Blockchain: Be Excited, Be Skeptical

An interview with Andrew Keys, an expert in blockchain technology.

Andrew Keys will be speaking at the SALT Conference in Las Vegas. Learn more and register here.

Privcap: Why don’t we start with a description of ConsenSys?

Andrew Keys, Consensys: ConsenSys is the largest software engineering company in the world focused on creating blockchain-based decentralized applications. We’re about a thousand people in all corners of the world, with headquarters in Brooklyn, New York.

Privcap: Please step back and explain what blockchain is and the role it will play in our lives.

Keys: Blockchain will be the substrate for the next generation of the internet. The internet that we know now essentially commodifies how humans communicate with each other. But as the internet of things adds millions of devices per year to the user base of the internet we need a much more secure process for digitizing our assets, digitizing our agreements, and digitizing our personal identities.

So, if I were to distill blockchain into three core concepts in terms of user experience the first would be that all assets will go from a natively analog format to digital. And when I mean all assets, I mean fiats like U.S. dollars, British pounds, Japanese yen, oil, gold, milk, electrons on a solar panel, a Beyoncé concert ticket, an American Express point, the digital rights management to a song. All of these assets will be natively digital. One thing you could do is divide an asset a thousand times or ten thousand times like a piece of real estate.

Next will be the digitization of our agreements. So, Microsoft Word documents created by lawyers and our agreements are going to turn into digitized agreements. Essentially computer code-based. That’s what’s called a smart contract. And with this upgrade in society you can see new types of living agreements such as an employment agreement where someone is paid by the minute.

And then lastly, the third key component to blockchain is what I would call self-sovereign digital identity. Right now when we go onto the internet, we log into an oligopoly of websites: Twitter, Facebook, Amazon, eBay, PayPal, Uber, Airbnb. All of those are essentially middlemen that provide trust. They provide reputation, like the five stars at the end of the Uber. They provide a payment rail, and in the future we will log into our own browser. So, David would log into David Browser rather than Facebook or Google. And that will be secured by a biometric, maybe a thumbprint, maybe an iris scan, voice recognition. And that will be the place where you’re going to be able to interact on a peer-to-peer basis and transact with these natively digital assets and  these digitized smart contract agreements. And basically what that will do is create a price discovering mechanism for the value of intermediation in any transaction. So we are going to go from a centralized internet where we have parties like Amazon, eBay, et al, in the middle to decentralized peer-to-peer internet.

Privcap: Most people have heard about Bitcoin, but your firm has a specialty in Ethereum. What’s the difference?

Keys: In my opinion Bitcoin was the opening act, gateway drug, the initial use case, the MySpace, if you will, for proving that Alice could pay Bob without a bank in the middle. And Bitcoin is brilliant. It solved what was called the double-spend problem. If I can view an email it’s okay for me to carbon copy somebody else. But if I send you money, that would not be good if I could carbon copy you that money. So basically, through advancements in cryptography and public/private key pairings Alice could send Bob money and we could know that we couldn’t double-spend that money. Really, that was the ingenious evolution of Bitcoin: peer-to-peer transfer of value.

With Ethereum, you can do peer-to-peer transfer of value, but where Ethereum evolves on Bitcoin is you can essentially do anything peer-to-peer. By that I mean smart contracts, which is what I previously spoke about. So basically, you could programmatically send value based upon certain conditions. So basically, Bitcoin is a singular use case, whereas Ethereum is an infinite  use case.

Privcap: Over a year ago there was a surge of interest in cryptocurrencies but that has since dropped dramatically. However, institutional investors are still interested in whether they should consider an allocation to cryptocurrencies. Should they?

Keys: I think that they should understand the different layers of what the next generation of the internet looks like. A lot of people got very hurt investing in the application layer, which I think we are very early in. If you want to use an analogy to legacy internet, we’re in 1994 right now and dial-up hasn’t even started yet. There are going to be thousands of dotcom companies created. Whether they’re Amazon.com or Pets.com, some will be very successful, some will not. The majority of them will fail. But, unlike the legacy internet you have the ability to essentially monetize the protocol layer. So basically, the technology below all of those applications. So in the analogy of legacy internet, if you were able to acquire things like HTTP or TCP/IP and monetize at that layer, I think that’s a much more interesting bet.

I believe that there will be a decentralized web stack. And that will consist of a smart contract layer, and I think Ethereum is the strongest competitor. You’ll have decentralized file storage, so essentially recreating things like Amazon Web Services or Dropbox for file storage, but on a decentralized platform. I think the strongest competitor there is what’s called the InterPlanetary File System. There will also be opportunities in mesh networking, decentralized messaging, and high proof of computation.

