This is part 3 of an introductory series, written to explain some of the high level concepts within the world of cryptoassets and blockchain technology.
At its core, blockchain technology is an innovation in record keeping. The Bitcoin blockchain keeps a flawless record of how many bitcoins every user owns. As people transact, the system updates everyone’s balance on a special database that’s like a big excel spreadsheet that can’t be cheated or tampered with. Suddenly, the banks that have historically been trusted to keep track of how much money everyone has can be replaced by an open system for value exchange.
While an “innovation in record keeping” doesn’t exactly sound exciting, keeping records is an essential ingredient to just about everything we do as a society. Subsequently, blockchain technology can be applied to revolutionize how society functions as a whole. Blockchains can keep records of financial agreements, title to real world property, stock ownership or anything of value. As with bitcoin, people can transact with these assets over a blockchain - a shared global ledger that anyone can access but no single person, corporation or government owns.
Ethereum introduced the concept of a blockchain platform in 2013, with others like EOS, Cardano and Dfinity developing alternatives in the following years. These platforms allow developers to build applications on top of blockchain technology that can facilitate a wide range of value exchange. Where Bitcoin poses an alternative to the traditional banking system, blockchain platform applications can reinvent every aspect of finance and property exchange while enabling new industries and markets that weren’t previously possible.
Within the Ethereum network is a cryptoasset called ether. Ether is what you pay with to use Ethereum applications and is currently the second most valuable cryptoasset after bitcoin.
Just like you need gasoline to fuel your car, you need ether to fuel applications built on the Ethereum network. For this reason, ether is typically referred to as a crypto-commodity rather than a cryptocurrency.
Applications built on Ethereum employ a special type of computer program called a smart contract. Smart contracts can be programmed to move money or value when certain conditions are met and have tremendous implications for all aspects of finance and beyond.
Smart contracts allow for business logic to be written around the exchange of digital assets, allowing people to enter into financial agreements over blockchain networks. Intermediaries needed to execute traditional agreements can be replaced with transparent computer code that execute the terms of the deal once certain conditions are met.
Smart contracts in the real world
An insurance policy exists as a piece of paper detailing an agreement between the policy holder and an insurance company. When that paper record is digitized and put on the Ethereum blockchain, smart contracts can execute the terms of the agreement automatically without traditional intermediaries. To better understand how this technology can revolutionize modern finance, let’s take a look at a pilot program being run by French insurance giant, AXA.
AXA offers a “flight delay insurance” product. For example, someone can buy a $5 insurance policy that pays out $100 if the flight is delayed by 2 or more hours. If the flight is delayed by over 2 hours, the customer files a claim, waits for the company to manually process it and waits for AXA’s bank to issue the payment - a process that can take weeks or even months. A smart contract can automate this process in one shot and issue the payment in real time.
A smart contract can be written and deployed on the Ethereum blockchain that states, “IF flight is two hours late, THEN pay $100 (in Ether) to policyholder.” A public database that monitors flight times is linked to the smart contract. If the database shows that the flight lands two hours after it was scheduled, the smart contract is triggered and the $100 payment is issued immediately over the blockchain. No claim has to be filed and no manual processing has to be done by the insurance company or by their bank.
This process can be applied to a wide array of financial agreements to create a highly efficient global economy.
The tokenization of everything
In our insurance example, the paper contract has been “tokenized” on the Ethereum blockchain. The policy holder receives a digital token representing the contract that they store in a digital wallet. Just as a financial agreement can be “tokenized”, so too can property, content, data or anything of value.
Ownership of many real world assets amounts to possessing a paper record. When you buy a car, you’re handed a piece of paper from the dealer representing ownership of the vehicle. When you buy a house, you’re handed a piece of paper called a deed. Crypto-tokens are simply a digital record, representing ownership of an asset, registered on a blockchain - a global database shared across thousands of computers.
Instead of storing the title to your car in your glove compartment and the title to your home in a filing cabinet, they can be stored on a blockchain and accessed through a digital wallet. What this does is bring the records of all of the world’s assets under one roof. When you combine tokenized assets with smart contracts on public blockchain platforms, new and interesting avenues for collaboration become possible.
Marketplaces of the future
In a world of paper based records, exchanging our assets is expensive. When all of our assets become “tokenized”, new kinds of digital marketplaces become possible. Smart contracts and tokenized assets can unlock value all over the world.
What would happen if someone in Mumbai tried to sell 5% of their home to someone in New York? It wouldn’t be possible because the lawyers and brokers needed would make the transaction prohibitively expensive (8 middlemen are involved in the average real estate transaction in the US). Since that sale isn’t cost effective, such a marketplace doesn’t exist.
If that same person in Mumbai tokenized their home, this kind of transaction becomes possible. A smart contract can be written that effectively replaces most of the middlemen currently needed - IF person in New York sends 5 ether, THEN transfer asset tokens. The sale is recorded to the blockchain and value is created in two ways - the New York real estate investor gets access to a new market and the homeowner in Mumbai gets revenue that they can reinvest - all because of this new global platform for value exchange.
The significance here is that smart contracts and tokenized assets allow for value exchange without traditional intermediaries. Barriers that exist in the paper based world are removed, enabling new possibilities. Since blockchain platforms are global, physical borders become insignificant and new avenues for collaboration can be created.
The Internet of Value... under construction
Tokenizing financial agreements and real property simply provide a glimpse into what applications built on blockchain platforms are capable of. With this new technology exists the potential to revolutionize how global commerce is conducted as a whole. Just as we could have never predicted platforms like Uber and AirBnb in the early days of the internet, it’s difficult to truly predict all of the new forms of collaboration that blockchain platforms will enable.
It is however, important to understand that this new internet for value exchange is still under construction. Currently, applications built on Ethereum are difficult for the average person to use and can’t support anywhere near the traffic of the average iPhone application. Additionally, for real world assets to transition from paper based to the blockchain, exchanges for trading these assets have to mature; rules and regulations need to be put in place to bring clarity to these new kinds of marketplaces.
With that said, solutions to scale Ethereum significantly are in place and regulators are quickly working to catch up with this fast paced technology. Competing platforms like EOS, Cardano and Dfinity are all rapidly developing alternative approaches. Ultimately, we’re moving towards a world in which value flows as freely as information, and that’s something to get excited about.