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A Deep Dive into Distributed Ledger Technology

Thomas McCarthy
Coinmonks

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“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

- Henry Ford

“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”

- Etched in Bitcoin’s genesis block by Satoshi Nakamoto

Introduction

My summer months throughout university were dedicated to immersing myself in various countries across the globe to travel, study abroad, or shoot travel videos. After experiencing painfully slow and expensive international transfers, I quickly recognized major inefficiencies in our banking system. International cash settlements can cause major headaches for both consumers and companies. Transactions can take a week or more to settle, and banks charge exorbitant fees. Even with today’s technology, you can move money faster by boarding a plane and flying to your destination instead of using current banking infrastructure. Distributed Ledger Technology (DLT) promises to radically transform how economies exchange money by disintermediating costly third parties and allowing users to instantly transfer both data and value on a secure distributed network at a very low cost. DLT introduces the concept of programmable money and offers advantages that physical money simply cannot compete with. The internet completely disrupted how society exchanges information, but the banking payment rails set in place since the late 1970’s remain unchanged. DLT will modernize banking infrastructure and remove unnecessary fees that hinder unbanked populations from obtaining financial services. These applications merely scratch the surface of the explosive opportunities the Internet of Value will launch as we move into new digital economies spearheaded by the biggest innovation in computer science since the internet.

The History of Money

To fully comprehend DLT’s ability to create new money, one must first understand the history of money and its properties. The general public automatically thinks of government-issued currency when they hear the word money. Money “serves as a medium of exchange” where separate parties collectively agree on value; in essence, money is a belief system (Das, 2015). Money must fulfill three characteristics: store of value through scarcity, a unit of account, and a medium of exchange. Society’s earliest forms of money included seashells, glass beads, salt, and gold. Salt achieved high value since it prevented food from spoiling. The salt trade proliferated in Africa during the 9th century where merchants would exchange “pound for pound” between salt and gold (Cartwright, 2019). Economies today, however, mainly interact with money through fiat currencies. Fiat money represents state-issued currencies, including the U.S. Dollar ($), Euro (€), Japanese Yen (¥), and all other national currencies. Fiat money ($, €, £, ect.) derives its worth from the act of a governing state establishing its currency as legal tender. The danger with fiat rests in that a physical commodity does not back its value. The British pound remains the oldest active fiat currency and dates back to 1725 when the Bank of England first issued banknotes. The longest standing current fiat money holds a short history of nearly 300 years of existence. Roman coinage, paper notes in the Tang dynasty, and more recently, the German Mark and Italian Lira, all share a common history: all were centrally created legal tender that ultimately ceased to exist.

Prior to 1971, gold reserves backed the United States Dollar (USD). USD held a claim on gold, and thus USD holders could convert dollars to gold. When the United States (along with every other country) severed the tie between its currency and gold, they posed major risks to its citizens. Fiat allows central banks to maintain complete control of the currency’s monetary policy. Central banks act on the behalf of governments and enact policies that benefit a countries’ interest, even if it harms the citizens they govern. Governments can also print excess money and distort the currency’s value, resulting in inflation. The citizens of Zimbabwe, Argentina, and Venezuela all recently suffered high levels of inflation.

“Value in business markets is the worth in monetary terms of the technical, economic, or service” that someone is willing to pay (Anderson & Narus, 1998). Scarcity of items, or limited supply, in a marketplace can increase not only the demand for the object, but also its valuation. Demand for rare comic books have risen sharply thanks to the highly popular Marvel and DC superhero movies. A copy of the original 1938 Superman comic book recently sold for $3.2 million (Perez, 2014). Take a step back and consider why someone paid such a high price. First edition superman copies remain in short supply, and no one can create additional 1938 original copies. Similarly, gold, which has been universally accepted as a store of value for thousands of years, also benefits from a limited supply. Gold possesses strong monetary properties since it’s impossible to replicate, and it can only be found through expensive mining operations, further increasing its value proposition.

Distributed Ledger Technology

DLT represents the most important technological innovation in computer science since the internet and offers a revolutionary method to create digital programmable money. DLT is a distributed public database with a decentralized network of computers that use a consensus mechanism to upload information, transfer value, and record transactions in a cryptographically secure peer to peer system. Blockchain, the technology underpinning most decentralized networks, falls under the umbrella of DLT. Most major digital assets including Bitcoin (BTC) and Ethereum (ETH) use blockchain for its distributed system. Data enters the public ledger in blocks that link together forming a chain, hence the name “blockchain”. One can compare each additional block to a new page in a physical ledger.

Separate computer nodes verify all incoming transactions inside the block before formal entry. Nodes are any electronic devices (computer, phone, or file server) that connect to a network. A decentralized group of computers collectively work together to secure the network and keep the system running. These nodes span throughout the globe, and a decentralized network eliminates the threat of a single point of failure. Corporate databases are prime targets for hackers, since these data centers store information for millions of people. Even worse, this sensitive information typically remains in one location, making it easier for hackers to attack. Massive data breaches are now ubiquitous within society. Facebook, Marriott, and countless other companies suffered from hacks that exposed consumer data (Kiesnoski, 2019). DLT solves this problem by storing information across several different computer nodes in various geographic locations. Rather than attack one database, hackers now need to fight the combined power of all nodes in a distributed system. This adds a strong additional layer of security not found in standard corporate databases today.

