How the Blockchain Ushers in a New Form of Trust

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Wharton's Kevin Werbach provides an in-depth explanation of the blockchain, as presented in his new book.

417XJdJGkdLBlockchain is one of the biggest buzzwords in technology today. But confusion exists about what it is exactly: The blockchain is often mentioned in the same breath as bitcoin and other cryptocurrencies, but it encompasses far more than that.

Kevin Werbach, Wharton professor of legal studies and business ethics and a blockchain expert, has written a book that explains this technology with great depth and precision. For example, he points out that bitcoin refers to the cryptocurrency, while Bitcoin comprises the bitcoin network.

He recently spoke with Knowledge@Wharton about his book, The Blockchain and the New Architecture of Trust. Following is an edited transcript of the conversation.

Knowledge@Wharton: What got you interested in bitcoin and the blockchain?

Kevin Werbach: I study emerging technologies. I’m a legal scholar by training, but I’m interested in internet-related technologies that have significant business impacts. And like many people, I first heard of bitcoin several years ago, when it was still very small, and found it fascinating.

This idea that it was possible to create money — something that stored value in a decentralized way — and that it actually worked, that people would actually trust it as being valuable, I found tremendously interesting. But it was only when the whole blockchain space developed and became a broader business environment a few years later that I really started to increasingly focus my research on this area.

Because really, blockchain is a fusion of law, business, technology, economics — all these different areas where I have some expertise, and where I think there are really potentially huge opportunities to create new kinds of organizations and new kinds of [businesses].

Knowledge@Wharton: One thing about your book that struck me was that it makes a great effort to be precise about a topic that confuses many people. So, perhaps we could start with your explaining the difference between bitcoin and the blockchain.

Werbach: This is important. One of the reasons that I wrote the book was because I was speaking to many people — senior business executives, policy makers, and others — who were smart people, tech-savvy people, who would say to me, “I just don’t get this blockchain thing.” And so, I tried to write something that was a deep, substantive treatment of the issues. It goes into legal questions and policy questions, but that starts with articulating for a broad audience what’s going on here.

“Blockchain is basically a family of technologies for ordering transactions, for having a decentralized kind of database where there’s not one actor that controls it.”

The first piece of this is that there are actually several different related phenomena. Bitcoin was the first piece to come on the scene. The bitcoin white paper was released on Halloween in 2008, and the Bitcoin network started operating in early 2009. So, it’s about a decade old now. Bitcoin is a private digital form of money. So, the idea with bitcoin was: Can we create something that has the same functions as money — which means people trust that it’s still valuable, it can be used as a means of exchange, or a store of value, or a unit of account in theory — without a central entity issuing it, or validating transactions?

That was really the starting point for the whole blockchain space. Although it turns out that, when you look at bitcoin technically, it was actually based on, in many cases, earlier work that had been done in related areas, which has now been used in some of these implementations other than bitcoin.

Knowledge@Wharton: The blockchain is the technology underlying bitcoin, and that’s what makes it different?

Werbach: Bitcoin is what’s called a cryptocurrency. And a cryptocurrency is basically a token of value on one of these decentralized networks. The broadest term for the decentralized networks is Distributed Ledger Technology, or DLT. And that encompasses a whole wide range of things.

On the one hand, [we have] what are called permission-less, open systems like bitcoin — there are now something like 1,600 other cryptocurrencies that are out there, although most of them are not particularly used or valuable — and these allow anyone to be on the network. Not only can anyone make a transaction, but in most cases, anyone can be a validator, can be in the role of verifying the transactions are accurate. And what’s extraordinary is that these technologies make it trustworthy to have this system, even though anyone can be on the network.

That’s the cryptocurrencies. And they’re based on these underlying networks called blockchains. And blockchain is basically a family of technologies for ordering transactions, for having a decentralized kind of database where there’s not one actor that controls it, where multiple parties are in control.

