This is an Introduction to The Blockchain Economy book. This serialised book is a practical guidebook for investors, entrepreneurs and employees who want to learn how to prosper during the transition to an economy where value exchange is permissionless and disintermediated. For the index please go here.
The learning cycle for disruptive innovation goes through 4 phases:
- Phase 1. Terminology & Analogy. This is the level that busy people need at first. If Blockchain is as big a wave as Web and Social, everybody in business, whether working in a new venture or an incumbent, needs to know the basics. This chapter covers this level. After reading this you should understand enough to be able to make meaningful contributions when the subject comes up in meetings, unless the meeting is technical. This chapter/post also serves as a glossary, so you can quickly dip in when you see a word/phrase that you don’t understand. This Chapter gives you a base level of understanding before reading the rest of the book. If you are already past Phase 1, feel free to skip this chapter.
- Phase 2. Fundamentals & First Principles. If you work in a Blockchain centric business, you need to study at this level. There are many good educational resources online. Or if you prefer a printed book, a very good technical introduction is Mastering Bitcoin by Andreas Antonopolous. Most people won’t need to go beyond Phase 1. How many people studied the fundamentals of TCP/IP or HTTP? Phase 1 uses a lot of analogies as this is an easy way to learn something new without investing a lot of time. When you move to Phase 2, these analogies get in the way and you need to do a mental pivot to really understand the technology from first principles.
- Phase 3. Build Something. You go from theory to practice by building a product or service that people want to use. This is when you have the humbling realisation of how little you really know. The “proof of the pudding is in the eating”. This phase leads to the next phase – commoditisation of knowledge – as the user level services abstract the knowledge. For example, services such as WordPress meant you did not need to know about HTML in order to blog.
- Phase 4: Commoditization of knowledge. Most people in the Internet Economy use email, social media and e-commerce without knowing anything about technology such as HTML, TCP/IP etc. It is like driving a car without knowing how a carburettor works. In mainstream use, most of the technology becomes invisible. This is when knowledge supply catches up with demand. Up to this point there is a lot of demand for knowledge and very little supply, so knowledge has premium value. Seeing that premium encourages lots of people to study the technology. Demand slows down, as the technology becomes invisible, just as supply catches up to previous demand and so the value of knowledge crashes.
Terminology Glossary (conceptual flow)
This is a conceptual flow designed to be read sequentially (not in alphabetical order). Words/Phrases used in this Glossary are identified using Italic.
- Distributed Ledger Technology (DLT). All business people understand the concept of a ledger (thank you Mr. Pacioli in Venice in 1494 for the wonders of double entry bookkeeping). We have grown used to every business maintaining their own version of accounting truth in their own ledger, with complex coordination to do transaction reconciliation. The idea of a single distributed ledger that all parties have access to, eliminating all that reconciliation is conceptually easy to understand.
- Consensus Protocol. A Distributed Ledger requires a mechanism for all the parties to agree on what happened – who got paid, how much, when, in return for what. This the purpose of a Consensus Protocol. There is obviously massive motivation for fraud, so this has to be proven at scale. The only way to prove that something is hack-proof at scale is to deploy it at scale and invite hackers to “bring it on”. For example, hackers have tried since 2009 to break the Bitcoin Blockchain and failed (see later for Exchange hacks which is quite different).
- Blockchain. DLT means you need to record every transaction in a timestamped sequence and make that visible to everybody. That is what we call a Blockchain.Bitcoin was the first use case for Blockchain; so this has been proven at scale for many years. Blockchain is one type of DLT; there are other types, such as Tangles (aka Directed Acyclic Graph or DAG), but these have yet to be proven at scale.
- Bitcoin. Bitcoin is a digital asset (aka “store of value”) that uses Blockchain. Whether that asset is a commodity or a currency is something that courts and regulators are trying to figure out. Bitcoin is referred to as Cryptocurrency even if some think that CryptoAsset is more appropriate. The easiest analogy is digital gold. Like gold, value is based on limited supply and Miners. Like anything digital, it is easily divisible and transferrable (which is what makes it different from gold). If Bitcoin is digital gold it is both a commodity and a currency. So it is reasonable to refer to Bitcoin as Cryptocurrency. The idea of a currency that is global and not controlled by any nation state is clearly disruptive to current power structures. When Bitcoin first appeared it was seen as a stool with 3 legs. One leg was this store of value. Another was the underlying technology (which tends to now be referred to as Blockchain or DLT or Crypto). The third leg was as a currency for everyday payments (like using a small chip off your gold bar to pay for coffee).