A centralized database also poses risks if the people managing the data act without integrity. Those in control of centralized servers have the ability to change information without transmitting a signal that an alteration occurred. In 2015, Volkswagen came under intense scrutiny after the EPA discovered “software that could detect when cars were being tested, changing the performance to improve results” (Hotten, 2015). The former CEO of Volkswagen and four executives faced charges of fraud in connection to the emissions scandal (Ludwig Burger, 2019). DLT utilizes cryptography to ensure that no one can alter data once a block cements itself on chain. For the first time in history, we have a decentralized recordkeeping system that offers both immutable and publicly verifiable data that cannot be tampered with. DLT solves data integrity issues with the introduction of triple-entry accounting.

Over the last several hundred years, humans have conducted all accounting affairs with double-entry bookkeeping. Double-entry accounting uses a model with two equal and complementary sides: debits and credits. Ledgers in a double-entry system are stored locally, posing the same risks mentioned earlier. Triple-entry accounting builds upon the previous debit/credit system and includes all transactions in a joint ledger. The transactions “are cryptographically sealed by a third entry” and the third record offers proof the transaction occurred (Trya, 2014). This seal offers a digital receipt that includes parties involved, transaction details, and time of execution.

Any future change must undergo a new hash. Hashing “converts any form of data into a unique string of text” (Ray, 2017). A cryptographic hash can be viewed as a digital footprint. Each hash provides evidence of the exact time the data changed through timestamping. A timestamp shows both the date and the exact second of the hash. Each block references the previous block’s hash. “The sequence of hashes linking each block to its parent creates a chain” that connects all blocks to each other (O’Reilly, 2020). This prevents nefarious actors from changing, falsifying, and deleting information since the ledger will always timestamp new actions. This further enhances DLT’s ability to provide economies with digital records that companies can trust.

Marc Andreessen, cofounder of the legendary venture capital firm Andreessen Horowitz, famously stated in the Wall Street Journal that “software is eating the world” (Andreessen, 2011). Software touches nearly every piece of our daily lives. We interact with software through our phones, computers, and with the move towards electric vehicles — even our cars. Compare how your parents consumed media to how teenagers consume it today. Older generations either watched cable television or read newspapers and magazines. Today, nearly all Americans consume media in digital form through the internet on their computer or smartphone. Money remains the one area that did not experience a digital transformation during the Internet of Information.

Internet of Value

Long distance phone calls throughout the 20th century required users to pay extra fees and hindered the amount of time people could communicate. In 1990, the LA Times reported that the average San Diego resident paid “$60 to $100” a year for long-distance calls (United Press International, 1990). The first decade of the 21st century introduced Skype and Whatsapp; these products and other communication applications changed the landscape of human communication. The advent of mobile applications evaporated telephone companies’ ability to charge for long distance calls. Today, anyone with a smartphone and internet can communicate globally for free.

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) “went live with its messaging services in 1977” (SWIFT, 2020). SWIFT’s network spans across 200 countries and territories with 11,000 firms using the global network for international wire transfers. Nearly every single bank, corporation, and organization uses SWIFT. SWIFT’s payment network has not seen a major upgrade since its inception in 1977, meaning all current transactions rely on infrastructure built in the seventies. KPMG, a big four accounting firm, outlines three issues with SWIFT: throughput time of wire transfers, robust processes, and transfer costs (KPMG, 2019). Cross border payments may take up to a week or longer to settle. Each bank operates in its own individual technology stack, opening up the possibility to errors. SWIFT reports an average of 6% failure rate for all executed payments. Finally, each bank charges 7–12% to initiate a transfer. These costs further increase when transacting with smaller less liquid currencies. Unfortunately, all of these expensive fees pass down to users.

Nearly 164 million migrant workers send international payments back home to support their families. The World Bank estimates that global remittances reached “$689 billion in 2018” (The World Bank, 2019). International remittances are dominated by a handful of companies that control the payment rails. Western Union controls the majority of market share and generally charges 5–10% per transaction. These fees eat into the hard-earned profits of migrant workers. New companies in recent years have leveraged the internet to solve this issue. However, no company can fix the problem’s root cause: all international settlements must pass through SWIFT. DLT will solve inefficiencies encountered in SWIFT’s network and drastically improve cross border payments through the Internet of Value (IoV).

The IoV promises a future where value exchanges freely across borders as quickly as information travels through the internet. Value not only includes currencies, but also stocks, securities, and other financial instruments. DLT provides a “frictionless experience to send money globally” (Team Ripple, 2017). International payments occurring via DLT stand to benefit in at least three avenues: fast transactions, decrease costs, and irreversible final settlement. DLT transactions are faster than SWIFT and can occur anytime of the day. SWIFT payments still follow bank operating hours, which means that payments only flow through the system when banks are open. DLT eliminates several backend reconciliation procedures which decreases costs to process these payments. Removing costly SWIFT transactions will drastically decrease payment fees for both companies and consumers. This will immensely benefit millions of people that send remittances and allow migrant workers to retain more of their money. DLT will speed up the movement of capital across the globe. Faster global settlement improves business efficiency and translates to stronger economic growth.

SWIFT’s 6% failure rate cannot continue to service the banking industry. DLT significantly improves upon SWIFT’s failure rate and establishes irreversible final settlement for all payments. Frustration over the minimal advancement in USD financial infrastructure led to the creation of The Digital Dollar Project. The Digital Dollar Project aims to advance research on the benefits of digital USD infrastructure. This organization encourages the U.S. to modernize USD payment systems and establish a Central Bank Digital Currency (CBDC). Former CFTC chairman, Chris Giancarlo, leads the organization alongside project partner Accenture. The group aspires to make sending USD as simple and quick as sending a text message. A dollar digitization will open more access to people outside the US banking system who seek to store wealth in USD and avoid holding local currencies that suffer heavily from inflation.

