DECEMBER1,2016

ByPhilipEvans
withLionelAr,PatrickForth,NicolasHarl,andMassimoPortincaso

odedbyanunknownhacker,germinatinginthenetherworldofcypherpunks,Bitcoinwasnotdiscoveredbythe
businessmainstreamuntil2015.Justaspunkrockwasrepackagedasnewwave,sowasBitcoindomesticatedinto

blockchain.Itburstontothepopularimaginationandtheconferencecircuit.VisionaryDonTapscoarmed,Ivenever
seenatechnologythatIthoughthadgreaterpotentialforhumanity.CEOspointedlyaskedwhetherthiswasyetanother
disruptivetechnology.Theirsubordinatesweresettoinvestigatehowitmightwork.Andtheyfoundthatitisallrather
complicated.
Hintsofdisillusion.Time,perhaps,forsomestrategicanalysis.
Thetrulydisruptivetechnicaladvancesofthepastdecades,thePCandtheinternet,hadsomethingincommon.They
wastedanewlycheapresourcecomputingpowerandbandwidth,respectivelytodosomethingradicallynew.Digital
tokensandblockchains,twodistinctbutcomplementarytechnologies,wastecheapstoragetogivedatathecontinuityof
realworldassets.Bitcoinisjusttherstapplication.Thetechnologiesarefarfrommature,butifscalabilitylimitationsare
overcome,theywillhavelongtermdisruptivepotentialincomplextransactionnetworkssuchastrade,healthcare,andthe
InternetofThings.Anditisbynomeansobviousthattraditionalintermediarieswillbeabletocontrolthem.
Thisessayoutlineshowtheeconomicsoftransactioncostsandtrustcouldbereshapedbytokensandblockchainsandby
thestackedarchitectureonwhichtheyarebuilt.Theaimisnottoprescribeexactlywhatleadersshoulddo(everybusiness

isunique,andthedevilisinthedetails)buttoprovideastrategiccontexttohelpexecutivesframetherightquestions.For
example:
Whichaspectsofmyorganizationarevulnerabletodisintermediationandhowlikelyisittohappen?
Wherelikely,howdoIneedtorethinkandreshapemyexistingbusinessbeforeothersdoitforme?
WherecanItakeadvantageofblockchainenableddigitalcontinuitytobuildnewoeringsandbusinessmodels?
Whereblockchainbasedsolutionsareadvantageous,shouldIgoitaloneorcollaboratefordecisivescale?
Tobeginatthebeginning...

Inthewinterof2014,Ukrainewasonthebrinkofrevolution.ProtestersinKievheldsignsforthetelevisioncamerasasking
formoney.(Seeimagebelow.)ThesignsboreaQRcodethatalloweddonorstosendbitcointotheprotestmovement.
Thousandsaroundtheworldpointedtheircellphonecamerasattheonscreenvideoandmadedonationswithliterally
threeclicks.Thetransactionswerecommunicatedin20secondsandconrmedwithintenminutesatacostofafractionofa
centperdollar.Theywereanonymous:thegovernmentcouldnotmonitorthem,andtherecipientsdidnotknowwhomto
thank.

Adonorcouldhavemadethesamegiftthroughthebankingsystem,butthatwouldhaverequireddetailed(andpolitically
compromising)informationabouttherecipientsbankaccount,ifheorshehadone.Itwouldhavecostacommissionof
10%ormore,andtakenthreeorfourdaystocomplete.PayPal,ofcourse,wouldhavebeenquickerandcheaperbutwas
bannedbytheUkrainiangovernment.Payingwithbitcoinwasdirect,anonymous,andirrevocablelikeasympathetic
onlookercrossingMaidanNezalezhnosti,thecentralsquareinKiev,anddroppingacoupleofhryvniaintoaplasticcup.
Thatisnotjustagureofspeech.Abitcoinisadigitalbearerinstrument:ownershipandcontrolarethesamething. 1There
isnoneedforaBitcoinaccount:yousimplyholdbitcoins,justlikethecoinsinyourpocket.Likenotesandcoins,theycan
belostorstolen,andtransactionsareirrevocable.Asamediumofexchange,Bitcoincanbetentimesmoreecientthan
traditionalpaymentmethods,butwhenthecostoftransactinginandoutofat(governmentminted)currencyisincluded,
itisnotobviousthatitischeaper.Itoersanonymity:anoblerfeatureinthecauseofdemocraticrevolutionthanofmoney
launderingortaxevasion.
Somelibertariansseebitcoinsasdigitalgold:theincorruptibleglobalcurrencythatwillultimatelyreplacetheat
currenciesmanufacturedanddebasedatwhimbycentralandcommercialbankers.ButasJPMorganChaseCEO,Jamie
Dimon,hasvigorouslypointedout,ifBitcoincameanywhereneartosupplantingconventionalcurrencies,centralbankers
wouldalmostcertainlyintervenetostopit. 2SoBitcoinasacurrencyisdestinedtollasmallnicheinthepaymentssystem,
abrilliantbuthighlycircumscribedinvention.
Fromastrategicpointofview,Bitcoinsimportanceislessasacurrency
andmoreastheearlymanifestationofitstwounderlyingtechnologies:
token(inthiscase,bitcoin)andblockchain.Atokenneednotbeadigital

