Pitfalls over Profits Part 1 – Keir Finlow-Bates
At a recent event Keir Finlow-Bates took us on a journey of blockchain starting with looking at the fundamental principles behind blockchain, decentralised ownership and governance during incentivisation and attribution of value to tokens, to the different agencies involved in blockchain, both good and bad, and the risks that they bring and to examine some failures in the DeFi world, looking at how they happened and how the community has responded. This is Part 1.
What is a blockchain?
We need to look at the question: what is a blockchain? And what does a blockchain offer that a traditional database doesn’t. Looking at what a database does is therefore a good start. A database allows us to organise data in a structured manner so that we can retrieve it and search for it efficiently, and we can alter it.
Those alterations are then recorded and in that respect, blockchain is almost identical. It’s kind of like a database. You can’t change previous records. It has this immutability. You can only append to it. But other than that, it allows us to store data and then seek out that data later and do stuff with it. If you talk to a developer who hasn’t looked at blockchain in detail and they’re looking at it from a development perspective, you often hear people say, “well, why wouldn’t you just use a database?”
The answer to that: is that blockchain isn’t solving the problem of searching for and storing data.
It’s solving a bigger problem than that. It’s solving the problem of decentralised ownership in a digital space. In order to understand blockchain, you need to understand ownership and ownership is something that we have a kind of instinctive understanding of.
You only have to go to a playgroup for three or four year olds and you’ll see that they get it. They have a very clear concept that, “this toy is mine and you’re not supposed to play with it.” In the real world ownership kind of falls into a few categories. You have owning a physical object. So, “I have it in my possession, it’s in my house or in my wallet and you don’t have it. And I have control over it.”
In the digital world, it gets slightly different.
You generally own something by keeping it secret. So if you have photographs that you took, you keep them on your personal hard drive and you don’t share them with anybody else. Then you’re the only one who owns them. As soon as you put them out on the web, people can copy them and distribute them how and as they like. So one of the things that we’ve done in the digital world is that we’ve involved central authorities. We delegate the responsibility of guarding possessions in the digital world to, “a gatekeeper.” In fact, here, another form of ownership is where you have a registry or a ledger that says that you own something.
You can’t physically carry around the plot of land that your house is on, but the government keeps a registry of who owns what land. When you sell that land on, your name is taken off the registry and somebody else’s is put in its place. It’s these registries that are the best analogy to what blockchain does in that it registers ownership in a kind of registry.Now traditionally we’ve used the central authorities.
So you have things like banks or government land registries, things like that keeping track of who owns what. Therefore, you have a gatekeeper or in the case of, for example, the stock market, you have brokers and having these central authorities has worked reasonably well for us over history.
But it’s not always good.
Blockchain came in and solved the problem of managing a ledger of who owns what without having to have that gatekeeper. So now briefly sidetracking into something called Proof of Work, which is what the most famous blockchain users do in order to ensure that this ledger is maintained properly, that we don’t have double spending where people can spend some bitcoin on one occasion and then spend the same bitcoin again at another occasion.
When you look at the history of blockchain, you’ll see a lot of names crop up: Adam Back, Nick Szabo, Hal Finney, Satoshi Nakamoto. We would like to highlight the fact that Proof of Work was actually invented by a woman Cynthia Dwork with Moni Naor in 1993. Given that it’s such a key element of how Bitcoin works, it’s surprising how infrequently the name actually crops up in kind of historical discussions of Bitcoin.
Combating Spam Email
What Cynthia and Moni did was that they came up with a scheme for combating spam email and you’ll see why that’s relevant to open, public, permissionless blockchains and to Proof of Work.
They had this idea that we have a problem with spam email. There’s no cost associated with sending out a thousand or 10,000 or a hundred thousand emails. Would there be a way of somehow enforcing a cost on sending an email that would therefore mean that spammers can’t send these vast quantities of emails and therefore making our lives a little bit less miserable?
They came up with an idea that you should make people who are sending emails do a bit of work or rather their computer do a bit of work. The scheme that they had was this idea of conducting what’s called hashing. It’s making your computer cycle through a random number generator again and again and again, until it comes up with a random number that is really small.
You then attach that number to the email and it proves that you’ve done some work. Maybe the cost in terms of time is a 10th of a second, that doesn’t affect the sender of a normal email. But if somebody is trying to send a hundred thousand or a million emails, that time adds up and it becomes infeasible for them to send out that vast quantity of email and Satoshi Nakamoto took that idea and applied it to the Bitcoin system.
It’s the sort of underlying principle that maintains the ledger: in order to add transactions to the ledger, you have to do a bunch of work in order to prove that you’re allowed to do so. It builds up this chain in the ledger of more and more work and it means that people can’t go back and rewrite history because they would have to redo the same amount of work.
So that’s Cynthia Dwork and Moni Naor’s contribution to the blockchain world and that’s one of the issues that has to be overcome in blockchain. Another one is something called, “sybil attacks” and they’re named after a patient whose name was kept anonymous and the patient had multiple personality disorder.
The psychologist who was looking into the condition used the pseudonym, ‘sybil.’ We now use that in the computing world in order to talk about cases where people set up multiple accounts in order to subvert a system. If you have an open, permissionless system, like a blockchain where anybody can set up an account to use it, some people are going to set up hundreds or thousands of accounts and use them to have a greater influence over. For example, voting that might take place on the system that shouldn’t be allowed and again, Proof of Work can be used to overcome those kinds of problems.
Those are two of the technical issues that were resolved in order to make blockchain work. One of the great things that an open, permissionless public blockchain does is by being decentralised and not having a gatekeeper. You get something called ‘censorship resistance’. There isn’t a central authority that can decide arbitrarily to block any particular transaction.
This is important because if you take banks that handle financial transactions, they have the right to block your transactions. Sometimes this is good. For example, when they freeze the assets of criminals. However, sometimes this can be bad. There were cases in the U.S where banks or credit card companies were basically telling their customers, “ Yes, we know it’s your money, but we’re not going to allow you to buy cryptocurrency with it.”
Cryptocurrency was perfectly legal!
So really they should not have taken that decision but it showed that they do have the ability to arbitrarily censor transactions. This is a subjective problem in that a multi-user – an aphorism you may have heard of the expression that “one regime is freedom fighters are another regime’s terrorists.”
The gatekeepers may decide that they think that the activities that are being undertaken are bad activities and should be stopped even when you personally think they’re good. The difference here of course, is that the central authority ultimately has the complete power over the system and all you can do at best is appeal.
The other downside of having gatekeepers is that they can charge you for the service. When we use credit cards, we’re paying a fee in order to maintain, run and set up the financial system that it relies on. So again it’s not clear cut because if you’re using a blockchain system you are also paying a fee, but at least you’re paying the fee in the form of transaction fees to the entire system and not to one central company that’s profiting from it.
Therefore, it becomes a bit more democratised. There is nothing stopping you from running a mining node for a blockchain system in order to take some of the fees that are being paid. Whereas you can’t decide that you would like a share in the profits of a private bank. For example, if it’s a public bank, then I could buy shares in it.But that depends on the particular corporation that’s running the system.
Move Over Brokers!
If you’re really interested in understanding the nuts and bolts of this, Keir’s book, “Move Over Brokers” covers a whole bunch of these things and is an entertaining and educational read. There are also plenty of articles online as well to go and look up.
Link to book: https://mybook.to/moveover