What blockchain can and cannot do

Although blockchain technology has been highly sought after, most of it is still in the research and testing stage. There are also other technologies competing with it. The real large-scale commercial application of blockchain still needs time to test.

In 2014 , five years after Bitcoin came out of nowhere, the blockchain technology behind it began to become more popular than Bitcoin itself. Many institutions have invested heavily in this seemingly straightforward and not very beautiful technical concept, and some researchers claim that it will change the economy and society. This article intends to analyze blockchain from several perspectives, including blockchain and Bitcoin, what blockchain can and cannot do, centralization and decentralization, technical rules and legal rules, governance and supervision, central banks and commercial banks.

Blockchain and digital currency: technology and applications

Blockchain is a technology that has become popular along with Bitcoin. As a digital currency, Bitcoin must solve the trust problem in order to have transferable value. In the past, trust was achieved through centralized solutions, that is, all value transfer calculations were placed in a central server through the endorsement of a company or government credit. Satoshi Nakamoto, the founder of Bitcoin, provided a decentralized solution, namely blockchain, through a distributed ledger.

In this system, the ownership of currency is recorded by the public ledger and confirmed by the encryption protocol and mining community. It has the characteristics of distribution, decentralization, trustlessness, immutability, encryption security, etc. It is precisely because the blockchain has solved the "double-spending" and "Byzantine Generals" problems in digital currency that digital currencies represented by Bitcoin have developed rapidly within a certain range.

The so-called "double-spending" problem refers to the fact that before the emergence of blockchain encryption technology, encrypted digital currencies, like other digital assets, are infinitely reproducible. Without a centralized intermediary, people have no way to confirm whether a digital cash has been spent. Therefore, there must be a third party that can be trusted to keep the transaction ledger in the transaction to ensure that each digital cash is only spent once. Satoshi Nakamoto used the blockchain to stamp the timestamp and publish it to the entire network to ensure that each currency cannot be used for other payments after it is paid. Other nodes will recognize the validity of the block only if and only if all transactions contained in the block are valid and have never existed before.

The "Byzantine Generals" problem refers to how several alliance generals who were besieging a castle during the Eastern Roman Empire could prevent themselves from being deceived and confused by traitors and making wrong decisions because they could only rely on messengers to convey information.

To solve this problem, mathematicians designed an algorithm that allows generals to add their own signatures after receiving information from the previous general and then forward it to other generals except themselves. In this chain of information circulation, the generals can reach a consensus without finding traitors, thus ensuring that the information obtained and the decisions made are correct.

Blockchain technology can be used not only for digital currency, but also for other more extensive uses. The application of currency is called blockchain 1.0 , which mainly solves the decentralization of currency and payment methods.

As early as the creation of Bitcoin, Satoshi Nakamoto considered making it programmable so that it could support multiple types of transactions. With this as a starting point, the application scope of blockchain technology has surpassed digital currency. Blockchain 2.0 can be used to register, confirm and transfer various types of assets and contracts, such as various financial transactions, public records, private records, etc., thereby decentralizing the entire market in a more macro sense. Blockchain 3.0 goes further beyond the economic field and can be used to achieve increasingly automated distribution of physical resources and human assets on a global scale, and promote large-scale collaboration in science, health, education and other fields.

It can be said that blockchain is well known to people because of Bitcoin, but blockchain goes further than Bitcoin. Blockchain is a neutral technology, while Bitcoin is one of its applications.

As CICC's analysis report states, "Bitcoin has been far from mainstream since its birth in 2009 due to its drastic price fluctuations and bad reputation associated with crime. As the architecture protocol behind Bitcoin, blockchain is gaining more and more attention." The UK Government Office for Science's report "Distributed Ledger Technology: Beyond Blockchain" also points out that "the key is not whether the technology itself is good or bad, but what are the application scenarios of this technology? Why is it designed? How to apply it? What corresponding security measures are there to avoid possible problems?"

What blockchain can and cannot do: Advantages and limitations

Since 2014 , blockchain technology has been viewed separately from Bitcoin. More and more enterprises and government agencies have become interested in blockchain technology, and more and more capital has been invested in the research and development of blockchain applications. Not only have related startups continued to emerge, but traditional institutions have also begun internal research and external alliances to deploy blockchain.