DIGITALTOKENSAND
coin;itcanbeanykindofdigitalassetoranydigitalrepresentationofa
BLOCKCHAINS,TWODISTINCTBUT
physicalasset. 3Andablockchain(includingtheBitcoinblockchain)can
COMPLEMENTARYTECHNOLOGIES,
serveasashared,secure,irrevocable,andtrustedledgerforanykindof
WASTECHEAPSTORAGETOGIVE
DATATHECONTINUITYOFREAL
transaction.Soalthoughthemajorityofapplicationsrunningtodayarein
WORLDASSETS.BITCOINISJUSTTHE
payments,theintriguingquestionisnotspecictocurrency,oreven
FIRSTAPPLICATION.
banking;itiswhetherthetwounderlyingBitcointechnologiestoken
andblockchaincanserveasfoundationsforotherapplications.

HOWBITCOINWORKS
ThephenomenonweknowasBitcoindependsontwocomplementary
technologiesdigitaltokensandblockchainthattogetherfacilitatedigitalidentity,
ownership,contracts,andtrust.

Thepossibilitiesextendfarbeyondnancialservices,tosupplychaindocumentation,landregistries,healthrecords,
microtransactions,andsmartcontractsamongbillionsofintelligentdevicesworldwide.
Venturefundsandtechnologycompanieshavecommiedover$1billiontousingthesetechnologiestodisruptwhole
industriesormaybetosellingthemselvesandtheirservicestoincumbentstoforestallsuchdisruptions.
Sowhatprinciplesofeconomicsandstrategywillgovernthisbravenewworld?

Blockchainanddigitaltokensdeliberatelywastestorage,whichischeap,tocreatesomethingnewthatisvaluable.Thisis
actuallythethirdchapterinanoldstory.Overthepast50years,theinformationrevolutionhasbeenpropelledby
exponentialadvancesinthecost,speed,andcapacityofthreefunctions:computing,communication,
andmemory/storage. 4Organizationshaveexploitedthesebigexponentialsintwoways.Incumbentscomputemore,
communicatemore,andstoremoredatatoruntheirbusinessesmoreeciently,tocreatebeerandcheaperproducts,and
toenableextensionstotheircurrentbusinessmodels.Butatsomepoint,aresourcebecomessocheapandabundantthat
wastingittocreatesomethingcompletelydierentmakeseconomicsense.
PCswerelessecientthanmainframes,buttheygaveendusersgreatercontrol.PCsdisruptedthemainframeindustry.
Theinternetwasvastlylessecientthanhierarchicallyswitchedtelecommunicationsarchitecture,butitoeredrobustness
andshiftedthelocusofinnovationtotheperiphery.Theinternetdisruptedeverything.
Memoryandstoragearenowfollowingthatsamepaern.Withcostperterabyteinfreefall,therstresponseisto
accumulatemoredatahence,bigdata.Butwhatcanyoucreateifyouwastestorage?Bitcoin,foronething.TheBitcoin
blockchainprovidesaninviolablerecordofeachbitcoinshistoryatthecostofstoringeachtransactionrecord5,700times
over.

Thusblockchainisthedisruptivetechnologyforstorage,asthePCwasforcomputationandtheinternetfor
communication.Itisthelastresponsetothetransformativepowerofthebigexponentials. 5
Butwhatexactlyisachievedbywastingstorage?

Digitaltokenssuchasbitcoinwastestorageinmassivelyduplicativeblockchainstocreatevirtualcontinuity.Thisisthe
fundamentalbreakthrough.Continuityoutsidethedomainofquantumphysicsisauniversalpropertyofthephysical
world.IfIpassanobjectbehindmyback,youcanbereasonablysurethatwhatreappearsinmylefthandiswhat
disappearedfrommyright.Continuitypermitsidentityofboththingsandpeople;itpermitspropertybecausea
continuouslyidentiedthingcanbeownedbyacontinuouslyidentiableperson.Itthereforepermitstransactions
transfersofproperty.Itpermitstrust. 6Microeconomicsispredicatedoncontracts,whichinturnarepredicatedonidentity,
property,transactions,andoftentrust.Sothewholepanoplyofthecapitalistsystemispredicatedoncontinuity.
Continuityisnotsucientforpropertyandcontracts(youalsoneedlaw),butitisnecessary.Thispointissoobviousthat
noeconomicstextbookevenmentionsit.Signatures,passports,notaries,seals,chops,photoIDs,andsoforthallscaleand
extendcontinuityintherealworld.
Butinthevirtualworld,thereisnocontinuity.Thereisnoguaranteeindeed,generallynomeaninginsayingthata
stringofdataisanoriginalasopposedtoacopy.Neitheranobjectnorapersonhasidentity.Theoldjoke:ontheinternet
nobodyknowsyoureadog.Inmanycontexts,ofcourse,thatisadesirablefeature.Itlowersthecostofbroadcastingand
relayinginformationtonearzero.Butabsentcontinuity,thereisnopeertopeerbasisforidentity,ownership,transactions,
trust,orcontracts.
Wherethepartieshaveapriorrealworldrelationship,theycanestablish
avirtualequivalentdirectlythroughencryption.Butotherwise,theworld

