Bitcoin, Blockchain, and ICOs: What You Need to Know

One of the offshoots of CES this year was a CoinAgenda event. It was attended by over 1,000 folks paying about $1,000 each to hear and learn about Bitcoin and blockchain startups, and judge a variety of ICOs (Initial Coin Offerings). Bitcoin bubble or not, blockchain-based technology is here to stay. Maybe some other cryptocurrencies are as well. It’s still early days, but not too soon to try to understand what Bitcoin, blockchain, and ICOs are, and how they relate to each other.

Bitcoin (BTC if you want to trade it) is famous, has made a lot of people rich (certainly on paper), and gets a lot of public attention. After the recent crash, I suspect it has also made some people poor. It’s a way that I can send some value off to you without the fees inherent in systems like PayPal, or the need to trust a central arbiter (like PayPal or a bank). It’s sort of anonymous, too, but if you want to cash out, you’ll eventually need to have a bank account, which isn’t anonymous.

However, along the way Bitcoin’s aspirations have been mugged by three factors. First, the blockchain on which it runs is slow, so it’s kind of lame for most purchases. Second, transaction fees have skyrocketed as a result, so it isn’t all that cheap to transfer Bitcoin if you need it sooner rather than later. And third, it has become something of a commodity and is traded like one — which means it fluctuates more than most merchants will tolerate. So it is probably best to think of Bitcoin as something quite different from a currency. Either way, it is important to realize that the underlying blockchain technology will be here to stay, whether or not Bitcoin fizzles.

Bitcoin May Be the New Gold

Like gold, though, which has some sort of otherworldly value well beyond its industrial use, Bitcoin may continue to act as a backbone for the digital currency economy. It may always be a place to store value when you don’t need to spend it, and to hedge against the comings and goings of other offshoots. Put that way, you can certainly argue the digital investor of the future will want about the same amount of their portfolio in BTC as they do in GLD today (which typically isn’t that much).

Blockchain is Cool, Like Dot-Com, But Overhyped, Like Dot-Com

The problem with the dot-com boom wasn’t that dot-coms weren’t a good idea. As we can see from the long-term success of online businesses, they were indeed the future. The problem was dot-com was bolted onto every potential business plan, whether it made sense or not. In many cases, like the infamous Pets.com or Webvan, the infrastructure and customers just weren’t ready. The same thing is happening now with blockchain. Even if you leave out the insane examples of random companies adding blockchain to their name and having their stock prices double, a good number of the blockchain startups I saw at CoinAgenda had a hard time explaining why blockchain was essential to their success, or how it would guarantee their success.

At a high level, we can break some of that down for you. Blockchain provides a distributed “ledger” of transactions that is visible to everyone, and can be checked at any point in time by anyone. This has huge value for industries where there are lots of players and they all want to know what’s going on. For example, IBM and shipping giant Maersk have announced a joint venture to use IBM’s Hyperledger technology (that uses blockchain) to provide a system for everyone in the shipping supply chain to be able to perform and audit transactions. Unlike the awkward “who’s in charge” situation of trust on public blockchains, these industry-specific versions are run by large, hopefully trusted companies that can update the software and protocols as needed.

Blockchain Doesn’t Have to Destroy the Planet

One of the biggest fundamental issues with Bitcoin is that the way new Bitcoins are made and money is earned is through mining. Roughly speaking, mining is like being rewarded for leaving all the lights on and the air conditioner running in your house. It’s probably one of the most environmentally destructive ways to create value on the planet. The canard of having mining done with renewable energy is just that. If we have excess renewable energy, we should use it for something else.

Fortunately, mining isn’t the only solution. Private blockchains often certify trust a fairly old-fashioned way. They place trust in one or a few large organizations, who vouch for the system. Not very radical, but efficient. Some public cryptocurrencies, like Ethereum, have seen the writing on the wall and are moving to “proof of stake” instead of “proof of work.” That means that the majority owners of the currency control its future, which unfortunately has its own problems. Right now, for example, a massive percentage of Bitcoin are owned by only a few people, most of whom are anonymous. There are some other interesting concepts being tried, like CureCoin, where the mining is actually running needed research computing tasks on your computer in exchange for coins that are funded by cash donors.

Of ICOs and Tokens

First, ICO purchasers gain neither equity or oversight. So they have no way of controlling how the company uses the proceeds unless that is also part of the ICO (and there are plenty of class action lawsuits about founders who took the money and ran). Second, the notion that the coins will increase in value as the mini-economy grows seems fraught. If you want an economy to grow, you want to encourage the spending, not hoarding, of your currency. Third, if you want to monetize your coins in a particular, possibly obscure token, you’re likely to have some slippage turning it into a spendable currency.

Public Blockchain-Based Projects

Ethereum has extended the Bitcoin notion of a blockchain to allow code to be from the blockchain itself. This allows for something called Smart Contracts, where multiple parties can perform a purchase or other transaction that might include escrow in an automated and hopefully trusted fashion. I find the notion a little unnerving, though. Since Smart Contracts have no private key for their address, if a bug in the software leaves money sitting in escrow, there is literally no way to get it back out. However, many companies are building on top of Ethereum itself, or implementing a similar concept in parallel, so expect to see at least some of them succeed in providing a distributed trust alternative that disrupts the current business model. And one more interesting effort is BlockStack, which aims to reinvent the internet’s domain management system in a distributed way using blockchain technology.

[Image credits: Wikipedia, Flickr/BTC Keychain]