Opinion: The ultimate hope of encryption technology is not digital currency, but replacing the traditional state structure

The development of blockchain technology has brought more imagination to modern society. Bruno Maçães, a senior fellow at the Hudson Institute and former Minister of European Affairs of the Portuguese Ministry of Foreign Affairs, believes in this article that the ultimate hope of encryption technology lies not in digital currency, but in replacing the traditional state structure.
By Bruno Maçães
Compiled by: Wang Dashu, Echo
Original title: "Crypto Nation: Blockchain's Grand Deduction of Reconstructing Society"

Throughout history, world powers (Spain, the Netherlands, France, Britain) have often been replaced by more dynamic competitors.

Today, many speculate whether the United States will give way to China as the global superpower, but what if that assumption is wrong? What if we are experiencing a more radical transition? What if all contemporary states are being replaced by a new type of “state” that is different from existing governments and different from ancient empires or primitive tribes?

Technological creation brings new sources of power and new growth logic.

First, at the information level, Google knows you better than the government; second, at the social level, Facebook brings more people together on a public platform, which is unmatched by any society, including China or India; third, at the monetary level, Bitcoin is a new type of currency that is decentralized and not subject to political control; fourth, at the legal level, smart contracts are computer programs that can run without human intervention. So what kind of governance will be born with these new elements?

In a 2017 essay, Mark Zuckerberg used the philosophy of history to explain the rise of Facebook. Over the course of history, humans have evolved from tribes to city-states to nations, and now. “Today, we are about to take the next step,” he wrote. What Zuckerberg considers truly extraordinary is not that humanity is becoming a global community, but that he sees his company as playing a vital role in achieving that goal: “bringing us closer together and building a global community.” “In times like these, the most important thing we can do at Facebook is to develop the social infrastructure that empowers people to build a global community that works for everyone,” he said.

When Zuckerberg calls Facebook the "social infrastructure" of community, that term is the only name most people use to define the state. The state makes human community possible. It builds, organizes, and brings its members together. Or, as Zuckerberg puts it, it supports us, keeps us safe, and informs us.

Of course, Facebook has no territory and no territorial claims. It is committed to building a global community not in physical space but in virtual space. By getting rid of geographical restrictions, this new community will be open to everyone on the planet.

The story of Facebook's political suffering over the past few years shows that the desire to create a new type of "nation" is much more difficult than Zuckerberg imagined. The problem is that Facebook leads a double life. On the one hand, it wants to build a virtual community of global citizens. On the other hand, it is a company established under existing national laws, subject to both market competition rules and public regulations. Obviously, neither of these points is in line with the so-called global political role that Facebook pursues.

The existence of cryptocurrencies and crypto platforms more broadly provides an answer to this dilemma. With Bitcoin, we have seen the arrival of a new global infrastructure. In this country, people can achieve data and transactions without interruption on a trusted blockchain distributed ledger without intermediaries: no large multinational companies capture data, no banks are involved, and no national institutions can tamper with the record. Disputes in the community are automatically resolved by the existing distributed ledger, which plays the most important role.

As media critic Steven Johnson has argued, the inventors of the open protocols that shaped the internet failed to understand that they were building a community, not just a machine. Unfortunately, the ways of identity have been defined in the real world, and online communities simply replicate these standards. Offline, we rely on public authorities to confirm to others that we are who we say we are, such as marital status, wealth, age, taxes, contact information, etc., and national authorities will do their best to keep all these records.

In general, society works better if citizens can trust these authorities to get the job done. But on the internet, the amount of information has exploded. Now, the vast amounts of data collected online cannot be compared to the original records in the real world. Human information is transformed into data streams that can be recorded, analyzed, and evaluated in real time. Technology companies collect thousands of data points about each of us, and the profiles they create are like virtual avatars that are twice as real as our real selves.

Because there were no internet protocols for personal identity, and because the protocols that were available were of limited use in the real world, the private sector quickly rushed in to fill the vacuum, establishing a number of proprietary standards for determining user identity.

As Facebook becomes more and more central, I think it’s fair to say that things aren’t going well in this space. The global community that Zuckerberg wants to build is driven by things like targeted advertising, and the community must be built to maximize profits for Facebook and its advertisers. The threat of “surveillance capitalism,” as writer Shoshana Zuboff calls it, is that it threatens a massive expansion of mechanisms of social control that are based on making human behavior completely predictable.

At the same time, the powerful power accumulated by new technology platforms has awakened the interest of government regulators, reducing the possibility of realizing the dream of a new global community independent of traditional national structures.