The reason why blockchain is so popular is inseparable from its characteristics and advantages. According to the definition of the UK Office of Science, blockchain is a database that stores some records in a block (rather than collecting them in a single form or paper), each block is "linked" to the next block using a cryptographic signature, and can be shared and collaborated between anyone with sufficient authority, using a "consensus algorithm" to jointly maintain the authenticity of the ledger.

The above characteristics give blockchain technology the following advantages:

The first is decentralization. This means that there is no need for a trusted third party, and it also means that at least 51 % of the nodes must be attacked to destroy the entire network.

Second, the data is difficult to be tampered with. First, the hash algorithm is used to verify whether anyone has attempted to tamper with the information through a one-way mathematical function; second, each node can obtain a copy of the complete database, and any attempt to tamper with the database is obvious; finally, methods such as the proof of work mechanism are used to ensure that the honest chain is extended at the fastest speed and surpasses other competing chains. If you want to modify the blocks that have appeared, you need to have more than 51 % of the computing power of the entire network, which makes the cost of forgery higher than the expected benefits.

The third is trustlessness. There is no need for mutual trust between each node participating in the system to exchange data. The operating rules of the entire system are open and transparent, and all data content is also public. Therefore, within the rules and time range specified by the system, nodes cannot and will not deceive other nodes.

Fourth, transparency and privacy are consistent. The account is open to the public but the account name is hidden.

The fifth is neutrality. Take Bitcoin as an example. Anyone can use Bitcoin without being restricted by culture, language, religion, status, political system or economic region. This means that people who do not have bank accounts or cannot fully access financial services can use Bitcoin in a low-tech environment.

From the perspective of the financial sector, there are already some application examples in the banking, securities and insurance sectors. For example, Ripple provides financial institutions with blockchain solutions for cross-border payments and foreign exchange market making, and can provide 7 × 24 hours of all-weather real-time payment services. Generally, transactions can be completed in a few seconds, and algorithms can be used to find the best price for transactions, improve efficiency and reduce costs. NASDAQ cooperated with blockchain startup Chain.com to officially launch the Linq platform for private equity transactions. The first stock issuance was completed on the platform on December 30, 2015. Lloyd 's has started a modernization plan called Target Operating Model , including a blockchain-driven trading room and an insurance market alliance based on tokens. This blockchain-driven trading room can enable international insurance companies to participate in global reinsurance and reinsurance transactions more safely and conveniently without the need for intermediaries.

From the perspective of the economic field, blockchain has made some progress in the application of the Internet of Things, the sharing economy, and asset identification. For example, Everledger , established in 2015 , is a diamond digital ledger based on blockchain technology. It can create a digital "passport" for each diamond, record the source, track ownership, and use smart contracts to link the terms and conditions of diamond sales and transfers to automatically execute contracts.

In the field of government administration, blockchain technology has room for application in both developed and developing economies.

Estonia, located on the Baltic Sea, has a population of only 1.3 million, but it is the country with the most national public key infrastructure ( PKI ) in the world. Estonia has adopted blockchain technology for citizen identity information and corporate information management since 2013. Residents can use PKI to collect prescription drugs, vote, log in to online banking, view children's education records, apply for government benefits, file taxes, submit wills, apply for military service, etc., with more than 3,000 functions ; companies can apply for licenses, submit financial statements, and issue equity documents with PKI identities; government officials use PKI to encrypt files for secure communications, review and approve licenses, etc. Cabinet members use PKI to review agendas, vote and review minutes.

The United Kingdom also has a strong interest in blockchain technology. Institutions such as the Government Office for Science and the Bank of England have conducted in-depth research on blockchain. The British government has sponsored the D5 group of nations project, which aims to improve the quality of public services through digitalization. Members include the United Kingdom, Israel, New Zealand , South Korea and Estonia.

