Nouriel Roubini and Preston Byrne describe a series of concerns relating to Bitcoin and blockchain technology which I would like to address.
The authors claim that blockchain technology is very inefficient and slow compared to traditional centralized database systems in terms of latency, storage and processing load and that current centralized systems such as Visa, Paypal or SWIFT are much faster and efficient. This is not completely true as there are mechanisms such as Bitcoin Lightning Network being developed to significantly improve transaction speed, but more importantly the authors fail to explain why efficiency is important for blockchains to succeed. If their argument was true, bicycles should be the only means of transportation as they are very energy efficient, or we should use only airplanes as they are the fastest mean of transportation.
I would like to make clear that when I use the term “Blockchain” in this post I am referring to public Blockchains such as Bitcoin or Ethereum. That is, a Blockchain where anyone can participate and it works based on predetermined rules and free market mechanism without any central authority (i.e. decentralized consensus).
Bitcoin was born when centralized databases, Visa or Paypal already existed. Regardless of what Bitcoin creators claimed, I don´t believe that Bitcoin´s perceived utility was never a mean of fast and efficient transactions. The new disruptive features that Bitcoin brought in are the following features, in order of importance:
- Censorship resistance
- Emancipation of imposed monetary policies
Is is not by chance that the most valuable cryptocurrency, Bitcoin, is not the fastest or the most energy efficient, but the cryptocurrency that currently renders the highest degree of censorship resistance. Towards the end of their article, Roubini and Byrne do acknowledge that censorship resistance and transparency rendered by blockchain technology could be useful for some specific applications. I believe that they vastly underestimate the utility of these properties and I´ll explain why.
The improvement on censorship resistance (tampering resistance or transaction immutability understood in relative terms), is the greatest one since the adoption of double entry accounting, which allowed the emergence of corporations and large scale world trade. It is important to note that this tampering resistance relies on the decentralized nature of this technology and I agree with the authors that having to replicate transactions in multiple nodes by definition consumes more resources than recording transactions in just one central node, but also by definition, it is just not possible to achieve this level of tampering resistance in a centralized system.
What the authors qualify as inefficiency is not a problem or a bug of the system but a consequence of its most valuable feature: censorship resistance, notwithstanding that there might be solutions to significantly improve transaction throughput in Bitcoin or other cryptocurrencies, the same way scaling solutions were developed to allow high quality streaming video over the Internet, which many deemed impossible in the mid 90s .
The scope of this technology not only comprises the currency side of the transactions, it might comprise as well the non monetary side of transactions as goods, claims and services can also be taken into the blockchain and benefit from all its features, including transaction immutability.
What this improvement on transaction immutability will contribute to world trade remains to be seen, it is still very early, but it is reasonable to expect that it will be an extremely important contribution. I would love to elaborate much more on this topic because I believe it is really a quantum leap on trade history, but I find it really difficult and daring to try to give specific examples or predict exactly how this contribution will develop, it is the role of the free market to discover how to use this new level of immutability, but in my view it will deliver a dramatic reduction in the cost of trust, especially on international trade and this will allow many new business to exist which today are not possible due to the aforementioned cost of trust.
Openness. Bitcoin is just a set of rules like the double entry accounting system or the Pythagoras theorem. It is open, free and neutral, anyone can use Bitcoin as anyone can use double entry accounting, it won’t ask you who you are in order to be used.
Today´s banking system is based on debt and credit, which necessarily rely on legal certainty, property registries and identity registries so banks are able to enforce their credits when necessary. Most countries in the planet are just not able or even not willing to provide this basic legal infrastructure to its citizens. The limitations of the debt/credit nature of the current system cannot be solved only with technology (smartphones, Paypal, etc).
Building this basic legal infrastructure takes a huge amount of time and resources to develop and we can´t ignore this just because we give it for granted on developed countries, these infrastructure costs do exist, and they need to be considered if we want to be thorough in our analysis. Bank accounts, credit cards or Paypal are currently out of reach for billions of people, and for the ones that do have access, it is not without costs.
Opposed to all this, all you need to use bitcoin is a cheap smartphone and a basic Internet connection, which is much more accessible today than a bank account in most countries, not to mention that the growth potential of smartphone and Internet adoption is stronger and swifter than that of the development of sound legal infrastructures in developing countries.
Emancipation of imposed monetary policies. This one in my view is the least important of the three features because Bitcoin is not objectively the only way to emancipate from imposed monetary policies. Again, this is important in countries where monetary policies are failing. I would like to point out that what is important here is not if crypto currencies have a perfect baked-in monetary policy or not, which probably many of them do not. The important issue is that with crypto we are free to choose which monetary policy better fits our needs, which could be perfectly the current ones if we freely decide to only use cryptocurrencies to transact and fiat as a store of value.
The authors criticism about energy consumption is strongly linked to the utility criticism. Whether it is a waste of energy or not depends on the utility of this technology. Is it a waste if this technology allows billions of currently unbanked people to access a full set of first class financial services? Moreover, what are the authors prediction of bitcoin energy consumption in relation to adoption?, is it linear, exponential or logarithmic?. Furthermore, if we are all so worried about the environment it would be fair to make an effort within this argument to know what is the full energy consumption of all the companies involved in the current financial system throughout the whole world (servers, buildings, employee transportation, producing and handling physical bills and coins, etc).
Regarding the example of algorithmic trading related to latency, it is a really bad example because the authors fail to realize that algorithmic traders need to be fast in relative terms to all the other traders in the same trading venue, not in absolute terms. Furthermore, the authors do not take into account that crypto assets trade execution can be conducted off-chain and only settlement takes place on-chain while still keeping a decentralized approach. This is already happening.
The criticism about blockchain replacing internet protocols seems to me as a straw man fallacy. I haven’t seen any serious proponent claiming such an argument, except as an example explaining that blockchain is to transferring value what tcp/ip is to transferring data in a decentralized fashion. Obviously, Bitcoin nor blockchain was never meant to replace TCP/IP.
As a final note, the fact that crypto assets have shown an extremely volatile price behavior leading to what is probably one of the largest financial bubbles in history (maybe not in volume but in price increase) is indeed a confirmation, not a denial, of the great potential of this technology. We just have to take a look at the flower industry in the Netherlands 400 years after the tulip mania, the railroad infrastructure we have today in the whole world, or the development of the Internet after the .com bubble.