A lesson in conformity: blockchain social rules and why they matter

More than anything blockchain is a triumph of social computing. It allows a theoretically unlimited number of people to come together and agree on a system through economic incentives. In bitcoin miners buy hardware, are incentivized to operate honestly, and are punished through electricity costs when they fail to do so. But what does ‘honesty’ mean to the blockchain?

There is an agreed upon consensus for honest actions in the blockchain. When transactions are put through the system, an honest miner will check if the signature is accurate, whether the address has the value that they are trying to send, and finally whether their nonce is acceptable to the blockchain. This system makes sense, and is rooted in the concept of ownership that we share as humans. However, the true economic incentives don’t lie with honesty, they lie with consensus. In many ways consensus is the root of honesty in the mind of the public. Whatever most people agree is true is usually true. This, however, has been shown to be true only in the sense of bitcoin mining. There have been few if any successful attacks on blockchains, only on the services that provide access to them. One can say that this is a triumph of the technology, but it is rooted in greed. This is not to say that the system doesn’t work (in fact it may be the only way to make the system work) but what is significant is the spillover effects that this has on the blockchain community as a whole.

Tether and the quest for a free lunch

As many people have heard recently, a cryptocurrency called Tether has been partaking in some questionable business practices. They have printed over a billion Tethers, which are theoretically supposed to be backed by US dollars in a bank account so that they can be exchanged for the currency at any time. Tether, however, specifically states that they don’t claim to allow full access to these dollars, and more than that these dollars likely don’t exist. Considering Coinbase brought in a billion in revenue this year, it is highly doubtful that Tether has the necessary funds to back the absurd amount of value that is stored in its currency. Why, then, is Tether maintaining its valuation at $1?

The answer is quite simple, and it bears a lot of similarities to the process of bitcoin mining itself. In bitcoin mining, consensus rules dictate that the longest chain is the valid chain. There are high economic incentives to mining on the longest chain. The longest chain is virtually never disrupted by another (except in the event of single block forks, in which two are temporarily considered the longest) and any mining activity performed on alternate chains is wasted. In Tether, the incentives are similar. The ‘longest chain’ in this case being the valuation of a dollar. Bear with me here, as there are obviously significant differences in the mechanisms which are present in mining and trading, but the premise is the same. Mining consensus dictates that people will profit if they follow the system. This analogy rings true with Tether, because those who assume that Tether will maintain its dollar valuation can profit buy purchasing shares when it falls under a dollar. Despite all the bad press that Tether has seen, it remains faithfully priced at a dollar. The only explanation for this behavior is consensus. In an valuation model that considers expected value, Tether should surely be depreciating. There are significant risks as to whether or not you can actually trade a Tether for a dollar at any time. In this system, however, traders know that unless that trust is entirely destroyed in Tether, it will maintain its valuation by the rules of consensus.

Some may argue that this is good, it allows marginal faults by new companies trying to develop new technology without ruining the project. But the problem here is that this is not a localized issue. People continue to buy other currencies with fake money. Over a billion dollars have been pumped into the blockchain economy and has contributed far more than that to the cryptocurrency market cap. Ironically, this consensus system has created a central point of failure for the cryptoeconomy**,** despite the entire purpose of the technology being to eliminate such a thing. Where a consensus system may be good for processing transactions, can be emphatically detrimental to a market. Consensus is what causes the wild fluctuations in market price, the dot com bubble, the housing bubble, the list goes on. Obviously the stock market functions to some extent through consensus, but only when the consensus is based on intrinsic valuation models. In the crypto market, consensus means you buy when the price is going up, and you sell when the price is going down. This is what gave rise to the classic ‘hodl’ beckoning call in the crypto market, as those who truly care about the technology despise the wild fluctuations in price (this may be a euphemism for the real story, a drunk speculator depressed about buying at the peak, but it works for these purposes.)

The path forward

None of these examples are meant to imply that blockchains are inherently greedy, nor are they meant to express doubt about the future of the technology. Rather, the community needs to grow up and learn better ways to design consensus. The same gold rush we see today has many historical examples, and it is likely this would have happened whether or not the mining incentives were aligned in this way. The purpose of this passage is to stress the importance of defining consensus in a way that is not only economically profitable, but also socially profitable. Not whether they should include consensus, but whether the consensus mechanism is beneficial. The consensus mechanisms are the heart of blockchain technology, and they spell out, almost to the letter, the actions of the community. With this power in mind, blockchain developers need to think hard about not only the mining incentives for their protocols, but also the social and political consensuses that may arise from them. There is a lot of work to be done on this front; the bulk of which will have to be learned by trial and error. Ultimately the fate of this technology will be determined by the expected value of human morality, and though many may question it, I personally would bet my life on it.