THETECHNOLOGIESOFTOKENAND addressesthelackofvirtualcontinuitythroughintermediaries.Ihavea
realworldrelationshipwithmybank,forexample,youhavearealworld
BLOCKCHAINENDOWDATAWITH
relationshipwithyours,andthebankshaverealworldrelationshipswith

CONTINUITY:THEYMAKETHE
VIRTUALREAL.

oneanother.Collectively,intermediaries(ofwhichbanksarejustone
type)guaranteeourrespectivevirtualidentitiesandmediateour
transactions.
Therearetwoproblems.Whenthereisjustoneintermediary,itwillbea
monopolist,whichifprotmaximizingwillunderinvest,overprice,
andappropriatemostofthevalue.Butifinsteadthemarketis
competitive,theintermediariesthemselvesrequireintermediation.Inthe

multilayeredsystemofinternationalremiances,amoneytransfertoKievgeneratesmultipletransactions,delays,
duplicatedeort,anderrors.
Bitcoindemonstratestherevolutionarypotentialoftokensand
blockchains.Asexplainedinthesidebar,itestablishescontinuitybetween
twosequentialtransactions,sayXandY.Althoughitisjustastringof
numbers,thestructureofthebitcointhetokenguaranteesitsancestry:
thecoinintheearliertransactionXistheonlyparentoftransactionY.
Theauthenticityofthecoincanthereforebeprovedbytracingitbacktoits
originalmining.
Andtheblockchainguaranteesinheritance:thecoininthelater
transactionYistheonlychildoftransactionX.Thecoincannotbespent
twice.SothetwoaspectsofBitcointechnologytogetherwastestoragein

ordertocreatevirtualcontinuity.Virtualcontinuityenablesdigital
identity,ownership,transactions,andtrustandcontractsandmarkets
amongpartieswithnopriorrelationshipandwithoutintermediaries.

SEVENPOSSIBLEKILLERAPPSFORBLOCKCHAINANDDIGITAL
TOKENS
Beyondpaymentsandsecuritiesclearing,therearesevenotherpotentialkiller
appsforblockchaintechnology.Theyvariouslyexploitlowtransactioncosts,
eliminationofduplicatedrecordkeeping,theneutralityofashareddatabase,and
thesuperiorsecurityofadistributedledger.

Thetechnologyispotentiallydisruptivetoallvirtualintermediaries.Its
disruptivenessisproportionaltothecost,complexity,anddegreeoftransactionduplicationinthecurrentsystemof
intermediation.
Virtualcontinuityleadstoonenalsymmetry.RecenttechnologywavesnotablytheInternetofThings,theproliferation
ofsmartmobiledevices,andaugmentedrealitydirectlyendowphysicalobjectswithinformationandintelligence:they
maketherealvirtual.Thetechnologiesoftokenandblockchain,conversely,endowdatawithcontinuity:theymakethevirtual
real.Whentherealandthevirtualconverge,itisasifourworldandourmapoftheworldbecomethesamething. 7

Bitcoinhasastackedarchitecturethatservesasthemodelandtemplateforallothertokensandblockchains.Astackisaset
ofinteroperablemodulesarrangedinahierarchy.Upperlevelfunctionsdependonlowerlevelfunctions,butnotthe
reverse.Generalpurposefunctionsneedingscaleandreliabilityresideattheboomofthestack(theinfrastructure),while
functionsbenetingmorefromcustomization,experimentation,andinnovationoccupytheupperlayers. 8Interoperability
amongthelayerspermitsthesystemtobebothecient(attheboom)andadaptive(atthetop).Theinternethasastacked
architecture.
WithBitcoin,theeconomicsofeachlayerareradicallydierent:

BLOCKCHAIN
AttheboomofthestackistheBitcoinblockchain:adatabaseofalltransactions,groupedintoblocksandreplicated
acrossthousandsofnodes.Itismonolithicandscalesensitive(thereisonlyone),anditbecomesmorereliableandrobust
asthenumberofnodes(currently5,700)andthenumberofblocks(currently430,000)continuetogrow.Physically,these
nodesareracksofdedicatedcomputingdevices,operatedindatacentersownedbysocalledminingpoolsand
concentratedmainlyinChina.Miningisaforprot,commoditybusiness.