This is why Facebook’s digital currency project Diem is doomed to fail. Congressional hearings began immediately after the announcement, with the chairman of the Financial Services Committee calling on Facebook to halt its development. Unlike Bitcoin, Diem is centrally controlled by one specific company, making it an easy target for regulation.

One conceivable alternative is that everyone would have their own digital identity, which different services could use based on their current interests and choices, rather than having that identity recorded and updated by large internet platforms and then sold to advertisers without asking the owner of the digital identity.

With Bitcoin’s introduction of a distributed database, something truly remarkable became possible for the first time: a community coming together with no authority other than a database that records the collective lives of its members. The ultimate hope of crypto lies not in digital currencies but in replacing other state structures.

Bitcoin was created on January 3, 2009, at the height of the global financial crisis, in response to the breakdown of a global financial system that had somehow managed to allow private companies to operate autonomously and profitably while ultimately holding public authorities accountable. In other words, it was a response to the excesses of financial markets and the unlimited power of the state.

Satoshi Nakamoto made a fundamental claim: the financial system as it exists today relies on trusted third parties (primarily banks and other financial institutions) to function. The need for this mediation increases transaction costs and limits the minimum practical transaction size, making small, ad hoc transactions less likely.

Furthermore, the current system does not provide for the inviolability of asset and transaction records, and fiat currencies remain under the ultimate control of governments. The financial crisis showed that this is not an indifferent consideration, but even in more conventional circumstances, every government is inclined to use monetary and fiscal tools to tamper with the historical record, a record that Bitcoin enthusiasts believe is irreversible. There are also many things that people want to do with money, and politicians, bureaucrats, and political activists want to prevent them from doing so.

Cryptocurrencies grew out of the efforts of “cypherpunks” who used real computer science rather than fantasy physics to build a libertarian utopia in cyberspace. In large part, the goal was to strip money of its reliance on government.

Currency is just one area where public control could change hands once a decentralized accounting and governance system is in place. According to Buterin, the system could be used not only to transfer wealth, but also to take over certain roles of courts and, more broadly, the law. In short, the decentralized accounting process could accept anything that a computer can currently represent. At this point, the logic behind the new technology becomes clearer, even to beginners.

Whether Satoshi Nakamoto considered these possibilities when he created Bitcoin is debatable. His paper was limited to the special case of electronic money, but that in itself is not surprising. One always has to start with money, because all those who build, maintain, and improve any thoroughly decentralized system need to be rewarded for their efforts. Satoshi Nakamoto paid considerable attention to the classic problem of "incentives."

Buterin abandoned the idea of ​​Bitcoin and built the Ethereum blockchain with a programming language, enabling everyone to write smart contracts and decentralized applications, so that they can create their own rules for ownership, transaction formats, and state transition functions. It is worth noting that money is no longer just an output, but an input. All programmable computing in Ethereum is charged, and the fee is specified in gas units, which can be purchased using the system currency ETH.

Smart contracts automatically process social and economic exchange activities according to a predetermined algorithm. For example, as Buterin said, someone might have a contract of the following format: "A can withdraw up to X currency units per day, B can withdraw up to Y currency per day, A and B can withdraw anything together, A can prohibit B from withdrawing from it."

Or think of a vending machine, which, without a store clerk or other trusted intermediary, executes a contract to sell a drink at the advertised price to a customer who puts enough money into the till. The logical conclusion of this concept is a decentralized autonomous organization, a smart contract, or a set of contracts that contain assets and encode the rules of an entire company or organization.

Just as a computer without an internet connection has limited functionality, so too does a smart contract platform that cannot connect to external functions. However, as crypto becomes more and more functional, we get closer to a singularity: the moment when it is no longer composed of man-made systems, it is separated from reality, and becomes a control room for events in the real world. From that point on, it will acquire at least some of the properties of a state.

Many problems related to the interface between Ethereum and the real world have been actively discussed and studied. In some cases, ingenious solutions have been proposed. Most address ways to make the system accept real-world inputs.

Ethereum promises its users a universal system where they can do more than just trade internal currencies. For example, they can develop hybrid protocols that connect crypto assets with traditional financial instruments. Stablecoins are crypto assets backed by collateral tied to gold or the U.S. dollar. Synthetix allows the creation of synthetic assets whose prices can track currencies, cryptocurrencies, and commodities.

All of these options require access to market prices for the assets being tracked. Insurance smart contracts will require data feeds related to the relevant insurance event. For example, did the flight you purchased insurance for arrive on time? Trade finance smart contracts will need data about the shipment, supply chain, and customs of the goods being shipped to confirm the fulfillment of the smart contract. Information sources from the world outside the system are called "oracles."