Bitcoin

During the height of the Great Recession in 2008, an anonymous entity named Satoshi Nakamoto released the Bitcoin whitepaper to a small group of people in a cryptography email list. No one knows the identity of Satoshi, and we can only speculate whether Satoshi is a he, she, or group of individuals. Bitcoin opened Pandora’s Box: it introduced the world to money not controlled by any nation, government, or corporation. This novel idea became the first successful application of DLT. The opening line in Bitcoin’s whitepaper states, “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” (Nakamoto, 2008). Bitcoin introduced an internet protocol that offers a permissionless global digital payment system that allows anyone with an internet connection to securely transfer value. Consider how email changed global commerce and messaging between humans. E-mail allowed instant communication without having to consider geographical limitations. Bitcoin offers a similar solution, but instead of transmitting information, humans exchange value seamlessly.

Many view bitcoin as digital gold, since it achieves value due to its strong monetary properties. Recall the three properties of money: scarcity, unit of account, and a medium of exchange. Satoshi embedded in the code a hard-capped limit of 21 million bitcoin. Similar to gold, bitcoin remains in limited supply. Approximately every ten minutes, a new block issues fresh BTC until the supply reaches its limit at the year 2140. This starkly contrasts current central bank policies that consistently increase the money supply (i.e. print money) which in turn drives inflation. The chart below shows the United States Federal Reserve balance sheet expanding a whopping $3 trillion in 2020 alone.

The supply of bitcoin will increase until 2140, but BTC separates itself from fiat since the rate of issuance decreases through an event known as the halving. Every four years, the issuance rate of BTC cuts in half. No party can prevent this, since Satoshi programmatically coded this feature within the protocol. This means that BTC experiences disinflation until it reaches its max supply. Only 21 million BTC will exist, making it one of the scarcest assets on Earth.

BTC natively utilizes triple-entry accounting which means the system maintains a record of all units and transaction details. In May of 2010, Laszlo Hanyecz spent 10,000 BTC to buy two pizzas. He spent roughly $40 on this transaction, which is forever etched in Bitcoin’s public ledger. At moment of publication, those same 10,000 BTC would be worth approximately $120 million. This makes Laszlo’s transaction the most expensive pizza purchase ever. The picture below provides a summary of the historic transaction that marked the first time someone spent BTC to buy a real world item.

Bitcoiners celebrate May 22nd as Bitcoin Pizza Day

Gold retained its position as de facto money for thousands of years. The major drawbacks facing gold rest in its divisibility, portability, and medium of exchange. Dividing gold into small units requires costly production, which drives a higher price for gold coins. The U.S. Mint’s cheapest gold coin holds one-tenth of an ounce and sells for $260 (United States Mint, 2020). This high value price does not make it a suitable medium of exchange for everyday purchases. However, gold is globally-accepted money. Whichever country someone sets foot in, the value of gold will remain the same. Bitcoin’s price, aside from unique arbitrage opportunities, also remains the same across countries. Bitcoin incorporates gold’s strong monetary properties and takes it a step further, since BTC can divide up to 8 decimal points. There’s no minimum amount required to purchase bitcoin. Buyers can obtain any amount, whether it’s $1, $10, $100, or millions. This brings BTC’s accessibility to everybody. Transferring value with bitcoin offers a superior experience compared to gold. Gold’s limitations rest within its physical nature. Transporting gold requires it to move similarly to how the postal service moves mail, while BTC aligns more closely to e-mail. Bitcoin’s genesis block launched on January 3rd, 2009, and the network maintains a runtime of 24/7/365.

Prior to Bitcoin, transferring value digitally possessed a double spend problem since digital information easily duplicates. Double spending occurs when the “same funds are spent to two recipients at the same time” (Binance Academy, 2020). Physical cash does not face this issue, since money tangibly exchanges between hands. When Bob pays Alice $10, Bob hands her a $10 bill. Bob cannot use that same $10 since he gave it to Alice. The fear of criminals duplicating digital money forced society to trust banks and intermediaries to send digital money. Trusted third parties prevent economies from double spending cash, but this issue poses a massive threat when we remove a central authority and transact with money that exists entirely in digital form.

Consensus Mechanisms

DLT solves the double spend problem through a consensus mechanism. Consensus mechanisms are computer protocols that ensure all nodes synchronize when new information appends on the distributed ledger. This allows different parties who do not know each other to agree and trust each other. Bitcoin’s consensus mechanism employs Proof of Work (PoW), while most newly created blockchain platforms utilize Proof of Stake (PoS). PoW tasks computers to solve complex puzzles. These computers, commonly referred to as “miners”, compete with each other for the privilege of mining the next block. PoW requires expensive energy consumption to support computers that run twenty-four hours a day. Mining businesses pay money to consume energy that’s required for the computers to mine blocks. The miner that solves the puzzle first receives monetary compensation through transaction fees and the new issuance of coins known as the block reward.

Transaction fees occur when there’s usage on the network. If Bob wants to send Alice one BTC, Bob must first create a digital signature approving the output value. Bob will send an output value, and Alice will receive an input value. A miner will first verify Bob’s signature to confirm he owns a legitimate claim to the BTC. Bob must pay a fee to the miner that processes the block that includes his transaction. Suppose a malicious miner solves the puzzle and creates fake transactions. The output value of the block cannot exceed the total input value that includes transaction fees and the block reward. Other miners will notice the new block contains an incorrect output value with unsigned inputs, signifying invalid transactions. They will reject the block, and the malicious miner will not receive any reward. The miner will not receive a payout and will consume wasted energy for a monetary loss. This game theory incentivizes moral behavior and punishes malevolent activity.