Basically, I think institutional investors should understand the difference between the protocol layer that all of the applications will need to use and that application layer, and understand where we are in terms of the time horizon. And my position is that it’s just too early to invest in the application layer right now.

Privcap: You probably will not be surprised to learn that there are hundreds of people out there trying to raise venture capital funds, private equity funds, other forms of investment funds, that have some sort of cryptocurrency or blockchain theme. As investors survey these funds and try to figure which, if any, of these managers to commit their capital to, what would you suggest would be some of the most important qualifications that a manager of such a fund should have?

Keys: I think you have to have some sort of Venn diagram of previous value investing, because the market’s frothy, and a deep understanding of computer science. This is rooted in deep computer science and they will need to properly due diligence projects, especially very early in the game. And also, I think that you also have to have some type of legal and regulatory due diligence subject matter expertise as well because now we are essentially digitizing assets, and some assets may be deemed as securities, some assets may be deemed as software licenses. And the ability to understand the difference in those assets and what they are intended to do. Last year many of these projects could have misconstrued securities law, and a few have already been proven guilty of selling unregistered securities.

Privcap: You say all industries are going to be disrupted by blockchain. Let’s focus on one that my audience knows well – the financial services industry. How will financial services be disrupted by blockchain?

Keys: So the easy, low hanging fruit is middle and back office. This technology is creating a decentralized distributed ledger that has an immutable record of the truth, which helps a lot of those middle and back office processes. The “a ha” moment is the notion of double-entry accounting. Double-entry accounting is basically how planet Earth works right now. If you and I are counter parties to a transaction and if I send you a dollar for an invoice that you sent me there would be the debit in my books for the dollar, there’s a credit in your books for the dollar. And you could change that entry by mistake and put 99 cents. I could be disingenuous and put $1.05. And there’s essentially no watermarking, no receipt, no factual evidence that I did indeed send you the dollar.

So you add blockchain technology to this and in this example it’s a third entry where, when I send you the dollar, there’s an immutable handshake imprint of that transaction. What we just did was automated the process of an audit. So KPMG, Ernst & Young, PwC, Deloitte, et al, get paid billions of dollars per year to reconcile when you sent me the invoice and when I sent you the dollar. And those types of processes are easy examples of middle and back office functionality that will get automated as the distributed ledgers are added into our business functionality.

Privcap: If Ethereum a building block upon which all forms of transactions and agreements can be based, what does it even mean to own a unit of it?

Keys: Ether is the native token for Ethereum, which is in my opinion the digital version of oil. If we’re to use an analogy, we use oil in our cars, in our planes, in our trains, in our buildings, in our computer systems to basically operate commerce in society. Basically, for any transaction employing a digitized contract you need a micropayment of Ether. So, if I’m JP Morgan and you’re Goldman Sachs and we are entering into a trade, either of those counter parties would rather that trade occurring in some sort of neutral playing field. That typically happens in some type of intermediary today, like the DTCC, and essentially you could imagine a world where the DTCC is not needed anymore because the assets natively digital, and they are tokenized, and they are atomically swapped with each other. Rather than paying for the DTCC, your custodian, your network administrator, you now require a micropayment of this native digital token, ether, for that transaction to go through.

Privcap: Final question – the rise of blockchain in general, and cryptocurrencies specifically, has generated a lot of enthusiasm but also it generated just a tidal wave of skepticism, as I’m sure you’re very aware. What is the right level of skepticism, and where should be more enthusiasm?

Keys: Where I think the skepticism is warranted is in the production-grade readiness of the technology. People want something that has the transactional throughput of Visa or MasterCard that does 25,000 to 30,000 transactions per second. It’s not there yet. People want something that’s highly private, confidential, and upgrades are just being added. It is too early days. I also think there should be skepticism in something like Bitcoin as being the potential solution to central banking. I think there will always be central banks and I think that there will always be fiat. I don’t think that monetary policy is going away anytime soon.

Where I do think skepticism is overblown is that people are looking at the first iterations of these technologies and are dismissing them. We’re literally in the first out of the first inning, showing what is possible. If you remember, in the early days of the internet there were scams, there was gaming, there was gambling, there was pornography, and then it literally transforms how Earth works. And I think we’ll see something very similar to that with blockchains as a substrate for our financial, social, political operating systems over the next decade.