However, this does not mean that blockchain technology does not have limitations. The earliest and largest blockchain, the Bitcoin blockchain, has shortcomings such as limited block capacity, long confirmation time, and high energy consumption, which limit its commercial application. In recent years, some companies and institutions have developed other blockchain protocols to replace the time-consuming and labor-intensive proof-of-work mechanism with mechanisms such as proof of equity and proof of share authorization to increase transaction speed and reduce energy consumption.

Even so, blockchain still faces some challenges in its application.

The first is the trust issue. Although users do not need to trust the other party in the transaction or any centralized intermediary organization, they need to trust the software system under the blockchain protocol, and the public may still need an authoritative organization to endorse it. The decentralized and tamper-proof characteristics of blockchain technology are limited, and decentralization is more achieved at the private chain and alliance chain level. There are also higher-level institutions or systems that can control the entire blockchain.

The second is the technology gap. There is a gap between those who are able to safely use blockchain technology on the Internet and those who are unable to do so. To solve this problem, the system must be designed to be "foolproof", so that users can use it well without knowing too much about the system, and the system can clearly show users its functions and the results it brings.

The third is security. Although it is difficult to destroy the blockchain system by attacking more than 51 % of the nodes, attackers may turn to attack individuals who use it, such as hacking into their wallets or attacking related platforms.

Fourth, there are privacy challenges. The alias identities between users and wallets are actually very weak in terms of anonymity, and coupled with the transparency of Bitcoin blockchain transactions, anyone can draw conclusions about something by observing the blockchain.

Fifth, it is to smoothly integrate with existing application technologies and usage habits. Due to path dependence, old concepts may restrict the emergence of new models. Existing application technologies have a certain degree of customer stickiness. If blockchain technology is to be widely accepted, it must overcome the existing path dependence.

Sixth, technical rules may lack the necessary flexibility required in the real world. For example, CICC’s analysis report mentioned the shortcomings of the current blockchain in transforming financial infrastructure, including the lack of recourse after the fact, the inability to settle with net positions, the inability to lend securities, the lack of matching between trading tokens and physical assets, and the possibility that the automatic execution of smart contracts may form a self-reinforcing feedback loop that leads to financial instability.

Some of these obstacles can be solved through the development of blockchain technology, while others may require other technologies besides blockchain. Blockchain is not a panacea. After cost-benefit comparison, some areas are more suitable for using blockchain technology. For example, DTCC released a report stating that blockchain is particularly suitable for securities issuance and subsequent services, clearing, teaching settlement, transactions, records and comparisons of complex financial contracts, collateral management, etc.

Historical experience shows that there is a " 30 -year rule" for technological breakthroughs to go from the laboratory to commercialization, that is, technological breakthroughs require time to accumulate. Although blockchain technology has been sought after, most of it is still in the research and testing stage, and there are also other technologies competing with it. The real large-scale commercial application of blockchain has yet to be tested by time.

The trade-off between centralization and decentralization

Although decentralization is the core of blockchain technology, it also brings high redundancy, low efficiency and waste of resources.

Decentralization requires information to be broadcast and accounted for across the entire network. For financial transactions with a frequency of hundreds of thousands per second, broadcasting across the entire network places extremely high demands on network performance; and accounting across the entire network places requirements on storage space. Block capacity is also a problem. When Satoshi Nakamoto designed the Bitcoin blockchain, he set a capacity limit of 1MB for each block . With the increase in the issuance of Bitcoin and the promotion of its application, transaction time has been extended, and even some transaction requests cannot be successful during peak hours. The subsequent blockchain has expanded in block capacity, but there are still bottlenecks. In addition, the proof-of-work mechanism, namely "mining", brings a lot of energy loss.

In order to improve efficiency, subsequent blockchain technology has made improvements in the above aspects, and the forms of blockchain have developed in a diversified manner.

Depending on the degree of centralization and decentralization, there are three types of blockchains: public blockchains , consortium blockchains , and fully private blockchains . The differences between them are shown in the figure in the article.

The advantages of public blockchain have been demonstrated by the popularity of Bitcoin. Its fully decentralized nature can protect users from the influence of developers and bring about greater network effects. The freedom, neutrality and openness it advocates are welcomed by many people.