The major benefit to using PoW rests in the decentralized network of nodes that combine computational power. All computers combined form the hash power that secures the system. Most people solely focus on BTC’s price without considering the network’s strength. While price offers an important window to all digital assets, we cannot ignore a network’s security. In PoW, a network’s hash power offers strong insight to the security of the system. New nodes providing computation increases hash power and signals stronger security. On the contrary, less nodes mean that the network offers weaker security and is more vulnerable to hacks. In Bitcoin’s eleven-year history, the hash power consistently rises over time with new miners generally entering the space when BTC’s price trends upward.

Over 11,000 Bitcoin full nodes currently exist and are spread throughout 96 countries (Coin Dance, 2020). These nodes maintain a full record of the ledger and validate both transactions and blocks (Bitcoin Org, 2020). PoW achieved a massive breakthrough when it solved the double spend problem, however, this consensus mechanism still contains risks. Bitcoin transactions currently suffer from high latency and sit in a queue once initiated. Recall that each block occurs every 10 minutes. If Bob sends Alice 1 BTC, it takes six block confirmations or approximately one hour for Alice to confidently know she received a legitimate payment. There are other PoW blockchains that have higher throughput, but they still suffer from the same problem: all nodes must receive a full copy of the ledger to reach consensus and process blocks. Although PoW slowly reaches consensus, DLT experts laud their strong security measures (Samani, 2018).

A “51% attack” remains the only way to break data integrity within PoW. This occurs when malicious actors own at least 51% of the total computing power and gain majority control of the network (Binance Academy, 2020). With 51%, a hacker can double spend their coins. A hacker cannot stop all transactions, but they have the power to prevent certain transactions from processing and slow down overall throughput. This impedes users’ ability to move value and halts network activity. Even worse, just one double spend may cause severe reputational damage. March 29, 2020 alone had three separate transactions consisting of roughly 1,000 BTC (Blockchain.com, 2020). Each transaction moved between $6–7 million. A disaster would occur if a hacker double spent $6 million. People would begin questioning the system’s data, since they can no longer trust the ledger. Faith in the system will break, and users will move to a different network that offers higher security.

DLT engineers must design a system that entices participants to act honestly. Each DLT network hopes to build economic activity. In order for economic activity to flourish, the network must entice “partners, suppliers, clients, and competitors to contribute to the whole ecosystem” (Liu, 2019). In Bitcoin’s case, miners entering the space can either choose to participate honestly or attack. Attacking the network requires a massive amount of capital to purchase both mining equipment and energy. Attackers will continue to lose money until they reach 51%. Unless the hackers reach 51%, the attackers will realize that it makes more economic sense to act honestly. Bitcoin shows strong token economics since it keeps most incentives aligned between participants. Unfortunately, Bitcoin currently processes seven transactions per second. This makes the network very slow for large scale business adoption. Proof-of-Stake (PoS) offers an alternative consensus mechanism that allows DLT to reach significantly higher throughput with lower latency and less energy costs.

Proof of Work vs. Proof of Stake

Scalability continues to be the single largest obstacle facing DLT adoption. Twitter, Google, and Visa can handle thousands of online users at a single time, since their servers are centralized. DLT engineers face the challenge of combining all benefits of a decentralized network while also maintaining high transaction throughput. The Scalability Trilemma refers to the problem where DLT platforms must decide between “two of the three properties: safety ‘(security)’, scalability, and decentralization of block production” (Samani, 2018). PoW favors security and decentralization, while leaving scalability on the back burner. The picture below visualizes the scalability trilemma that blockchain developers currently face.

Practically all new DLT projects employ PoS or a variant of the consensus mechanism. Each project creates different rules to determine which node ‘mints’ the next block. In PoS, the block creation terms are forge or mint. These terms should not be confused with mining — although validators act similarly to miners in PoW. Validators carry the responsibility to mint blocks, confirm transactions, and protect the network. PoS requires validators “to lock a certain amount of coins into the network as their stake” (Binance Academy, 2020). The amount of time the assets remain locked depends on each system’s rules. Owning a larger stake size generally increases the probability that node will mint the next block. Without a stake, a validator cannot append new blocks. The validator receives payment through transaction fees. PoS also provides the option to add additional income through block rewards.

Requiring validators to lock digital assets ensures they have ‘skin in the game’. Validators must maintain network functionality or risk seeing their asset value depreciate. If transactions fail to confirm or the network faces security risks, developers will migrate and build on a different platform. Additionally, validators risk losing their stake if they act maliciously. A nefarious actor that processes invalid transactions may receive punishment through slashing. Slashing occurs when an entity does not comply with the rules, and they lose ownership of their staked assets. Each platform decides the severity of the punishment. Some networks may choose to have validators lose their entire stake, while others may slash 30%. Malicious validators have no option to redeem their staked tokens, since these digital assets remain locked in a smart contract (more on this topic later).

PoS optimizes for scalability and provides much higher transaction throughput. It consumes less energy and offers attractable cost efficiency (Schumann, 2018). Business activity will most likely occur on a PoS network since transactions reach finality much faster. Finality refers to the “amount of time one has to wait for a guarantee that transactions executed on the blockchain will not be reversed” (Ifegwu, 2020). A fast ‘Time to Finality’ offers assurance that initiated transactions quickly reach immutability. Fast finality allows businesses to comfortably transact on a public network and also have confidence their actions will not reverse. However, PoS networks run the risk of fewer entities controlling block production. Centralized block production leads to weaker security since there are less validators susceptible to attack or collusion.