PROTOCOL
TheBitcoinprotocolitsoperatingsystemsitsontopoftheblockchain.Thisisfree,opensourcesoftware,maintained
bytheBitcoinCoreteam.LikeLinux,ithasthestrengthsoftheopensourcebusinessmodel:rigorouscodetestingbyall
comers,rapidimprovementcycles,andtrustinthecollectiveproductbecausenobodyownsit.Italsohasthemodels
weakness:thedicultyofmakingstrategicchoicesbyconsensus.

TOKENS

Bitcoinsthemselvesarethenextlayer.Theyaretokensthatareexchangedwithinthesystemandmintedbyminersasa
rewardforvalidatingtransactions.Likeanymediumofexchange,thetokenshavevalueonlybecausepeoplethinkthat
otherpeoplethinktheyhavevalue.Therstknownbitcoinpurchaseoccurredin2010,whenHackerLaszloHanyecz
boughtacoupleofPapaJohnspizzaswith10,000freshlyminedbitcoins.Todaythosebitcoinsareworthmorethan$6
million.

APPLICATIONSANDSERVICES
Applicationsandservicesmakeupthetoplayerandconsistofwallets(softwaretoholdandmanagebitcoinsona
smartphoneorcomputer);exchangesthatconvertbitcoinstoandfromatcurrency;andinformationservices.Thereare
hundredsofsuchproductsandservices,chieydevelopedbystartupcompanies.

SOURCE:BCGANALYSIS

Blockchainsanddigitaltokensaretwokeyelementsofafourlayeredtechnicalarchitecture.

Theboomofthestack,theBitcoinblockchain,isextraordinarilysecure.Thetotalvalueofallbitcoinsome$10billionis
asucientlyrichhoneypottohavetemptedthebesthackersintheworld,yettheblockchainhasneverbeensuccessfully

aacked.Thetopofthestackisanotherstory,withclaimsofincompetenceandcriminalitycirculatingaroundsuchwell
knownfailuresasMtGoxandSilkRoad.Butthebeautyofstackedarchitectureisthatthemoralandeconomicfrailtyatthe
topdoesnotcompromisetherevolutionaryrobustnessattheboom.
Asshown,thisstackedarchitecturedenestherecombinatorialframeworkwithinwhichnewcurrencies,newservices,and
entirelynewconceptshavebeendeveloped:

COLOREDCOINS
Coloredcoinsaretopofstackinnovationsthatexploitablankeldwithineachbitcointorecordunrelateddata.TheUK
basedcompanyEverledger,forinstance,initiallyleveragedbitcoinstoputblingontheblockchainbyrecordingsome40
unique,laserreadidentiersofadiamond,providingproofofprovenanceandownership.Thebitcoinwasnotusedtobuy
thediamond,justtocreateaninviolablerecordofthetransferofaspecicauthenticatedstone.Thesameapproachcouldbe
usedtotrackanyvaluableassetwithacomplextransactionhistory. 9

ALTCOIN
AltcoinsborrowmostoralloftheBitcoinprotocoltocreateaseparatetokenwithitsownstack.Manyareexoticallynamed
jokesorPonzischemes:BaconBitsCoin(symbol:YUM),Kimdotcoin(KOIN),andZombiecoin(ZMB),amongothers.
However,somearemoreambitioustweaksontheBitcoinprotocol.Litecoin,forexample,isdesignedtoproduceblocksata
fasterrateandwithlesscomputationthanBitcoin,andMoneropoolstransactionstopreventevenpseudonymoustracingof
payments.

ETHEREUM

Ethereumisanentirelynewstack,whichonlyayearafteritslaunch,inJuly2015,hadamarketvalueofnearly$1billion.
ManycallitBitcoin2.0.Ethereumhasitsownblockchainandtoken(ether),andaprotocolthatsupportsnotjustpayments
butprogrammabletransactions:smartcontractsthatareexecutedincode,notlaw. 10Itscreator,VitalikButerin,describes
Ethereumastheworldcomputer.Ethereumhasnurturedarapidlygrowingecosystemofapplications,with(perhaps
predictably)mixedresults.Notably,TheDAO(aDAOisadecentralizedautonomousorganization)wasanaempttobuild
aventurefundingcompanyfromEthereumsmartcontractsalone.InJune2016,afterraisinganunprecedented(and
unanticipated)$130millioninether,itwasdefraudedandcollapsed.ButthevulnerabilitywasintheDAOprogramming.
OpensourcedevelopersbuildingapplicationsbeyondpaymentscontinuetofocusonEthereumastheirpreferredplatform.

PERMISSIONEDBLOCKCHAINS
PermissionedblockchainsdeviatesubstantiallyfromtheopenBitcoinparadigm,restrictingcertainrolesoraccesstoaclub
ofparticipants,typicallynancialinstitutions.Onlymembersarevariouslyallowedtoinspecttheblockchain,engagein
transactions,andoperateasaprocessingnode.Permissionedblockchainsallowtransactionstobewrieninlegallanguage
aswellasincomputercode;theyalsoenableregulatoryreview.Todaytheyareonlyattheproofofconceptstage,but
consortiasuchasR3CEVinbankingandmanynancialtechnologycompaniesarefocusedonmakingpermissioned
blockchainsareality,especiallyforclearingandselingtransactionsinsecuritiesandforeignexchange.