But there’s still confidence they’re all seeing exactly the same thing. The network comes into what’s called ‘consensus.’ So, at any moment, it’s possible to be confident that we all see the same information — the same transactions in the same order. For something like bitcoin or a cryptocurrency, that means we all see the same balances of money in our accounts. But it’s much broader.

Knowledge@Wharton: A lot of people think that, when you talk about the bitcoin blockchain, it’s really a system that doesn’t need trust. But instead, you’re arguing that the blockchain actually represents a new form of trust.

Werbach: That’s one of the key mistakes that I see people making. And again, one of the things that motivated me to write the book was I saw all these conversations in the blockchain and cryptocurrency world talking about this as a trustless technology. And the idea was that, well, trust is dangerous. If we trust someone, they could abuse our trust. They could take advantage of us. We see that with private companies.

For example, people stored their data with Equifax, and their data was stolen, so they trusted something untrustworthy. Or Facebook, which has had all of these issues with Cambridge Analytica and privacy breaches, and so forth. That’s part of the concern. So the argument is, let’s get rid of trust. Let’s have a system where we don’t have to trust anything except just the technology. And we can look at the code, and it’s based on cryptography, which is mathematical information security. And that’s all we need.

The point I’m making is that, even if that’s true, and I think that is true, and these cryptocurrencies and blockchain systems have been able to develop robust trust in the ledger itself — in the fact that this asset went from this person or this cryptographic private key to this other one — it takes more than that to have trustworthy transactions. You need to trust the system as a whole, because there might be abuses.

“There’s nothing inherent in the technology that will necessarily cause it to be used for illegal activity.”

You don’t necessarily know who you’re dealing with. There are other parties that are involved in that validation process, in developing the code, and so forth. And there are all kinds of situations where, even if people aren’t bad actors, there are disputes. And you need some way to resolve the dispute. So, the argument that I make in the book — and it’s basically the title — is that blockchain is not the end of trust. Blockchain is a new structure of trust, what I call a ‘new architecture of trust’ that recreates trust in a different way.

Knowledge@Wharton: When people hear the words ‘trustless system,’ the connotation is that it’s a lawless system. And I think in your book, you say that it’s exactly the opposite. Is blockchain compatible with the law?

Werbach: It’s absolutely compatible with law. But it doesn’t embed law in its native state. Absolutely, these blockchain networks can and are used in some cases to engage in illegal activity. People use bitcoin to engage in money laundering, to buy illegal drugs, and so forth. Now, it turns out that law enforcement, in many cases, has an easier time tracing that on the bitcoin network than on traditional financial networks.

When I go and make a cash transaction — cash is a true bearer instrument — it’s hard to trace. Whereas with bitcoin, it’s a public network. All the transactions are public. You just have to associate that cryptographic private key with a human person or entity. And it turns out that there are a variety of sophisticated ways to do that.

There is this illegal activity. There also is fraud going on. For example, there are what are called Initial Coin Offerings, where companies offer these tokens for fundraising. There’s a ton of scams and fraud in that world. The point I’m making is there’s nothing inherent in the technology that will necessarily cause it to be used for illegal activity. And in fact, there’s a vast amount of legitimate legal activity happening.

Businesses are deploying on blockchain technology because they see it solving real business problems. The challenge is how to safeguard and promote the legal activity and minimize the illegal activity and do it in a way that doesn’t create too much friction in the process. That requires, unfortunately, a fairly slow and at times cumbersome process of figuring out how to put blockchain together with law, regulation, and governance. [I spend a lot of effort in] the book outlining how that process actually works.

“Businesses are deploying on blockchain technology because they see it solving real business problems.”

Knowledge@Wharton: How should regulators approach the blockchain? You mentioned in the book three questions they should ask to determine whether or not to act.

Werbach: First of all, the regulators need to ask, “Is this a system that’s designed for legal or legitimate purposes?” There are bad actors out there. There are systems that basically make it harder to track transactions and make it easier to engage in illegal transactions, where that’s the point of the system. We saw this 20-odd years ago with peer-to-peer file sharing, with systems like Napster and so forth, where they were services that clearly were designed to facilitate copyright infringement. They were shut down.