DLT engineers around the world continue to vigorously work towards solving the Scalability Trilemma. Blockchain receives a plethora of criticism that it will never work due to slow speeds and high transaction costs. Similar accusations were made against the internet. Paul Krugman, a 2008 Nobel prize winner in Economic Sciences, infamously quoted in 1998 “The growth of the Internet will slow drastically… By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s” (Yarow, 2013). The early days of the web required users to establish an internet connection through dial-up. Connecting to dial-up necessitated additional time and did not allow people to make or receive phone calls. Broadband eventually replaced dial-up and introduced faster connection speeds while making internet access easier to the general consumer. DLT will undergo the same innovation curve as the internet. The blockchain space will eventually solve the Scalability Trilemma and give rise to digital assets.

Digital Assets

Practically all DLT networks create a digital token that’s used inside its ecosystem. Most individuals call them: cryptocurrencies, crypto, or digital assets. Ethereum, created in 2015 by then 21-year-old Vitalik Buterin, holds the position of the second largest digital asset by market cap. Ethereum uses ether (ETH) for its digital asset that underpins the system. ETH developers building the protocol hope it becomes a world computer with a “platform that other applications can build on top of” (Jacqui Frank, 2019). The network will exist “on neutral, open-access infrastructure, controlled by no company or person” (Ethereum Org, 2020). This very unique approach spawned other DLT founders to build their own platforms to compete with Ethereum. While bitcoin cements itself as digital gold, all remaining digital assets will need to either serve a money use case or attract developers onto their platform to build successful decentralized applications (dapp).

Consider the collective value of companies and products created through Apple’s App store and Google Play. Consumers around the world rely on Uber, Whatsapp, Venmo, and other applications to perform necessary life functions every single day. Many of these companies did not even exist fifteen years ago. Dapps aim to function similarly to mobile applications today. However, the backend infrastructure relies on public DLT instead of centralized company servers found in apps today. Dapps take advantage of all DLT strengths previously mentioned. The internet gave rise to companies that built internet services on the application layer, while DLT introduces digital assets that exist at the protocol level.

ETH and various other digital assets resemble resources that purely exist digitally. Accessing computing services on each DLT network demands use of the protocol’s native asset. In Bitcoin’s case, you must pay transaction fees in BTC. Bitcoin offers an excellent system for debits and credits, but the code falls short for developers who wish to build robust dapps. Some dapps have gained traction, but the overall number of users remain very small in comparison to standard apps. When the first dapp manages to reach mass adoption, demand for the digital asset powering the dapp will increase. Imagine a fast-lane highway where vehicles must pay a toll to drive on. This analogy applies to DLT, but all transactions occur digitally. The DLT community commonly use the phrase “gas fees” when discussing the network fee of a transaction. Higher gas means the transaction requires more capital to run and inversely, lower gas signifies lower costs. Each network decides their own rules for token economics. DLT still remains in its infancy stage, which means that no single project holds all the correct answers. Ultimately, the protocols that will experience value accrual must attract network activity that creates valuable transactions, offer high security, and incorporate strong token economics.

Digital assets not only resemble digital resources, but they can also hold voting rights. Once again, each DLT platform owns the freedom to decide the rules of governance. Typically, owners with a large token balance will claim greater voting rights. Some networks may use a 1 token 1 vote system, while others require a minimum balance before permitting governance participation. Digital assets with governance rights introduce a community model where geographically dispersed individuals can efficiently work together to drive a protocol’s vision and decision making. Entities with voting privileges will collectively govern each platform. Digital assets offer a compelling case for value accrual if the protocol they represent succeeds. Prior to DLT, separate entities could not cohesively work together without using a third party to enforce contract obligations. Vitalik brought forth the second generation of DLT when he embedded smart contracts as a feature in Ethereum and made ETH programmable money.

Smart Contracts

Our society currently uses law firms and trusted third parties to establish trust between stakeholders. Involving outside parties adds further costs to business transactions, especially when they lack trust. In 1996, Nick Szabo introduced the topic of smart contracts. Smart contracts are digital enforceable contracts that exist as software code and execute based on terms that were previously agreed upon (Szabo, 1996). Szabo references a vending machine to offer a simplistic example of how smart contracts function. Bob needs to pay $1.00 to receive a chocolate bar. The machine will only dispense chocolate once Bob pays the full $1.00 balance. Without full payment, the vending machine will not provide chocolate. Smart contracts “benefit from the security, permanence, and immutability that blockchain offers” (Stuart Levi, 2018). If all parties meet the parameters set from the contract, the code will automatically self-execute and fulfill its terms.

Imagine fictitious companies named Zion and Laer conduct business for the first time. Zion will sell 100 computer chips to Laer. Both agree that Laer must deposit the full amount in an escrow account. Zion will receive payment once the chips arrive to Laer. Laer’s deposit will sit in a cryptographically secured escrow inside of a smart contract. Laer submits the deposit and Zion receives a notification to ship the computer chips. Laer’s warehouse scans the barcodes confirming the shipment arrived. The scan triggers the smart contract to self-execute and Laer’s deposit automatically transfers to Zion. This payment occurs seamlessly without human interaction. On the contrary, the contract will not execute if one party fails to honor the agreement. If Zion fails to ship the computer chips, Laer’s deposit will automatically refund and Zion will not receive payment. This highlights just a small example of smart contracts’ use case. Businesses can create highly complex agreements and use smart contracts to increase business efficiency and honor agreements. Permanent and immutable software code allows two unknown parties to safely engage in business knowing that contract terms cannot be changed.