Distributedledgersareoftendescribedasatrustlesssystems,butthatisnotquiteright.Moreprecisely,theirlocusof
trustmovestotheperiphery.
WhenEverledgercertiesadiamond,youknowwithblockchainlevelcertaintythatsomeonepossessingEverledgers
privatekeypostedcertaindataonacertaindate.ButyoustillhavetotrustEverledger.Everledgerthereforereliesona
globalnetworkofindustryrespectedcerticationhousestoauthenticatethediamond. 11Everledgerinscribesitscertication
intotheblockchain,alongwithassociateddatapointsandhighresphotography,tocreateadigitalrecordofprovenancefor
thestone.UnderanEthereumsmartcontractforcropinsurance,allpartiesstillneedtotrusttheoraclethatpostsweather
datatotheblockchain.Withtheexceptionoftokensthatrepresentassetscreatedwithinthechainitself(thatis,digital
coins),tokensareonlyastrustworthyasthepartythatoriginallypostedtherealworlddatathattheyrepresent.
ThisleadstowhatwemighttermaCoaseantheoryofblockchains.RonaldCoasefamouslypositedthatcorporationsexist
toeconomizeonthetransactioncostsofmarkets.Butwhensomedegreeofscaleisreached,organizationalcomplexity
overwhelms.Theoptimalsizeofthecompany,accordingtoCoase,isthereforethepointatwhichtheincrementalbenet
fromtransactioncostsavingsisosetbytheincrementalcostofcomplexity.

SOURCE:BCGANALYSIS

Theoptimalsizeofthefirmisdeterminedbythetradeoffbetweentransactioncosts,whichdecreasewithscale,andorganizingcost,
whichincreases.

Blockchainssimilarlyexisttoeconomizeontransactioncosts:theyprotectacommondatabasefromfailureoraack;they
eliminateduplicaterecordkeepingandassociateddelaysanderrors;andtheyconveytrusttransitivelyacrossthenetwork.

Butthelargerormorecomprehensivetheblockchain,thelesstrustworthyisthedataenteredbytheleasttrustworthy
member.Thus,theoptimalsizeofablockchainisdeterminedbythetradeobetweentransactioncosts,whichimprove
withscale,andperipheraltrust,whichdeteriorates.

SOURCE:BCGANALYSIS

Theoptimalsizeofablockchainisdeterminedbythetradeoffbetweentransactioncosts,whichimprovewithscale,andperipheral
trust,whichdeteriorates.

Thisisnotmeretheory.Oneofthemostscrutinizedusesofablockchainisfortheclearingandselementofsecurities
transactions,currentlyacomplexnetworkofbrokers,custodianbanks,stocktransferagents,regulators,anddepositories.A
singletransfercanrequireadozenintermediarytransactions,andtypicallytakesthreedays.Some20%generateerrors,
whichmustbecorrectedbyhand.
Withablockchain,twotradingpartiescouldreadandwritetoacommon,trusted,anderrorfreedatabase.Thetransaction
couldbewrieninlegallanguageaswellasincomputercode,sothatthedataexchangeitselfistheselement.Andit
couldbevisibletoregulatorsbutnottootherinstitutions.ThisistheconceptbehindCorda,apermissionedblockchain
protocolunderdevelopmentbytheR3CEVconsortium.Itwouldeliminatebilateralerrorsandperhapsbecheaperthan
modernizingexistingselementplatformsthefocusisoneciency,notdisruption.
Butwhystopthere?Thebrokers(asagentsofthebuyerandseller)couldtradeonalargerblockchaintodisintermediatethe
custodians,therebyfurtherreducingtotaltransactioncosts.Institutionsissuingsecurities,suchascorporationsand
municipalities,couldissuethemdirectlyontotheblockchain,therebydisintermediatingtheirstocktransferagents.

Whatlimitsthesemoreambitioussolutionsisperipheraltrust.Some50regulatedglobalbanksmighthavesucientreason
totrustoneanothershonestyandcompetence.Butforhundredsofbrokersandthousandsofissuinginstitutions,trust
wouldbemuch,muchhardertoachieve.Hencethetradeobetweentransactioncostsandperipheraltrust.

Onecanimagineapermissionedsecuritiesblockchainstartingsmallbutevolvingtoprogressivelylargerscaleandlower
costs,asmethodsaredevelopedtoqualifythetrustworthinessofadditionalparticipants.Butthereisaradical,if
speculative,alternative:signicantfunctionscurrentlyperformedbysecuritiescouldbeperformedbynew,
deconstructedsmartcontractsthataredenominatedintokensnativetosomeblockchain.
Forthosecontracts,peripheraltrustwouldbealesserconstraint,perhapsirrelevant.Suchablockchainwoulddisruptthe
cluboftrustingintermediaries,directlyconnectingtheprincipalswhocreate,buy,andsellthecontracts.Securitiestrades
wouldthenbeasfast,cheap,andsecureasBitcoinpayments.Andabigpieceofthenancialservicesindustrywould
disappear.