Then there were other systems that use very similar technology. BitTorrent is a good example. The company that makes BitTorrent — which for a while was a huge percentage of traffic on the internet because it was used for sharing video — was never sued successfully. It was never shut down by the government because it built a technology that was really valuable, actually, for companies wanting to share media files, and did what it could to limit the illegal uses. So, the first question is, who’s behind this? And what are the indications about whether they see the potential illegal uses as the goal, or something that they want to work on minimizing?

The second question is, what are the mechanisms of achieving the government’s purpose? People in technology — entrepreneurs and people like advocates of cryptocurrencies — often think that governments regulate because they want to control things. I used to be a regulator. I was at the Federal Communications Commission early in my life. Governments generally don’t do that. They regulate because they want to address their objectives, serve their missions.

If your mission, for example, is to combat money laundering and terrorist financing, and using money to facilitate crime, then you’re going to want to come up with a system that does that. So, the question is, what are the mechanisms governments can use? As I said, in the case of things like bitcoin, it turns out that governments can actually track the transactions on the blockchain, as opposed to preventing the transactions from happening when those could be legitimate transactions. So, the second question is, what are the alternatives for meeting the government’s need?

The third one is cost and benefit. There are huge benefits, directly, in terms of having regulation to prevent people from losing their money, and [to curb] illegal activity. But there are also broader benefits to the blockchain community. It comes back to trust. We need a trustworthy environment where ordinary people and existing companies are willing to commit their money and commit their resources to this exotic, weird, decentralized new technology. It has to be trusted. Regulation actually can play a good role there.

Regulation also has costs. It can be over-broad. It can limit innovation, and so forth, if it’s not designed well. Regulators need to think hard about those costs and benefits. I think if they ask those three questions together, they’ll be well-positioned.

Knowledge@Wharton: Let’s move on and talk about the potential of the blockchain. How do you think blockchain technology can be used pragmatically today, or in the near future? How do you see it being adopted?

Werbach: There are three buckets of adoption that I see. One is cryptocurrencies, which is the most radical, but also the least mature part of this world. And that’s either using something like bitcoin as a substitute for money or using these cryptocurrency tokens to power decentralized applications because basically, a blockchain is a kind of distributed computer and it’s possible to [have] applications — just like we have applications running on the internet — running on these decentralized ledger systems.

“The real revolution is seeing this at a deep level as a new structure for trust.”

The power there is potentially, they’re not controlled by any entity. The platforms are not under the control of very powerful intermediaries who have an incentive to bias the system, and to pull back the value to themselves. That’s an area where there’s a huge amount of fascinating experimentation. People may have heard of things like CryptoKitties, where there are games that are being built on it, and real applications. But it’s still very, very early — technically very early in terms of adoption.

The second bucket is the blockchain — the ledger solutions, which are about tracking things. Any time there are multiple organizations that have to work together on some business process, who don’t fully trust each other, there’s a cost, right? Because they have duplication of information. Each wants to keep its own copy of information. They have to reconcile and settle. And you add this up across the entirety of global business, it’s trillions of dollars that are lost in these processes.

Blockchain, by creating a virtual ledger — a shared source of truth across organizations — can provide value in a massive range of these applications in pretty much every industry you can think of. In that second category, there is a fair bit of adoption. There are companies that are doing real productions systems — there’s one consortium I talk to called Hyperledger that has 50 production networks operating on its technology, and that’s just one platform — which are the actual systems of record between real companies. But in most cases, it’s still fairly early. The volumes are still fairly small. But it seems to be coming.