Supply Chain

Global corporations develop complex supply chains to service their partners, customers, and vendors. Large businesses use enterprise resource planning (ERP) to “tie together a multitude of business processes and enable the flow of data between them” (Oracle, 2020). ERP systems include supply chain operators, project management, accounting, and countless other crucial functions a corporation needs to manage its daily operations. These systems thrive for corporations and make business processes more efficient inside a corporation’s ecosystem. However, companies inside the ecosystem struggle to interact with entities outside of its network. Even worse, small businesses outside of an ERP umbrella do not receive the benefits of a coordinated supply chain. Most corporations today enjoy the benefit of ERP, while most small businesses must manage supply chain dataflow on their own.

Each step of a supply chain includes interactions with multiple businesses that process sensitive data. This forces entities to mainly conduct business inside their own corporate ecosystem. This presents a single point of failure when one central authority can both control and see all information. DLT relies on public infrastructure that allows any entity to opt in or out without seeking approval from a central authority. Ernst & Young (EY), one of the big four accounting firms, announced the launch of the Baseline protocol on March 4th, 2020. Baseline introduces “a new package of public domain blockchain tools that will allow enterprises to build and deploy procurement and other business processes securely and privately” (EY Press Release, 2020). Baseline will support both smart contracts and zero knowledge proofs. Zero knowledge proofs allow you to verify data values to a different party without having to share the underlying sensitive information. Each party benefits since they only reveal information they wish to share. This allows small businesses to benefit from ERP solutions currently utilized in large corporate supply chains without fear of vendor-lock in.

Gartner, a research and advisory company, stated in a 2019 press release that “organizations might use blockchain to track global shipments with tamper-evident labels” (Gartner Press Release, 2019). DLT allows companies to digitally trace their goods throughout the entire supply chain and offer real time updates on the progress of inventories. “Counterfeit wines are a multi-billion dollar” issue that plagues the entire wine industry (Micallef, 2018). Fraudsters will refill empty wine bottles, then repackage it to make the bottle appear authentic and unopened. This harms both producers and consumers of vintage collectible wines that sell for six figures. DNV GL, an international accredited registrar since 1864, aims to equip rare collectible wine bottles with tamper-proof labels. My Story, DNV GL’s blockchain enabled digital assurance solution powered by VeChain, allows prospective buyers to scan labels and read a product’s lifecycle information. Buyers can read the entire wine bottle’s journey, starting from where the grapes were grown, the producers’ tank operations, bottling process, and transportation data. Collectible wines that need extra security can have labels that automatically timestamp when someone opens the bottle. Consumers can trust the information since all data derives from public DLT infrastructure.

The picture above shows a simplified version of a medical supply chain. At each new step, a block containing new shipping data appends itself on chain. Not only does this provide better overall shipping information, but it also pinpoints exact movements of goods throughout the supply chain. Timestamping goods throughout its lifecycle opens up a wide range of use cases that can benefit companies in times of crisis. The department of Health & Human Services released a report stating the Food & Drug Administration “did not always have an efficient and effective food-recall process that ensured the safety of the nation’s food supply” (Mccallister, 2017)”. The report referenced that it took an average of 57 days for food producers to recall contaminated inventories. In 2019, nearly 100,000 pounds of salad were recalled due to possible e-coli contamination. When a food recall occurs, producers frantically search through antiquated processes to determine which tainted supplies require removal. DLT simplifies this process and offers producers an immutable audit trail. Timelines for food recalls can dramatically decrease, since all shipping information exists digitally. Companies can pull shipping data to determine where the outbreak began and remove effected inventories.

DLT integrated supply chains can extend beyond collectible wines, medicine, food, and can incorporate any product that people buy. However, DLT still requires a bridge between the physical and digital world. An oracle provides external data that exists outside the network. Oracles carry the responsibility of authenticating external data sources prior to relaying the information. Trusted oracles prevent malevolent actors from uploading false information. In My Story, DNV GL auditors will work alongside producers and use its extensive certifications experience “to verify that the data sourced from these activities are accurate and relevant” (DNV GL, 2018). This combination of expert auditors and immutable data records offer a viable solution to consumers who demand proof of authenticity and the origin source for products they consume.

Decentralized Finance

The World Bank Group released a report estimating that “1.7 billion adults remain unbanked” (World Bank Report, 2017). These adults have no access to financial services and cannot take advantage of banking systems that billions of people rely on. This issue exists in both developed and emerging countries. Approximately 24 million U.S. households live underbanked and another eight million survive unbanked (FDIC Executive Summary, 2017). Unbanked populations have no relation with any financial institution while underbanked people have a standard banking account, but must seek outside help for financial services (borrowing, lending, exchanging, ect.). Two driving factors why Americans remain unbanked relate to inadequate funds to open an account and high banking fees.

Those living in emerging economies risk currency inflation that devalues their wealth. Venezuelans suffered 10 million percent hyperinflation in 2018, Argentinians experienced 53% inflation in 2019, and Lebanon faces 25% inflation in 2020. Countless other countries have inflation concerns that hurt its most vulnerable citizens. Wealthy elites in emerging economies understand inflation and hedge their portfolios to fight it. They hold part of their wealth in USD, foreign real estate, stocks, and other financial assets. USD possesses its own inflation concerns, but relative to the rest of the world, it retains its value far superior than other fiat currencies. Venezuela’s government recently allowed circulation of USD and usage exploded with now “more than half of all transactions in Venezuela are in dollars” (Reeves, 2020). Despite the desire of those outside the United States who want the ability to hold dollars, our current system makes it nearly impossible for the average person to access USD. Low income populations could not easily obtain USD until DLT introduced Decentralized Finance (DeFi). DeFi utilizes DLT’s programmable money and global accessibility to tear down barriers and allow anyone to receive financial services.

