracy of the block, and the immutability of the history of the blockchain.

The verify part of “Don’t trust, verify” is built into the creation of the blockchain using cryptographic techniques. Just the fact that the block has been created, added to the chain, and accepted by the miners, is all that is required to know it is accurate, and complete. The famous double-spend problem has been vanquished for evermore. As has all the administration, auditing, reconciliation, and all those other tasks that drain productive capital out of the system of creating wealth.

I should add a caveat here, which is that “Don’t trust, verify” requires decentralisation.

Decentralisation, much like democracy, comes in many forms. We all have our own interpretation and understanding of these concepts, but we must try to find some common ground. One definition of decentralisation is that no individual miner, or group of miners acting in concert, controls 51% or more of the hash power used to secure the blockchain. There are mitigating factors even if that were the case (a topic we will come back to), but for now it is a relatively simple definition that we can easily understand. More importantly, it helps us to gain insights into the limitations, and failings, of private blockchains.

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A private blockchain can be set up to mirror the exact system for Bitcoin, or in any other way that one might wish.

J.P. Morgan was probably the first major bank to create its own private blockchain, known as Onyx, I believe, or something similar. Excuse my haziness on this point, but I have zero interest in the private application of blockchain tech, for my libertarian nature is always to the fore. Private blockchains do not cut the mustard in that respect.

There is a delicious piece of irony here, for Jamie “you cannot fire me” Dimon, CEO of J.P. Morgan, famously threatened he would fire any of his traders who invested in BTC. Dimon has long been a high-ranking lieutenant in Warren’s anti-freedom and anti-liberty army, though even this die-hard naysayer has begun softening his rhetoric of late.

What Dimon saw in the private blockchain is that it is a superior alternative to a database in one key respect – so long as your input, amendment, and deletion controls remain in place, with only one version of the blockchain stored internally the reconciliation process is vastly reduced, as is the need for detailed audits of the data.

This reduces back-office headcount and all the associated costs, it reduces mistakes (genuine or otherwise) that always cost money, and makes the bank more profitable, reducing the cost of capital for all business and making all of us wealthier.

Which is all to the good, and one day all databases will be replaced by private blockchains. But the gains are marginal. Of more import is that these private blockchains cannot confer the other advantages of decentralisation to which we will now briefly turn our attention.

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I say briefly, because this part of the discussion could take us long past Christmas if you let me, and that is of no use to anyone, least of all me.

I think it helps to break down the benefits of public blockchains into two parts. The first part considers the benefits to humankind’s wellbeing at a higher spiritual level, and the second part addresses the benefits to humankind’s wellbeing at a practical level.

Let’s crack on, starting with the spiritual.

The first and most obvious point to make about public blockchains is just that – they are public. This means that they are transparent. Anyone can interrogate the blockchain, anyone can follow the money. This is a key reason why money laundering forms such a tiny part of the crypto ecosystem it doesn’t even touch the sides. But that is just one minor beneficial side-effect of transparency. There is no human endeavour which is not improved by transparency, and the resultant responsibility and accountability conferred on individuals who might otherwise be lax or deficient in exercising their duties.

Security is at the heart of all public blockchains. The cryptographic techniques employed by blockchain tech guarantee a level of security never seen before in physical or digital records.

A decentralised organisation has the potential to be truly democratic, allowing all participants to have their fair say in the decision-making process. I can see hands raised, probably hoping to make the point that democracy comes in many forms and is usually imperfect. Which is where public blockchains come ready-made with the answer – build it according to your preferred definition of democracy, to attract the supporters of your definition. It will succeed or fail on its own merits, not because of some historical anomalies that you may or may not be comfortable with.

Finally, simply because of that previous point, resource allocation can be optimised, dramatically lowering the cost of capital compared to the centralised process.

There are other elements to our spiritual wellbeing that are improved by public blockchains, but it is time to move onto the practical, before I lose you all.

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There is no activity in the centralised world that cannot be improved by the application of blockchain technology.

It is in the intersection of the centralised world and the decentralised world where we see the biggest gains in terms of improving productivity, lowering the cost of capital, and making us all wealthier. Here are some simple examples that benefit us all.

Automation using smart contracts offers us the possibility of moving on from legal disputes in commercial relationships, with precise definitions of inputs and the output when certain events have been actioned. Insurance companies are threatened by the concept that they might not be able to wiggle out of a commitment they have previously made.