Withinmosttransactionnetworks,thelargeracommonblockchain,thelowerthetransactioncostsbutthelesstrustedthe
partiesatitsperiphery.Theseandotherscaleeconomicsareconstrainedbyamorenarrowlytechnicalsetofissues:the
blockchainsscalability.
Scaleeconomicsinvolvemorethanjustbalancingsizeandtrust.Therearefourothermechanisms:
Thelargerthenumberofnodesandthegreatertheheightoftheblockchain,themoresecurearetherecorded
transactions.Thisgivesestablishedblockchains(notablythoseforBitcoinandEthereum)anadvantageoversmaller
andneweralternativesnotjustinpaymentsbutinanyapplicationthatcanbebuiltontheseblockchains.
Thelargerthedollarvolumeofdigitalcoinsincirculation,themoreliquidthecurrencyand,probably,themorestable
itsexchangerate.Thisagainfavorsestablishedcoins(suchasbitcoinandether)overstartups.Butmoreimportant,ifa
digitalcoinweretoreachcriticalmass,itwouldbecomeacceptableasamediumofexchangeandastoreofvalueinthe
economyatlarge,andabigpieceofitsassociatedtransactioncoststhecostoftradingintoandthenoutofthecoin
woulddisappear.
Asinglecompellingkillerappcanpullthroughanentireecosystemofassociatedinnovationsandcreateanetwork
eectatboththetopandboomofthestack.However,oneofthestrikingfeaturesoftheblockchainlandscapeisthat
nokillerapphasyetemerged.Bitcoin,thecurrency,appearstobeenteringtheaerpartofitsScurve(daily
transactionvolumehasgrownbyonlyathirdinthepast12months),andTheDAO,whichmanythoughtwasthekiller
appforEthereum,hascollapsed.

Thelargertheblockchainandthemoreheterogeneousitsparticipants,themorepoliticallycomplexisthechallengeof
seingstrategy.Inpermissionedchains,consortiummanagementamongmembersthatotherwisecompetewithone
anotherbecomescritical.(Banks,inparticular,haveacheckeredhistoryofmanagingindustrycollaborations.)In
permissionlesschains,thechallengeistoformulateandexecuteatechnologyroadmapinthefaceoftheconicting
prioritiesofopensourcecoders,miners,andcommercialdevelopers.Withdigitalcurrencies,conictsescalateasthe
dollarvalueofthecoinsownedbysomeofthesepartiessteadilygrows.Andopenentryimpliesopenexit:absent
proprietaryintellectualproperty,dissatisedcodersconvincedthattheyknowbeercanforkthecodeandstealthe
growthaswellasthelimelight.

Besidesissuesofbusinessscale,therearehugechallengesintechnicalscalability.
Currently,Bitcoincanhandle3to5transactionspersecondand
Ethereum15to25.ButtheinterbankVisasystemhandles2,500.Soif

IFBLOCKCHAINSHAVEASERIOUS
FUTURE,THEYMUSTOVERCOME
CURRENTSCALABILITY
ROADBLOCKS.

blockchainshaveaseriousfuture,theymustovercomecurrentscalability
roadblocks.Bitcoinscapacitylimitisdictatedbythexedrateatwhich
blocksarecreatedandthemaximumblocksize.Fasterblockcreation,itis
feared,woulddestabilizevalidation,sincearoguechaincouldpropagate

fasterthantheconsensusmechanismchasingitacrossthenetworkcould
disownit.Andlargerblocksizewouldintensifyeconomiesofscalein
mining,drivingconsolidationandmakingthevalidationsystemmore
vulnerabletocollusion.(Already,58%ofthehashpowerisheldbyfour
Chineseminingpools. 12)
Moreover,thedeliberateinecienciesofBitcoinandEthereumwilleventuallyimposepracticallimits.Nodescancreatea
blockonlybysolvingaveryarduousandarbitrarycomputationcalledproofofwork(foreachblock,10,000terahashes).
Thisineciencysecuresthenetworkbymassivelyescalatingthecostofrewritingtheblockchain.Butbitcoinmining
alreadyconsumesasmuchelectricityasaUScityof280,000,andbyoneestimate,asmuchasDenmarkwillconsume
by2020. 13Thecostandcarbondioxideburdenwillbecomeeconomicallyandenvironmentallyunsustainableasvolumes
growbyordersofmagnitude.

Thebroadcomponentsofascalabilitysolutionarewidelyrecognizedbuthavenotasyetbeenimplemented:

PROOFOFSTAKE
Underthisprotocol,astringofblocksisdeemedvalidonlyifthenodescreatingitdemonstratesucientownershipofthe
assetrepresentedbythetokentogivethemacompellingmotivenottosubvertitsvalue.Proofofstakewouldradically
reducecomputingandtransactioncosts,enablingblockchainstofacilitatemuchsmallertransactions.