Mobile phones offer a mechanism for unbanked individuals to store their money in DeFi dapps. In Africa, the amount of “people with mobile phones outnumber those with electricity” (The Economist, 2017). DeFi reconstructs traditional financial systems and uses smart contracts to programmatically execute all transactions without using an intermediary. Contrary to current banking systems that only serve people in one region, DeFi exists natively on the internet and launches globally day one. Stablecoins remain one of the most popular digital currencies in the entire DLT space. “A stablecoin is a digital currency designed to maintain price parity to some ‘stable’ asset” (Circle, 2020). The market capitalization of stablecoins grew $2 billion in just the first three months of 2020.

Stablecoins exist on top of DLT platforms and benefit from all of the previously discussed advantages of blockchain — including fast, low cost, and global payments. Most stablecoins peg their value to $1 USD. USD Coin (USDC), created in 2018 by Centre, represents a digital token that maintains a 1:1 peg with $1 USD and runs on top of Ethereum. USDC achieves price parity with USD since every single USDC token must equal the same amount of USD reserves held in a U.S. regulated bank. Grant Thornton LLP conducts monthly audits of these bank accounts and publishes their reports online. This transparency builds trust for users, since they can verify themselves that USDC tokens do not exceed the amount of USD held in reserve.

DeFi users can create their own digital wallet on their phone without a minimum monthly balance and account fees. This opens the door for countless individuals to access fast low cost financial services. DeFi already offers users the ability to earn interest on their digital assets. Similar to banks, DeFi uses deposits to issue loans through smart contracts to borrowers. DeFi does not discriminate on wealth, gender, race, or religion. Loan applicants no longer need to submit credit checks and instead can receive instant financing.

Currently in 2020, most DeFi loan processes require users to deposit digital assets and over collateralize their loan positions. Over collateralized loans refer to instances where borrowers deposit assets for collateral that exceed the value of the loan itself. For example, a loan of $100 with a 150% collateralization requires a deposit of $150. Unfortunately, most people seeking a loan cannot afford to over collateralize. DeFi is very nascent and still needs improvement before reaching mass adoption. Developers continue to experiment with new ideas including better reputation systems to solve this problem. DeFi does not solve every issue facing the unbanked, but it brings financial services one step closer to this underserved community. USD pegged stablecoins offer a tremendous opportunity for people in impoverished countries to store their wealth in USD instead of currencies that face high risks of inflation. DeFi aims to allow every human being on Earth to access all financial services using open source software on their phone.

Conclusion

Innovations in DLT aim to disrupt the financial industry similar to how the internet in the early 2000’s disrupted media, news organizations, and retail shopping. Most DLT critics state adoption will never come, due to slow transaction times and poor user experience. However, all innovative technologies endure these problems in the beginning. Older adults and grandparents will recall the atrocious experience of dial-up. Technology’s ability to continuously improve upon itself remains its most powerful quality. Humans naturally seek to solve problems that save both time and money; DLT solutions allow economies to improve in both of these areas. A separate, common argument against DLT claims that companies will not upload data to a public platform and will instead use private permissioned networks. Corporations in the future will most likely build their own permissioned distributed ledger that will certainly increase efficiency. However, a private DLT will not benefit from value accrual seen in open public networks. Some large companies have their own intranet for employees to view company specific private information, but every modern company maintains a public webpage on the internet. Companies overwhelmingly decided to build a strong presence on the public internet, since it allows them to easily connect with clients, customers, and guests.

The advent of email revolutionized how humans communicate. At a basic level, one can similarly compare email to DLT since it allows humans to send value natively on the web. Bitcoin offers a better economic future for all participants since it embodies the strongest properties of money. Bitcoin separates itself from all other forms of money, even gold, when Satasohi Nakamoto baked into BTC’s protocol a hard-capped limit. There will only ever be 21 million bitcoin in existence; no amount of money, influence, or power can change this. The only route to change this rule would require establishing strong consensus from a large portion of the Bitcoin community. Ask any developer, business building on top of BTC, or investor if they want to increase the supply of BTC, and they will always respond with a resounding no. This directly contrasts central bank policies that continuously print more fiat. In the first half of 2020, the US Federal Reserve expanded their balance sheet from $4 trillion to $7 trillion. Travis Kling, CIO at Ikigai, summarizes Bitcoin’s value proposition perfectly. “Bitcoin is a non-soverign, hardcapped supply, global, immutable, digital store of value. It is an insurance policy against monetary and fiscal policy irresponsibility from central banks and governments globally” (Kling, 2019). Everyone must ask themselves: Do I feel more comfortable storing value in a currency controlled by a small group of wealthy individuals with an unlimited supply, or with a non-sovereign asset that’s censorship resistant with a hard-capped limit?

Similar to gold, Bitcoin does not possess a central body that controls its monetary policy. The beauty with DLT rests in the communities’ ability to govern itself through consensus mechanisms and smart contracts. Western countries today uphold separation of church and state as a pillar to freedom. At the time, this idea was radical and the church fought heavily to retain its power. Over the next 100 years, we may start seeing a new revolution occur: the separation of money and state. Our society fails to research the history of money and cannot comprehend that national governments created fiat money out of thin air. Central authorities run by a small group of humans always run the risk of two factors: self-interest and human error. If 2020 can prove anything, trust that central banks will stop at nothing to continuously print fiat. The United States built itself upon establishing freedoms for its citizens. The first amendment protects freedom of religion, freedom of speech, the right to assemble, and to petition the government; but it fails to address people’s freedom of money. DLT removes power from central authorities and returns it to the people. In essence, it allows people to have freedom and true monetary sovereignty over their own money without relying on a third party custodian.