When goods are sourced from around the world, supply chain verification becomes reliant on a vast array of different systems applied within different cultures and different languages. Public blockchain tech has the potential to solve those problems.

Here is one I was talking about with someone in the pub last night: we all need to prove our identity to so many centralised organisations, whose security over your very personal and private data often leaves a lot to be desired. Public blockchain technology that incorporates zero knowledge proofs (https://en.wikipedia.org/wiki/Zero-knowledge_proof) allows one to prove one’s identity to a third party without revealing the source of that proof. Even more importantly, a true zk proof means that even if someone hacked into that third party’s systems, they could not rely on that proof. In effect, your identity is only ever revealed to those whom you wish to reveal it to, with no prospect of that information being shared with anyone else. That is so powerful, and so very annoying to the feral scammers who work for murderous Putin and portly Jong-un.

Banking for the unbanked – there are large parts of the world not served by internet connections nor by financial institutions. What does exist in many of these places is a robust mobile network which can be used to provide financial services for the unbanked via the medium of cryptos.

DeFi – oh boy. This is the one of most exciting and disruptive technologies ever experienced by humankind. One small example explained below will surely convince you of this.

My final example concerns cross-border payments, particularly those that are made by some of the poorest people on the planet who have travelled to work overseas on low pay and in terrible conditions, to support their families left behind. The World Bank, needless to say a crypto naysayer, has reported that a $200 remittance can incur costs ranging from 5% to 9.3% (https://www.un.org/development/desa/dspd/wp-content/uploads/sites/22/2020/01/World-Social-Report-2020-FullReport.pdf). These outrageous fees gobbled up by centralised financial institutions at the expense of the poor and needy can only be condemned as an outright disgrace, and a moral failing at that.

Using stablecoins across different public blockchains reduces those fees to mere cents or much less.

If you do not support this application of public blockchain technology, then I bear you no grudge, I wish you Godspeed, but our paths must part, for your view of the world is not one I can countenance.

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Cryptos are not a by-product of public blockchain technology.

Cryptos are necessary for the functioning of the public blockchain, regardless of the consensus mechanism chosen.

There is no point in doing the work for PoW systems, or staking capital for PoS, unless there is the prospect of financial remuneration. Public blockchains need cryptos to be public, otherwise they are private blockchains, merely conferring administrative efficiencies, and no more than that.

The benefits of true decentralisation cannot be realised without cryptocurrencies. Cryptocurrency investors are not simply on the make – we are making the world a far better place than it has ever been or could ever have been imagined to be. Ours is the good and moral fight, for everyone’s benefit.

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In conclusion, private blockchains are an upgrade to current database technology, but the benefits that accrue from being private are but the merest glimpse of a fleeting shadow when viewed against the shining potential of public blockchains, powered by cryptos.

Here endeth the lesson taught to us by our Lord and Saviour, Satoshi Nakamoto.

Curious Cryptos’ Commentary – One small DeFi example

With a h/t to the Milk Road, the CC Treasury recently put on a new trade that looks like this:

-          Deposit SOL into Kamino earning interest of around 5%.

-          Borrow 50% of that notional in PYUSD paying interest of around 5%.

-          Buy SOL with PYUSD and deposit back into Kamino.

Let’s look at the economics of this trade.

If you believe that we are still near the beginning of this bull run, and you believe that SOL will be one of the major winners, you have increased your exposure to the price action of SOL, both to the upside and the downside. This is easy to understand with two worked examples.

Assume SOL is at $150 today. Let’s compare the financial outcome of buying one SOL compared to putting on the trade above.

If the price of SOL doubles to $300, buying one SOL would give a return of $150. The trade above has 50% extra exposure to SOL, giving a return of $225.

If the price of SOL halves to $75, buying one SOL would give a return of negative $75. The trade above has 50% extra exposure to SOL giving a return of negative $112.50.

With just a few clicks of your mouse, you can swiftly and easily tailor your crypto investments to reflect your views of what will happen going forward, with no paperwork, no middle-man, and no counterparty/credit concerns.

What’s more, because you are earning 5% on 150% of your initial notional, and paying 5% on 50% of your initial notional, carry is positive. You are getting paid to express your view. Note that the interest rates for borrowing and lending change daily, meaning that trades like this one do require constant monitoring.

DeFi is a truly powerful tool that will disintermediate the legacy financial system in so many ways.