In the third bucket are what I call ‘cryptoassets,’ which is the one where there’s actually the most economic activity, because it’s the least radical. This is basically Wall Street and the financial system using these as tradeable assets, saying, basically, if I’ve got a cryptocurrency like bitcoin or some other token, and there’s a … sufficient confidence that it is a legitimate store of value, it’s a native digital asset. It’s something that can be securitized, that can have rights and responsibilities, can be the basis for derivatives, can feed into this massive global financial transactional system that we have.

That’s actually the area where, over the last year, there’s been the most activity, and I think where we’ll see the most financial transactions in the near term. It requires a little bit of legal clarity. It requires a little bit of building interfaces and middleware systems, which is happening, but it doesn’t have to change the basic structure of the marketplace. And so, in that area, we’re seeing real interest by institutions and traditional sources of capital. Because again, it’s a more efficient solution for what they were already doing.

Knowledge@Wharton: You write in the book that blockchain could change the world, but, and this is a quote from you, “crucially, how and when remain uncertain.” What do you mean by that?

Werbach: That’s always the question with transformative technology, right? Anything that is deep enough and significant enough to potentially affect global business is not something that’s going to be a light switch. It’s not something that’s going to happen overnight. And it’s not something where it’s going to be uniformly adopted because there are costs. Because this requires people to think about doing things differently. And there are going to be losers in the move to this new system.

If you think of blockchain just as a way to speculate in these tokens, or you think about it as an alternative form of money that will only succeed if it replaces the traditional fiat currencies, then I think you’re missing the big picture. The real revolution is seeing this at a deep level as a new structure for trust. And when you look at where trust is important in business, it’s everywhere. But because it’s so broad, that means it’s going to be a long, unfolding process where we don’t know what the killer apps are.

 “I don’t … think that bitcoin or any other cryptocurrency will subsume or replace dollars and the existing currencies we have.”

I gave you a model of three buckets. But specifically, where is this going to be adopted, what countries, what parts of the world, what industries are going to move first — in hindsight, it will all be obvious. In hindsight, we’ll say, “Yeah, that’s the killer app.” Of course, you would buy books on the internet. And then of course you’d buy everything on the internet on Amazon. Of course, advertising was a way to monetize search into this massive tens-of-billions of dollars industry. I can tell you, at the time, none of those things were obvious. And people were skeptical of all of those claims. So, it’s a similar sort of thing. Because the potential is so great here, that’s why there’s so much uncertainty about exactly what the path forward looks like.

Knowledge@Wharton: It’s been almost a decade since the bitcoin white paper came about. And cryptocurrencies are very popular obviously, but you don’t see the blockchain adoption reaching a stage of maturity that perhaps one would expect. So, in your view, based on your research and experience, is the blockchain really a revolution?

Werbach: We’ll see. I think some aspects of it are clearly revolutionary. Whether it will actually be a successful revolution, that’s the open question. I’m very confident at this point it’s not going away. It’s going to be widely adopted, and just integrated into the fabric of business, just as many internet technologies have been. We sort of take them for granted now. But it took a long time, with many challenges, to get to the point where they were moving into all of these different companies all around the world in a deep way.

I think you somewhat have to choose. If you want the revolution, that’s really exciting. But it also reduces the likelihood it’s going to happen. I don’t, for example, think that bitcoin or any other cryptocurrency will subsume or replace dollars and the existing currencies we have. I think actually what’s going to happen is the major governments like the American government — and probably sooner than that, the Chinese government and many of the others — will tokenize their currency. They’ll use the blockchain technology in a permissioned way to digitize their fiat currency. Is that a revolution? In some ways, absolutely. It’s not the same revolution as we’re all going to be buying things in bitcoin. I think there’s still a place for bitcoin and the other cryptocurrencies, but maybe not as much of a sweeping revolution as people think in that vision.

Look, it depends on whether you’re focused on true disruption of the way things are done, which very rarely happens. When it does happen, it has huge costs as well. Or are you saying, what’s going to be important? What’s going to actually affect business across the board to the point where, 10 years from now, no one could ignore it? … I think that latter [scenario] is where blockchain is going. And if that’s not a revolution, fine with me.

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