DLT delivers a digital recordkeeping system of truth. Businesses of all sizes can easily utilize triple-entry accounting and reduce counterparty risk. Data secured in DLT offers increased transparency and allows auditors a large window into business activities without compromising on security. Trade activity will increase, since DLT permits companies to engage with businesses that were previously deemed too risky. Multi-day bank transfers will disappear and everyone will enjoy instant global payments. Web 3.0 will increase efficiency while eliminating fraud and lengthy back-end procedures prone to human error.

DLT will bring forth a third layer on the internet, named Web 3.0, that will create new business opportunities that solve current inefficiencies in our economy. The first iteration of the internet introduced web pages and email. Google Suite and mobile applications transformed the internet landscape and brought indispensable new features. Web 2.0 products birthed multi-billion-dollar tech companies ranging from Google, Amazon, Facebook, Uber, Netflix, and several others. DLT already plans to bring tremendous innovation through smart contracts and DeFi. These dapps will spawn new innovation. Similar to how humans in developed countries cannot live without a smartphone, we will look back at DLT and wonder how economies functioned without robust, decentralized smart contract platforms.

The computer science field undergoes a technological innovation approximately every 10–15 years. The 1950’s introduced mainframe computers, personal computers were invented during the 70’s, and the internet came into fruition in the late 90’s. Smart phones and mobile applications in the app store represent the most recent innovation from the mid 2000’s. We now find ourselves in 2020 which means the tech industry will soon experience a new wave of advancement. I believe DLT will continue to drive computer science innovation and companies leveraging DLT will rise to prominence. Successful DLT networks that attract usage may also experience large valuations for the underlying digital asset. The disruption of money and value exchange represents a unique and key difference that separates DLT from the previously listed technological breakthroughs. Should DLT succeed, not only will it upend internet infrastructure, but it will also change money itself. Similar to technology, money evolves over time. Humans have previously used seashells, glass beads, salt, and gold for money. After gold, modern day nation states created fiat currency banknotes. Present day fiat primarily exists digitally with most transactions occurring online or with debit and credit cards. The Chinese economy has practically replaced physical cash entirely with stores not even having the capacity to accept cash or cards. Chinese citizens use mobile applications to facilitate all financial transactions.

Software continues to permeate all facets of life, and it remains short sighted to think money will escape this trend. DLT represents the creation of a new type of money that exists entirely in digital form that’s also programmable. Programmable money opens the door for entirely new financial concepts that will benefit society ranging from DeFi, smart contracts, and new tools that humans have yet to conceive. DLT represents a rare opportunity for humans to build a new type of money without a central authority maintaining unilateral control. Technology will continue to innovate, but there only exists a few moments in history that society witnesses the birth of new money. The internet allowed for the free flow of information, and DLT aims to follow suit and introduce a world where money freely moves across the internet. DLT, Bitcoin, and blockchain symbolize financial freedom. The DLT community envisions a future where humans have a permission-less global immutable smart contract platform to safely exchange value and engage in low cost trade with anyone in the world, at any time with just a few clicks.

“NYTimes 09/Apr/2020 With $2.3T Injection, Fed’s Plan Far Exceeds 2008 Rescue”

- Etched in Bitcoin’s 629,999 block by F2Pool

***

Authors Note:

I want to express my earnest thanks to Linda Xie, Mary Ann McCarthy, Karina McCarthy, Jonathan Defuso, and Ariella Senzamici for their constructive criticism. Their feedback was instrumental and their insight proved valuable.

I also want to extend my heartfelt gratitude to everyone who read this essay. I spent countless hours and weekends researching, writing, and synthesizing all DLT information I’ve consumed over three years into one piece. I sincerely hope this essay helped you form a better understanding of DLT and sparks a fire in you to jump into digital assets. I truly believe in my heart that DLT/blockchain will change the world and provide a better economic future for everyone on Earth. There’s so many layers to DLT and understanding it is a daunting task. If you’re a newcomer to crypto, I want to extend an invitation with open arms and welcome you to the crypto community.

To anyone who still doesn’t understand bitcoin, crypto, and DLT; do not feel disheartened at all. It took me two months of reading and digging into numerous materials before I discovered my eureka moment. Some may grasp this subject in a day while others take much longer. If you’d like to discuss any topics in this essay, feel free to connect with me on Twitter where I constantly provide updates on current events in DLT. The crypto community is vibrant on Twitter and we’re always happy to explain topics to anyone who’s interested in learning. I’m also open to any constructive criticism and I’m curious to hear your feedback on this essay.

Twitter: @tmccarthyv94

Please consider donating if this essay helped you in anyway. Even if you don’t, I am still immensely grateful you read this. If you want to brighten my day, then donate to any of the addressees below. Thank you and hodl strong.

Stay Humble & Stack Sats.

Bitcoin: bc1qjnr7zcg66vw72mvgv6k2az5e5zwx8w0sg8u4l9

Ethereum: 0x0477F4AF28A961e94fFc828B3DAA356b0DC0698f

DAI & USDC: 0x0477F4AF28A961e94fFc828B3DAA356b0DC0698f

VeChain & VTHO: 0x6f1E6a7Ab6A1F250B20608c37034A353cC23F686

Disclaimer: The contents of this essay should be considered solely for educational purposes. Do not treat anything in this paper as financial advice. Please do your own research before investing in digital assets.

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Thomas McCarthy
Coinmonks

Written by Thomas McCarthy

11 Followers
Writer for

I live in Washington, DC and work at the Chamber of Digital Commerce where I strive to ensure digital assets reach mass adoption. Stay Humble & Stack Sats.