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Part 2/Chapter 3: Protocol Layer 1 The  Bitcoin Maximalist debate

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Blockchain Layer 1 is the operating system for the decentralized Internet. Although this layer is technically complex, the winner is not necessarily the technically best software. In the PC era the winner was a program that was initially called QDOS (which later became MS-DOS) that stood for Quick & Dirty Operating System and there were social networks that were technically better than Facebook. What matters is adoption/network effects. Technically the software just has to be good enough – which is actually a pretty high bar at the  Protocol Layer of the Blockchain Economy.

This is Part 1/Chapter 4 of The Blockchain Economy. 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 3 layers of Blockchain Economy Infrastructure, seen from top to bottom are:

The boundaries between Layers 1 & 2 are fairly fluid. In both cases, the users/customers are developers; developers are building for developers. However there is some debate about what functions should go into the two layers and some of the work that is happening at Layer 2 will impact how we use Layer 1 and vice versa.

If you operate at Layer 3 you need to understand how Layers 1 & 2 work.

This Chapter covers:

– Function 1: Internode Communications.

– Function 2: Consensus

– Function 3: Virtual Machine Management

– The fat protocol thesis

– The bitcoin maximalist thesis

– How platforms may evolve into “horses for courses”.

Internode Communications.

Blockchain works because people/companies dedicate compute resources to being “nodes” on the network that perform tasks which in aggregate deliver a useful service. The nodes are “peers” on the network; thus it is a Peer To Peer (P2P) network. The most basic task of a Layer 1 platform is  communications between these nodes, so that in aggregate they deliver value. For example,  Ethereum has the DEVP2P library at this layer. This basic layer is needed in all P2P network systems and is relatively easy compared to the other functions because Blockchain is not the first P2P network, so the solutions have been tested before (eg in Voice Over IP or VOIP networks such as Skype).

Consensus

The Consensus function is native to Blockchain. Before Bitcoin, nobody had ever built a decentralised consensus method at scale.

Blockchain is a decentralized data structure/ledger that uses a method of getting to consensus on who did what when that does not rely upon a centralized intermediary. The Blockchain Consensus generates the order that blocks are created (aka the blockchain) and validates blocks created by other nodes in the network. The latter function is done by specialist nodes called miners.

The most proven consensus method is Proof Of Work (POW) that is used by Bitcoin, Ethereum (today) and, with modifications, by many other cryptocurrencies.

There are many things wrong with Proof Of Work. It is slow and consumes too much electricity and mining power consolidation can lead to centralisation via the back door.

The most promising alternative consensus method is POS (Proof Of Stake), to which we dedicate a separate chapter.

The search for more efficient consensus methods has led to a number of alternatives that tend to be labelled Proof of X (where X can be activity, burn, authority, elapsed time etc). There are two reasons why these  alternative consensus methods struggle to get mainstream acceptance:

Virtual Machine Management

Blockchain platforms are the next generation of operating systems. All earlier operating systems ran on a single computer such as a mainframe or a PC. For the first time we are getting operating systems designed to run on a network. So a third key job of a Blockchain platform is managing this network of machines (each of which also has its local operating system).

There are two types of Virtual Machine Management systems:

Turing-complete is named after Alan Turing and now refers to a system that can run any program (irrespective of the language), given enough time and memory.

Theoretically, Turing-complete is better. The practical nuance comes from considering the line “given enough time and memory.” In practice, time and memory are constrained. So in practice a simpler Turing-incomplete system might be better.

The market may blur the boundaries. For example Rootstock offers a way to build functionally rich smart contracts on the Bitcoin blockchain, so you are not constrained by Bitcoin Script. Whether something is Turing-complete or not may be debated by developers, but for practical purposes the question is “does the platform enable me to build the functionality that our application needs?”

The Fat Protocol thesis.

During the Centralised Internet Economy, the big money was made at the application layer, through services that delivered value to end users – think Amazon, Google, Facebook, Netflix etc. They used a “thin” protocol layer (eg TCP/IP and HTML). The Fat Protocol thesis is that this will be reversed in the Blockchain Economy; we will have a Fat Protocol layer (where most of the value creation will happen) and a Thin Application layer (where not much money will be made).

For example, we can look at both Bitcoin and Ethereum as Protocols. In both cases, far more money has been made buying and selling BTC and ETH than creating applications that sit on top of those protocols.

If you buy both the Fat Protocol thesis and the Bitcoin Maximalist thesis (see next section), there is s ridiculously simple way to make money in the Blockchain Economy which is just to buy and hold BTC.

You could take a slightly more complex portfolio with say 80% BTC and 20% ETH. That does not need any expensive intermediaries, just a simple way to buy, store and sell those Tokens.

It is as if you could have “bought a stake in the Internet” around 1994.

If you are inclined to invest in platforms other than Bitcoin and Ethererum, you need to take one of these two approaches:

The bitcoin maximalist thesis

There are 3 reasons to be an economic Bitcoin Maximalist.

Note that this is different from being a moral Bitcoin Maximalist (which says Bitcoin is better for the world). An economic Bitcoin Maximalist simply says  that Bitcoin will be better than Altcoins as an investment.

How platforms may evolve into “horses for courses”.

In a world dominated by network effects, there is still room for niche players. For example in the social media era, Facebook was the huge winner but Twitter, WhatsApp and LinkedIn prospered by offering something that Facebook did not excel at (such as Interest Graph for Twitter, mobile for WhatsApps and work for LinkedIn). The same may happen in the Blockchain era. We may have multiple niche horses for courses platforms.

These niches include Blockchain Platforms optimised for:

There is some technology innovation that is making this horses for courses niche platform scenario more likely:

What all of these new technologies have in common is that they all work cross platform.

Bernard Lunn is the CEO of Daily Fintech and provides advisory services to companies involved with Fintech (reach out to julia at daily fintech dot com to discuss his services).

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For the index to Bernard’s serialised book, The Blockchain Economy, please go here.

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