Blockchain Foundations

Today’s Agenda

• What is a blockchain? 
  • Reducing Counterparty Risk
  • Digital Transparency
  • The Store of Value Narrative and Gold
  • Censorship Resistance

What is a blockchain?

Blockchains are ever-expanding ledgers of transactions. They have a handful of qualities that differentiate them from traditional computing networks, and they open doors to entirely new ways of doing things. They’re intended to be censorship-resistant, immutable record sources with interoperable capabilities. Immutable in the sense that these transactions can not be reversed and interoperable in the sense that blockchain accounts can seamlessly interact with other accounts and applications.

Transactions on a blockchain are grouped into blocks and are verified by a distributed network of computers that earn money for participating in the verification process. Distributed means that these computers are not governed by any central entity but rather by a widespread collection of individual entities. This network collectively puts together a public ledger that can be indexed and searched with extreme detail. Anything that happens on a public blockchain is immediately and immutably a part of the public record. 

Accounts & Wallets

Each account on a blockchain is accessed with a digital wallet. Accounts hold an individual or entity’s tokens which can be freely transferred between wallets and interact with applications that are compatible with the wallet. These applications can be financial or used for gaming, messaging, and virtually anything else.

Unlike traditional markets, blockchains operate all day, so on-chain markets run 24/7, and anyone with a wallet can partake in them.

Reducing Counterparty Risk

Consensus methods are the backbone of any blockchain. In the next chapter, we’ll go into more detail about how they work. Still, they are meant to give disparate network participants the ability to verify the truth without having to trust anyone or rely on any centralized entity to act accurately or ethically. 

Not wanting to trust a counterparty may sound counterintuitive, but if there is no counterparty, then there is no counterparty risk. If there are no ethics, there is no misbehavior. It’s a technical philosophy embodied in the code behind decentralized systems, and it’s all possible because of consensus methods.

Consensus methods are algorithms that an incentivized computer network uses to participate in collective transaction verification. The process of how this works varies from method to method.

Digital Transparency

Specific blockchains (ZEC, MXR, SCRT) are oriented towards privacy, but most are transparent by default. Every detail of every transaction can be openly searched and indexed on a blockchain scanner, as shown below.

You can see that there was a transfer from one wallet to another of 0.00203928 SOL on March 18, 03:21:07 AM +UTC, and the transaction fee was 0.000005 SOL (a fraction of $0.01).

On other blockchains, transaction fees can go into the dozens and hundreds of dollars pretty quickly depending on network congestion. Using Solana, you can make 1,000,000 trades and only pay ~$10 in transaction fees.

The Store of Value Narrative and Gold

Bitcoin was initially intended to be a peer-to-peer medium of exchange, although its narrative has switched mainly to that of a global store of value. Countries that use their proprietary currency other than the big 6 (USD – United States Dollar, CAD – Canadian Dollar, EUR – Euro, AUS – Australian Dollar, JPY – Japanese Yen, and GBP– British Pound) – are subject to grave risks imposed by the arbiters of the big 6. 

Rather than hold onto, for example – the Turkish Lira or South African Rand and have their spending power decline over time, many have fled to BTC or other cryptocurrencies that enable pseudonymous, secure transfers of value and opportunities for capital appreciation. Bitcoin, for example, increased in value by 6,965,454,545.45% between 2010 and 2021.

Its low was $0.00099, and the all-time high was $$68,958.

Uncertainty

Financial markets serve many critical economic functions, although they do not always reflect what’s happening in the real world. They often aren’t. The stock market, for example, is constantly attempting to base prices and valuations on future expectations. To predict future outcomes, you want the least amount of uncertainty involved. 

Markets crave certainty. 

Markets crave certainty. 