Compared with public blockchains, consortium blockchains and private blockchains have more advantages in efficiency and flexibility, which are mainly reflected in the following points:

First, the transaction cost is cheaper. Transactions only need to be verified by a few trusted high-computing nodes, without the need for confirmation by the entire network.

Second, nodes can be well connected, failures can be quickly fixed through human intervention, and consensus algorithms can be used to reduce block times, allowing transactions to be completed faster.

Third, if read permissions are restricted, better privacy protection can be provided. Fourth, it is more flexible. If necessary, the community or company running the private blockchain can easily modify the rules of the blockchain, restore transactions, modify balances, etc.

The development and evolution of blockchain well reflects the mutual confrontation and penetration of centralization and decentralization that has repeatedly appeared in economic and financial history. The actual application of blockchain depends on the actual needs. As the founder of Ethereum said, "The idea that only one blockchain can survive is completely misleading... everything depends on what you need."

Legal and technical rules

Another important reason why blockchain is highly praised is that technical rules constrain behavior. Take smart contracts as an example. They are data records with executable properties in the ledger. Their contents will be triggered and executed under specific circumstances. The triggering methods include time-driven (such as mortgage redemption), event-driven (such as will execution), condition-driven (such as gambling agreements), and cash-for-goods (such as unmanned factories).

In fact, the digitization of the real world has been underway for a long time, and legal rules and technical rules are in effect at the same time, but blockchain technology makes the role of technical rules more prominent. Bitcoin based on blockchain shows that they can operate effectively without legal rules and only rely on technical rules. Every participant in the network runs the same or compatible software, which defines the code of conduct.

For example, participants can only spend the balance they can prove with their keys; each transaction needs to be verified before being logged into the ledger, and validators compete for the opportunity to record accounts through mining and receive Bitcoin rewards; the number of Bitcoins produced is limited, etc.

Technical rules have a significant advantage, that is, the compliance cost is very low: participants only need to use a compliant software package to issue transactions. This allows people to transcend time and space limitations and rely on technical rules instead of trust to complete collaboration, transactions, etc.

However, in the application of blockchain, people have gradually discovered that relying solely on technical rules cannot solve all problems. First, machines will rigidly execute rules, even if compliance with the rules will lead to unforeseen or unwanted results. Second, if the application of blockchain involves physical assets, and physical assets are subject to the legal rules of jurisdiction, then the coordination of technical rules and legal rules is very important. Third, technical rules cannot be governed by mathematical algorithms alone. They are also formulated by people, but in the form of code and software. Who formulates the rules embodied in the software affects every participant involved in the technical rules. This also reveals that in the development of blockchain, it is crucial to participate in the formulation of technical rules.

Governance and Regulation

This question is related to the previous one. Governance is the establishment of rules by participants in a system to protect their private rights, while regulation is the establishment of rules by external agencies to protect the public interest. The former includes both internal governance of enterprises and institutions, as well as self-regulation by industry associations and alliances.

The application of blockchain is constantly developing. For enterprises and institutions, on the one hand, they need to meet customer needs through the optimization of internal governance, and on the other hand, they need to actively participate in the formulation of rules of relevant alliances. Chinese enterprises and institutions have begun to try this. On February 3 , 2016 , the Zhongguancun ( 000931 , Stock Bar ) Blockchain Industry Alliance was established to build a cooperation and exchange platform across universities, research institutes and enterprises, organize domestic and foreign blockchain production, learning and research cooperation, and strive to solve the technical problems encountered by member units in the development, intellectual property protection, industrialization and other problems, and create a complete blockchain industry chain.

For regulators, the task is even more arduous. The development of technology requires regulators to consider regulating through both legal rules and technical rules at the same time to make up for market failures and resist systemic risks.

A huge challenge in regulating public blockchains (such as Bitcoin) through legal rules is that their decentralized nature makes it difficult for existing laws to find applicable regulatory objects and easy to bypass. An alternative solution is to regulate those companies that handle Bitcoin, such as exchanges and wallet service providers, to ensure that related transactions do not violate existing legal provisions, such as anti-money laundering and anti-terrorist financing.

As mentioned above, blockchain technology highlights the importance of technical rules. For regulators, it is important to consider