The question immediately arises how to design an oracle that does not falsify the logic of the system. For example, in 2019, the Synthetix oracle transmitted false data to the platform, which was then exploited by a trading bot. Although no users were affected, Synthetix had to pay a considerable fee to the bot owner to fix the inadvertent hack.

Another instructive example is prediction markets, where for example predicting the name of the next US president is a smart contract that will automatically execute a money transfer once the election occurs.

The advantages of smart contracts are obvious: we don’t need to trust the other party or the intermediary, and there is no way to cancel or change the principal invested. Of course, the problem is how to provide the correct information about the election results to the smart contract. Many different solutions are being tried, and one option is to create a decentralized oracle network.

According to Chainlink’s founder, both blockchains and oracles can produce “deterministic truth.” That is, the Bitcoin blockchain establishes definitive facts about Bitcoin ownership. Chainlink uses the same approach to provide deterministic truth about the outside world: multiple independent nodes confirm data from different, independent oracles. Similarly, in the decentralized prediction platform Augur, the consensus established by a group of “reporters” is considered the “truth” for determining prediction results.

We have now reached the crux of the matter. Because individual assets in the aforementioned system are protected by cryptographic keys, and the system itself is protected by a fully decentralized protocol, existing nation-states are increasingly finding it difficult to track or control economic activity and transactions occurring on the blockchain.

If the state and banking system cannot see transactions in the new crypto economy, the ability to collect taxes disappears. Tax rates in the rest of the economy will have to increase to make up for the lost revenue, but the tax increase could drive more people into the crypto economy. Not surprisingly, crypto transactions became part of the IRS tax return form for the first time in 2019. In the first section of basic personal information it is written: "At any time in 2020, did you receive, sell, send, exchange, or otherwise acquire a financial interest in any virtual currency?"

At first glance, this doesn’t seem like a sustainable dynamic for crypto. After all, nation-states still have a monopoly on violence. But in reality, violence is not available on blockchains. As Buterin once told me, if outsiders were to exert violence by controlling the user’s physical body, blockchains themselves do have a growing toolbox of technology, including complex and obscure smart contract wallets, that makes it difficult for attackers to use force to obtain crypto assets. But if violence were to occur, things would be more complicated. In this sense, there is no obvious way for crypto systems to control the use of violence, which is the defining characteristic of modern states.

However, here is my initial suggestion of how things might play out. The key issue is, of course, taxation. It is here that cryptocurrencies present a more decisive challenge to the core power of the modern nation-state. Some in the crypto space believe that the slow erosion of the state’s taxing power will ultimately determine its eventual collapse.

Many people have told me that they expect all nation states to disappear in the coming decades, with the exception of China, which they believe has the political and social resources to penetrate or disable fundamental bottlenecks in crypto systems. China accounts for half to two-thirds of global Bitcoin mining, but the government has made it clear that it is skeptical of the cryptocurrency space. In 2017, China banned fundraising through initial coin offerings, and all digital currency exchanges were shut down. If the government decides to cut off China's Bitcoin network, it could make it difficult for mining pools to synchronize their data on the blockchain with the rest of the world.

The Chinese case does offer a possible template for the ongoing power struggle between cryptocurrencies and nation-states. In this scenario, crypto systems would double down on their technological advantages, while states would necessarily resort to their secret weapon, their monopoly on the legitimate use of force. But the second scenario seems more plausible, at least outside of China. Public institutions and crypto systems could reach a grand agreement or collaboration, whereby the state would be able to tax crypto assets in exchange for crypto security guarantees.

The old systems and structures in the political world are not going away anytime soon, so it is crucial for blockchain projects to be able to interact with them. I believe that old systems can also benefit from this. The Swiss canton of Zug has taken the first step in this direction, recently announcing that starting in 2021, taxes can be paid in BTC and ETH.

One could even develop a form of smart contract or chain of smart contracts whereby the protocol could be automated, and the payment messages sent to the centralized tax processing infrastructure would depend on the proper functioning of crypto exchanges and mining nodes. If the latter were shut down, outputs would be suspended or frozen.

The solution is similar to a “slashing” algorithm, where if a node operates the network in a malicious or harmful manner or violates the protocol guarantees, the node will be punished, including partial or full destruction of locked funds or temporary or permanent removal from the network.

What if “confiscation” means “confiscation” by the state? One might conclude that the coercive means of the nation-state have been effectively absorbed by the new “state” system.