When outcomes are uncertain – such as when a supply chain crisis, a war, or a pandemic occurs- prices will reflect that. Speculative assets like revenueless tech stocks or purposeless altcoins will reflect uncertainty by having their price spike downwards because there is no more perceived value. Re-pricings will occur, even if it’s not immediate. It’s easy to forget that asset prices can go down another 99% after dropping by 99%.

Mimetic Desire and Gold

Physical bars of Gold has outperformed most assets during periods of economic strife. As one of the oldest forms of human currency, Gold has become what is referred to as a safe haven asset. It’s important to understand that money flows from speculative investments to safe-haven assets isn’t happening automatically. It’s a result of trader psychology being influenced by mimetic desire, and it happens slowly, then all at once (similar to how risk works – stairway up, elevator down).

Mimetic desire is best explained with an analogy. Imagine you are standing next to someone on a trampoline. That person sees something they want that requires them to jump to reach it. When they jump, you feel the movement of the trampoline underneath you. A natural reaction is to look at where this movement is coming from. When you see what the person next to you wants, Mimetic theory argues that you’ll also start to want that thing.

Learn more about it here.

Other than its use in jewelry, Gold is perceived to exist outside of the traditional financial system, although banks are the largest owners of it, and derivatives are constantly used to manipulate its price – so that is a relatively naïve assumption. Below is one of the many headlines detailing big bank baboonery. In this instance, JPM Chase had to pay a $920 million fine.

They’ll survive.

Even though Gold has performed well in the past during times of distress, this rise in value is not based on any fundamental, intrinsic characteristic. Gold is not easy to transport or store, especially at scale. Try moving $1 billion in Gold across an ocean. Due to big players in the industry, Gold is actually a very centralized commodity, and the price will only appreciate because of a fluctuating extrinsic value. Someone will see that someone else has Gold, and they’ll want it.

What if everyone thought silver was a better store of value, or tungsten, or rhodium, or zinc… or Bitcoin?

Bitcoin as Digital Gold

Narratives drive markets as much or more than fear and uncertainty do.

Although Gold hasn’t been a practical currency in hundreds if not thousands of years in most places, it’s still being recommended by big banks and asset managers as a safe haven asset worthy of 1-5% of a traditional financial nest egg in the off-chance that calamity happens. This narrative that it stores its value in times of distress is just that – a narrative. It will work until it doesn’t. If rarity or scarcity is the argument, there are more scarce assets on this planet that could replace Gold if the narrative shifted.

Bitcoin is one of them.

As proposed in the white paper, Bitcoin was initially conceived as a peer-to-peer method of exchange. It has since become part of the larger store of value narrative that Gold can attribute its declining relevance to, except this time – it’s digital. Bitcoin has been referred to as Digital Gold by many investors and mainstream media pundits, partially because that’s the most digestible explanation they can come up with and partially because it’s true.

It’s not the whole story behind what, how, and why Bitcoin came to be, but it’s a good and strong story. Traditional investors can now fathom investing 1-5% of their portfolio into Bitcoin, and more progressive investors have a new lens to view markets with. 

The idea of existing outside the traditional financial system will be an important one to touch on again when we start covering DeFi (Decentralized Finance) later in this course. 

Censorship Resistance

Some blockchains, particularly the privacy ones listed above, are intended to resist censorship. The goal is for anyone to build and use them. There are no credit checks and the only requirement to open a digital wallet is to have an internet connection. 

The reality of censorship resistance in crypto is that some blockchains do a better job than others. The blockchain industry is barely a teenager, and there are many schools of thought regarding how it should operate. Maximalism, tribalism, and investor bias all contribute to a never-ending conversation on which consensus methods and blockchain infrastructure are the most secure and most censorship-resistant.

All in All

Blockchain technology and application can be interpreted in many ways, so it’s essential to consider all facets with an open mind.

Understand the tech and then form an opinion.

That’s enough for today. If you’re inexperienced in this world, these concepts can seem quite complicated and full of jargon at first, so it’s best to learn them in continuous and small doses – with the occasional obsessive deep dive.