The Blockchain and Inherently Equitable Markets

In the late 1990's I was beginning my teaching career. It was the very beginning of the technology revolution. The California State University system gave all teachers a free personal email account which we accessed via a dialup modem and the glorious Pine email client: text on a monochrome monitor. These were the early days of network computing - the Internet before hyperlinks and pictures. There was a clear sense back then that you were on a computer that was connected to another computer far away and to get more or different information you had to connect to a different computer that was located somewhere else. For me, this was magic - magic in a way that it is probably hard for a digital native to understand. 

A map of traffic on the Internet

A map of traffic on the Internet

Back then you could actually sense the network of individual computers that served files to individual users on their own individual computers. Today, with the prevailing metaphor of The Cloud, it requires some imagination and stubbornness to realize that the network of individual computers and files is still there. It is. In fact, the Internet is exactly that.  It is a peer-to-peer network meaning that any computer can connect more or less directly to any other computer. (Truth is there are a lot of traffic routers in the middle that really are computers but they have the sole purpose of routing your requests to your intended destination.) To manage this network web, the Internet has a standard protocol, a set of rules to which all computers must adhere to be discoverable, to be relevant. There is not a cloud. There is only each of us, Me and Google and you and Silk Road and Amazon and everyone one else. This is the essence of Network Neutrality, that each of these nodes is a citizen in an equitable network.

  Idealized Power Law Graph

  Idealized Power Law Graph

But this does not mean that the Internet is a random network where each node is equal. Far from it. Some nodes are more popular than others as demonstrated by the traffic map of the Internet. These clusters of activity follow a statistical relationship called power law where the quantity of sites on the Internet varies as a power of the amount of traffic each site gets so there are only a few sites that get a lot of traffic (the left side of the graph) and a lot of sites that get a little traffic (the right side or long tail of the graph.)

And so here is the punchline of this walk down my nerdy memory lane, equity and equality are not the same thing. Equity refers to a pre-condition of interaction like the nature of the network or the level of the playing field. Equality refers to a relative comparison of the value of nodes in a network or the players in a game. There will always be some inequality. In the map of traffic on the Internet above, the clusters of activity - the small number of sites with a lot of traffic - are formed by a process called preferential attachement where the sites with the most traffic generate the most new traffic because of their popularity. Even in an equitable network, preferential attachement is present but in an inequitable network - one where value is assigned arbitrarily or with prejudice - preferential attachment is exacerbated because it is not rooted in actual value relative to the other nodes. This is what we are seeing in our economy today. We have an inequitable network that is producing un-natural or perverted inequality. One way to address this problem is to redistribute value. That is what our inequitable economy has been doing since about the 70's - redistributing value to the rich. We should re-redistribute value to those with less. We should also create a more equitable economic infrastructure. This is why you should care about the block chain.
Here are the two facts about the block chain that I think are the most relevant. 

  1. Block chain is a simple, secure and transparent way to manage the exchange of value. 
  2. Block chain nodes or clients are distributed meaning they are built on a peer-to-peer topology.

Her is what Wikipedia says.

"A block chain is a distributed data store that maintains a continuously growing list of data records that are hardened against tampering and revision, even by operators of the data store's nodes. The most widely known application of a block chain is the public ledger of transactions for cryptocurrencies, such as bitcoin. This record is enforced cryptographically and hosted on machines running the software.[1]" - Wikipedia

The block chain first came to popular awareness as the database underlying Bitcoin. While Bitcoin continues to be a fascinating financial experiment, I believe that the block chain database that powers Bitcoin will be the true revolution. However, because block chain is an infrastructure innovation it will likely not be noticed by most people except as the catalyst behind more efficient and equitable markets. Just as the Internet has a protocol that provides the instructions for each computer to interact as a node in the network, the block chain will be the protocol for a new market infrastructure.

Currently, the network on which our financial markets reside is the opposite of peer-to-peer. Our financial market networks have a hub and spoke topology brilliantly illustrated by Kurt Vonnegut in Breakfast of Champions. Hub and spoke means that the user or client is out on the end of a spoke and all transactions must pass through the center. In market terms this is known as "clearing". (Granted this is an oversimplification as there are several hubs especially when you are looking at a global scale like I did with the example of the Internet as a network.) In the hub and spoke topology equitable transactions are possible; however, perverted or corrupted transactions are also possible because a third party that is required to sit at the hub and clear the transaction. This position at the hub infers immense privilege and temptation as evidenced by various recent scandals (LIBORFOREX, and of course the credit default swap casino that lead to the crash in 2008)

In a block chain market, there is no hub, no single place where transactions must be cleared. Instead, value is sold and cleared simultaneously, well, actually in a few minutes because the block chain node your are transacting through must check in with all the other block chain nodes to understand the provenance and the validity of the value that is being exchanged. This is possible because block chain data bases are transparent.  All transactions are recorded and can be queried by anyone. There are several examples of what is called a block chain explorer that query and display Bitcoin transactions. At its core, the block chain is a database.  If you follow the previous link you can click in to a transaction and explore the public details of the transaction. The anonymous details of the transaction can only be accessed by the actors who are party to the transaction and that private data can only accessed via secure private keys. It is those secure private keys that also designate the parties of the transaction - access is ownership.

Because a block chain database has no hub there is no privilege associated with being close to the hub and there is no need for a third party to clear the transactions. That fact combined with the combination of security and transparency means block chain markets are inherently more equitable and less susceptible to manipulation. 

Finally, it is important to note that this is not just a someday-maybe kinda thing. NASDAQ has hired to explore creating a new market infrastructure and companies like Ripple Labs are creating a new payments infrastructure for the equitable exchange of value anywhere in the world. Additionally, a company called Synereo is creating a social network built on the block chain which will be a fascinating alternative to the hub and spoke network of Facebook et al. I highly recommend reading the first chapter of Synereo's white paper.