- Cryptocurrency. A currency that is secured through a decentralised Consensus Protocol rather than a sovereign government. This is often shortened to Crypto which annoys those who think it should refer to Cryptography.
- Crypto. Shorthand for Cryptocurrency (which uses Cryptography).
- Altcoin. Coins aka a Cryptocurrency other than Bitcoin. Many Altcoins are Utility Tokens and a few are Security Tokens and a few are Currencies but all can be traded on Exchanges like a Fiat Currency so the term Coin has stuck even if AltToken is more technically accurate.
- Fiat Currency. Used to describe a currency that is controlled by a sovereign government because they can simply issue more money “by fiat decree”. This is what we traditionally think of as money or currency. Examples: US Dollar, Euro, Pound Sterling, Swiss Franc.
- Cryptography. This emerged from military intelligence – most famously the Enigma cipher machine in World War 2. Data is encrypted (aka scrambled) so that only somebody with the appropriate private key can see the data “in clear” (ie unscrambled). A Cryptocurrency uses Cryptography because monetary value is stored data so it would be stolen if it was not encrypted/scrambled.
- Proof Of Work. Bitcoin “miners” use their computing power to solve a mathematical challenge and by doing so they “vote” on which transactions came at what time. This creates a decentralized timestamp that records valid transactions on a Blockchain. As a Miner you are rewarded for this work by being given Bitcoins. Proof Of Work is one example of a Consensus Protocol.
- Miners. An individual or company that dedicates computing power to solving Proof Of Work Cryptographic puzzles that timestamp a transaction on the Blockchain. A Miner is rewarded with some cryptocurrency. The analogy is mining for gold which works as it costs time and money to mine and both gold and Cryptocurrency are stores of value.
- Proof Of Stake. Proof of Stake does not have “miners” but the objective is the same, which is a group of people who form a consensus that a transaction is valid and make some money by doing so. Proof Of Stake “voters” commit capital (they prove that they have something at stake). In Proof Of Stake, people tend to talk about “voting” rather then “mining”. Like all analogies, it goes wrong if taken too literally, but as the aim is to get to consensus that a transaction is correct, the analogy does fit.
- Token. Something that represents value that can be traded and exchanged digitally using DLT. A Token can represent a currency, a security or any type of asset.
- Smart Contract. Business logic usually in some form of If This Then That type of logic that is automatically executed. This can be complex business logic or as simple as a Notary like service (release asset when x parties approve) or payment splits (when cash received send x% to Party A and y% to Party A). The difference from traditional business logic is that execution, including payment, is automated across multiple independent parties.
- ICO. Initial Currency Offering. Maybe should be called Initial Token Offering ITO or Token Generating Event but ICO is in common parlance. This is a bit like an IPO (thus the name ICO) but is regulated differently.
- Wallet. Where users store their Cryptocurrency (unless they store it on a Centralised Exchange). Can be on mobile or browser or specialised hardware or on paper. Specialised hardware wallets are increasingly popular for security reasons. They are like USB drives with a User Interface.
- Exchange. There are two main types. One type is a centralised exchange, which is increasingly regulated like a Bank because they store assets on your behalf (and an exchange operator could steal them as they did at Mt. Gox and some other Exchanges). The other type is a decentralised exchange, which is increasingly like a wallet in the sense that the Exchange never holds your assets but just facilitates exchange of assets.
- Permissioned vs Permissionless. A DLT that is permissioned only allows access to registered users and some set of individuals or companies control that registration. A DLT that is permissionless allows anybody to join. Bitcoin is permissionless.
- OnChain and OffChain. OnChain means a transaction is validated on the Blockchain (using Proof Of Work in the case of Bitcoin). OffChain, usually for smaller transactions, happens on an attached network, such as Lightning Network and Raiden.
- Lightning Network. An example of an OffChain network attached to Bitcoin.
- Raiden. An example of an OffChain network attached to Ethereum.
- Ethereum. The second largest cryptocurrency by market cap. Differentiates from Bitcoin by offering a platform where any application can be hosted (known technically as a platform that is “Turing complete” meaning you can run any application on Ethereum). All local operating systems are Turing complete, but a decenralized operating system that is Turing complete is novel.
- Dark Web. Where you can do illegal transactions without exposing your identity.
- Privacy Coins. A Cryptocurrency that you use when you want something more private (maybe illegal), for example to go on the Dark Web.
Bernard Lunn is the CEO of Daily Fintech and author of The Blockchain Economy. He provides advisory services to companies involved with Fintech (reach out to julia at daily fintech dot com to discuss his services).