Matt Ridley: Minimising the need for trusted third parties

The price of a Bitcoin has risen tenfold in ten months. Yet whether and when the bubble will burst is beside the point, which is that Bitcoin works. What I mean by this is that Bitcoin has proved that the blockchains technology behind cryptocurrencies is capable of doing what it was claimed it could: create an asset of limited supply and high security, like digital gold.

“Running non-stop for eight years, with almost no financial loss on the chain itself, [Bitcoin] is now in important ways the most reliable and secure financial network in the world,” writes the legal scholar and computer scientist Nick Szabo. This is likely to be a more enduring legacy than any burst bubbles or scandals over the use of cryptocurrencies by drug dealers. Blockchains may change more than money.

Cryptocurrencies are worth north of $300 billion, about half of that being Bitcoin. With 16.7 million Bitcoins in circulation, it is little wonder that there are now Bitcoin billionaires, such as the Winklevoss twins. The biggest such Bitcoin plutocrat is probably its inventor, Satoshi Nakamoto, who is thought to have about a million Bitcoins, worth roughly $10 billion, making him (perhaps briefly) about the 130th richest person in the world. Yet his identity remains a secret, hidden behind a Japanese name, a German IP address, east-coast American hours and British spelling (he also once quoted The Times).

To understand Satoshi’s thinking, it pays to study the writings of Szabo, especially an essay a few months ago called Money, Blockchains, and Social Scalability. As one of the “cypherpunks” who assembled in Santa Cruz in 1992 to discuss how to use computer science to secure property and privacy in cyberspace, Szabo was the inventor of Bit Gold, on which Bitcoin built. Many people think Szabo is Satoshi, since he dropped somewhat out of sight around the time Satoshi popped up, and has a similar writing style. He denies it. (Governments generally prosecute the founders of alternative currencies, usually on dubious pretexts.)

Szabo’s argument is that institutions such as government, markets and money are designed to create “scalability”, to enable us to behave towards numerous strangers with almost as much confidence as we do with a few family and friends. He sees blockchains as an online version of such an institution and argues that human society has not yet evolved to take full advantage of online technology. Uber, Facebook and eBay still have to be actual companies with offices, for example.

Taking his lead from Adam Smith and a remark by Richard Dawkins (“money is a formal token of delayed reciprocal altruism”), Szabo became fascinated by the evolution of money: how humans apparently began around 100,000 years ago to use sea shells as bridewealth, compensation for injury, or inheritance. Later they started using wearable gold, then gold and silver coins, then gold-backed paper IOUs and then fiat currencies as a medium of exchange, a unit of account and a store of value. Szabo dreamed of creating something that was lent value by its scarcity and incorruptibility, but cost nothing to transport: a digital version of gold.

The solution is a network of thousands of computers rewarded for updating a chain of blocks of code, which gradually seal the story of any transaction deeper and deeper inside an increasingly hard-to-crack shell — like a fly in amber, to use Szabo’s analogy. As he writes: “Blockchains don’t guarantee truth; they just preserve truth and lies from later alteration, allowing one to later securely analyse them.”

The goal, says Szabo, is “trust minimisation”. If this sounds paradoxical — surely we want more trust? — then bear with me. Right now you have to trust the Bank of England that a tenner is worth £10, or an accountant that a company is worth what it says, or a lawyer that somebody owns a house she is selling, or a government that somebody is a citizen of the country whose passport they hold. We still rely on human beings, outside cyberspace, to verify what happens within. That should change. Blockchains promise decentralised and trustworthy computing: programs checking up on each other’s work.

Blockchains, writes Szabo, “allow one to seamlessly and securely work across human trust boundaries (eg national borders), in contrast to ‘call-the-cop’ architectures like PayPal and Visa that continually depend on expensive, error-prone and sometimes corruptible bureaucracies to function with a reasonable amount of integrity”. Admittedly, Bitcoin cannot rival PayPal or Visa, because its emphasis on security ensures that it works slowly and uses a lot of electricity. Satoshi made “radical tradeoffs in favour of security and against performance”, as Szabo puts it.

One phrase that Szabo coined early on was “smart contracts”. This has since been taken up by many blockchains start-ups, especially the darling of the market, Ethereum. It is here that the technology shows most long-term promise. As Lord Holmes of Richmond argued in a paper published last week, the British government should be actively studying how to revolutionise its work through distributed-ledger technologies, such as blockchains.

Lord Holmes has tried to breathe new life into the recommendations last year by the government’s chief scientist, Sir Mark Walport, that “distributed-ledger technologies have the potential to help governments to collect taxes, deliver benefits, issue passports, record land registries, assure the supply chain of goods and generally ensure the integrity of government records and services”.

The Holmes report suggests that border control could work more seamlessly using a distributed ledger, shared and updated by the agencies that have an interest in the operation of the border. In the private sector there is a rash of new startups offering blockchains breakthroughs. For example, Cambridge Blockchain promises to tackle the costly and time-consuming know-your-customer regulations that entangle banks and customers in absurd and repetitive questionnaires about who they are.

How many of these ideas prove practical remains to be seen, but some probably will. If you think of blockchains as the decentralisation of the solution to the trust problem in cyberspace, you can see how far this could go. Blockchains may represent a far greater threat to the jobs of middle men — lawyers, accountants, Facebook employees, civil servants — than artificial intelligence does. And a far greater opportunity to go global even than Brexit.

Matt Ridley, a member of the British House of Lords, is an acclaimed author who blogs at www.rationaloptimist.com. This article was first published in early December.