CHANNELS
Channelsareanotherlayerinthestack.Asubgroupofpartiestransactsdirectlybutcommitsonlyasmallfractionof
transactiondatatothemainblockchain.Channelscanthusproliferatewithoutburdeningthemainblockchainandwhile
stillenjoyingsomeofitssecurity.Therearemanyvariantsonthisidea,suchastheproposedLightningNetworkforBitcoin.

SIDECHAINS
Closelyrelatedtochannels,sidechainsareblockchainsintheirownright.Theycreateanddestroytheirinternaltokenasa
mirrorofatransactionthatimmobilizesanequivalentonthemainchain.Thiseectivelyallowsuserstomovetokensfrom
themainchaintosidechainsandbackagain.Thesidechaincanoperateonanyprinciplewhatsoever:lowersecurityfor
minusculetransactions,fastblockcreation,smartcontracts.Itcanevenbeaclosed,permissionedchain.

SHARDING
Thisisanapproachthatpreservesasingleglobalblockchain,butnotallnodesvalidatealltransactions.Itsacricesa
measureofsecurityforthebenetsofscalability.
Thesedevelopmentsareatthecuingedgeofblockchainresearchandexperimentation.TheBitcoinCoreleadershipis
movingcautiouslyinthesedirections,asbetsablockchainadvantagedforitssecurity.TheEthereumdeveloper
communityismovingmuchfaster:the2017Release2.0,codenamedSerenity,willbeexplicitlybuiltonallfourdesign
principles.
Butstartupswithnolegacytoprotectaretryingtobeatestablishedblockchainstothepunchwiththerightcombinationof
theseprinciples.TheymaybuildonexistingBitcoinorEthereumcodeandcurrency,ortheycouldstartafresh.Thepieces
arelargelyknown,buttheworldisstillwaitingforthekillercombination,thekillerapp.

Therearevebroadprinciplesthatwillshapestrategyfortokenandblockchaintechnologies.
BLOCKCHAINSTRATEGYISMOREABOUTCOLLABORATINGTHANCOMPETING.Itmakessensetoexpend

resourcesondigitaltokensandblockchainsonlywhenmultipleentitiesaretransactingathighcostandwithimperfect
trust.Therefore,theimplementationopportunitypresentsitselftotheentiretransactionnetwork,nottoanindividual
participant.Globalenterprisetechnologycompaniesareinvestingtobuildalliancesamongtheircustomersthatcould
underpintransactionplatformsinfragmentedindustriessuchashealthcareandinternationaltrade.HundredsofSilicon
Valleystartupsarefocusedonthesamegoal,oratleastonadvancingfarenoughtogetthemselvesacquired.Thesewillbe
decadelongprojects.Participantsinthosefragmentedindustriesneedtodecidewhetherthegainsingrowthandeciency
areworththeriskofbeingatleastpartiallycommoditizedbyanew,dominanttransactionplatformand,ifnot,whether
theycanactinconcert(asbanksareaemptingtodo)inordertoprotecttheirautonomy.
ORGANIZATIONASMUCHASTECHNOLOGYWILLDETERMINETHERELATIVEADVANTAGEOF

BLOCKCHAINSAcentralconictoverthenextfewyearswillbebetweenpermissionedblockchainscuratedbycoalitions
ofintermediariesandthefarmoreradicalprogramtogiveendusersdirectaccessthroughopenprotocols.Oligopolyversus
democracy,assomewouldhaveit.Inmanyintermediaryindustriessuchasnancialservices,incumbentsarerationally
respondingbyadoptingthetechnologyamongthemselves.Butitisabigandopenquestionwhetherthatwillultimately
suce.Openblockchainsenjoyanadvantageinscale:theyhavemoreblocks,morenodes,andmorerigorousvalidation.By
design,theycanaddparticipantslessconstrainedbydiminishingperipheraltrust.Butpermissionedblockchainshavean
advantageinscalabilityrelativetotheirtargettransactionnetwork.Theyneedfewerparticipantsandcandispensewith
nonscalablefeaturessuchasproofofwork.Sowhetherandwhenthestatusquoisdisruptedandbyhowmuchdepends
lessontheabsolutepaceoftechnicaladvancethanontherelativepaceatwhichprivateandpublicimplementations

advance.Andthatislargelyacontestofpoliticalorganization.Industryconsortianeedtoworktogetherwhentheir
membersareotherwisecompeting.Andopencommunitiesneedtosticktoasinglescriptwhenindividualshavediverse
ideologicalcommitmentsandaretemptedtoforkthecodebase.Thestrategistneedstounderstandboth,intimately,andbe
clearheadedaboutwhichcampholdsthewinninghand.

