What’s the purpose of blockchains?

This post summarizes the main argument for why blockchains are useful. Most of the material is synthesized from Vitalik’s blog posts.

Coordination

Coordination is an extremely important ability that distinguishes humans from animals. For example, the concept of private property is a form of coordination, around a common ledger of who-owns-what. Some argue that the most important driver for innovation in the west has been “land ownership”, because settlers were incentivised to develop their piece of land.

Let’s try to break down what coordination is. Coordination requires consensus (we agree on a plan) and trust (you will not deceive me). Think how family chooses their future spendings, how small community agrees on a budget, etc.

To achieve coordination (consensus+trust) on a bigger scale, centralized control proved to be very effective:

  • Centralized entities can effectively make decision on a large scale (government’s policies on military, public education, public healthcare, etc)
  • Centralized entities can effectively maintain databases (paypal, facebook)
  • Centralized entities can effectively stop people from stealing from each other, by promising to punish them (police)

Collusion

Another effective tool for coordination, but with no trust/consensus, are free markets. There economic incentives drive people to specialize and exchange goods. But there is a flipside to free markets: economic incentives may drive people to coordinate in a bad way. This phenomenon is called collusion. A simple example would be someone selling their vote in an election. A more complicated example would be all sellers of a product in a market colluding to raise their prices at the same time.

In addition to free markets and economic incentives, the second most frequent component in collusions is a centralized control. Examples are endless:

  1. A dictator taking advantage of their power, by using citizens’ taxes to enrich themselves/friends (by signing gov contracts with dictator’s friends), or sending country’s soldiers to a war that is destined to be lost.
  2. A lobbyist giving a politician a bribe in exchange for that politician adopting the lobbyist's preferred policies.
  3. Companies excessively raising their prices in a monopoly.
  4. Discretionary censorship in social media platforms.
  5. Facebook and other internet giants not sharing profits with their users, whose data and attention they are selling (if you think about it, this is the special case of 3.)
  6. Banks not sharing revenues with depositors, justifying this by low interest rates environment (again, a special case of 3.)

Blockchain is a collusion resistant coordination tool

From this point on we will focus on the following problem: how to safely coordinate people around ownership (”who owns what”)? In more simple terms, how do we keep track of people’s balances. An almost trivial solution is to use a central party (e.g. paypal) which will keep track of all the balances. But there is a

Key problem: achieving ownership coordination (trust+consensus) via centralization heavily skews economic incentives, leading to collusion = bad coordination. So how can we achieve coordination without trusting a central authority?

  • We cannot all trust each other, because there could be malicious actors. Thus we need our communication to be verifiable, and this leads us to cryptography, namely digital signatures.
  • But also, how do we agree on a plan? Thus we need to have a consensus protocol.
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Groundbreaking solution: blockchain = decentralized consensus protocol for keeping a cryptographically verifiable (and therefore trusted) ownership ledger. This technology enables ownership coordination at scale, without collusion.

Let me reiterate: fundamentally, blockchains allow good coordination at scale without invoking collusion (bad coordination).

Diagrammatic summary
Diagrammatic summary

Remark 1. Blockchains are not “fully trustless” because there are certain trust assumptions in the consensus protocol, like “more then 50% of nodes are honest”.

Remark 2. Decentralization has another nice property (in addition to collusion resistance): lack of a single point of failure. This implies fault tolerance and attack resistance.

Remark 3. Collusions happen in blockchains too, but there are ways to defend: counter-coordination by forking!