GOVERNMENTISAWILDCARD.Thecurrentregulatoryclimateissurprisinglyfavorable.Bitcoinislegalinmost

jurisdictions,regulatedasacommoditybutnotasanancialinstrument.Theprimaryfocusofregulationisthetopofthe
stack(exchanges,inparticular)ratherthantheboom(blockchains).Indeed,blockchainsfacilitateregulatorygoals:they
reducecounterpartyrisk,cancomplywithknowyourcustomerandantimoneylaunderingrules,andcanprovidean
ecientbackdooraccesstotransactions.Butofcoursetheregulatoryclimatecouldchangequitesuddenly,especiallyin
thefaceofsecurityvulnerabilities.Ontopofthat,governmentsthemselvescoulddrivetransformativeblockchain

applicationsinidentity,healthcare,anddigitalcurrency.Theyhavetheincentiveandthecriticalmass.Manypolicymakers
seethiskindoftechnologyasthecatalystforbroadereconomicstimulus,jobcreation,andnationalcompetitiveadvantage.
Somecountriesaremorelikelytothinkthatwaythanothers.
FINANCIALSIGNALSAREPROBLEMATIC.TherearealreadymurmursinsomeboardroomsthattheROIonthese

technologiesisnotthatimpressive.Highfalutinrhetoricaboutembracingdigitaldisruptionnotwithstanding,incumbents
havelileincentivetocollaborateandinvesttocreatealevelplayingeldthatmerelylowersindustryprices.Executives
havetobelieveeitherthatsuchinnovationwillopennewmarketsorthatitisanecessaryresponsetoarealdisruptive
threat.Otherwise,itiseasytoimaginethemajorityquietlyshelvingthetechnologyandthegrandindustrycoalitionsfalling
apart.AfewvisionaryCEOswillignoretheirbeancounters.Ifthedisrupterslatersucceed,thosevisionarieswillbecome
theheroesofbusinessschoolcasestudiesandifnot,thefools.
RADICALUNCERTAINTYISTHENORM.Itonlytakesonereallycompellingandbroadbasedapplication,onekiller

app,todrivewidespreadadoptionandpullthroughcomplementaryinfrastructure,products,andservices.Allweknowis
thatitsnotbitcoin,thecurrency.
Conversely,somehackercouldndanirreparablesecurityaw:notenoughtodeterenthusiasts,perhaps,butsucientto
spooktheregulators.Orscalabilitycouldproveaninsuperableproblem.
Oramiddlescenario:afewdisparateapplicationsmightenjoymodestsuccesswithoutconvergingintoatidalwave
comparabletothePCortheinternet.Transformationalideascoulddieonthevineforlackofselffulllingmomentum.
SiliconValleycouldhaveanotherbustorjustmoveontothenextnewthing.
Thetruthisthatnobodyknows.

Aswithanyearlystagetechnologysubjecttonetworkeectsandstronglyincreasingreturns,thebusinessequilibriumis
radicallyunstable.Strategycannotbebasedonapointestimateofwhatthefuturewilllooklike,whetherderivedfrom
nancialprojectionsoragrandvision.Instead,strategyunderconditionsofuncertaintymustfocusonacuity,options,and
experimentation.
ACUITY.Yourorganizationneedstoknowitsenvironmentintimately:thetechnology,competitivemoves,alliancepolitics,

crazystartups,andshiftsinpublicpolicy.Lookoutfordiscontinuities.Someopenblockchainprotocolcouldeclipsethe
closedeortsofanindustryconsortium;somegovernmentsponsoredinitiativeontheothersideoftheworldcould
catalyzeakillerapp.Somebreakthroughinencryptionordecryptioncouldtransformsecurityorscalability.Some
developmentinanotherindustrycouldwashoveryours,thewaywholeindustriesbecamemereappsonthePCorthe
internet.Acuitycannotbedelegated,becausethecorrectframingofthethreatsandprioritiesisnotyetapparent.Senior
managersneedtobepartofaprocessofcontinuouslearning.

OPTIONS.Instrategyasinnance,thegreatertheuncertaintythegreaterthevalueofhavingoptions.Optionsarean

investmentwhethertheypanoutornot;itisfalseeconomytoskimpordelayuntiltheoutcomeisevident.Soattheriskof
redundancy,andevenofsupportingcontradictoryorcompetitiveinitiatives,investbroadly.Buyintoaportfolioof
alternativetechnologies.Joinindustryalliancesandconsortia:membershipwillgiveyourorganizationearlyparticipation
inwhateversucceeds,thechancetolearn,andanopportunitytoshapethegroupsprioritiesfromtheearlieststages.
EXPERIMENTATION.Applyagileprinciplestothedevelopmentofsmallscaletokenandblockchainapplications.

Experimentsmaerbecausetheycanpointtoastrategyandalsobecausetheverypracticebuildsoperationalcapability
andcondence.MITsDavidClarkfamouslyarticulatedthemantraoftheearlyinternetcommunityasroughconsensus
andrunningcode. 14

Sostayclosetothecoders,theentrepreneurs,andthepolicymakers.Keepyouroptionsopen.Experiment.Thesearethe
watchwordsforthinkingoutsidetheblocks.Andtheyarebeerguidestostrategythantheairyenthusiasmofevangelists
orthemyopiaofbeancounters.