A digital dilemma? The value of the blockchain system

The reaction I receive when I mention that I work in the field of cryptocurrencies or blockchain is often the same: "Why do we need something like this at all?", "It's all a scam!" or "Why should something digital have any value?". In many cases, the topic is quickly dismissed. Unfortunately, I seldom had the pleasure of someone outside this field asking me about my motivations or why I'm so excited for this technology. Therefore, I wanted to write down my thoughts and try to answer this question for myself.

The fundamental issue in this context is: Why can something digital have value at all? Entire dissertations could be written on the word "value," what it means, and the implications it carries. Two important points worth mentioning are firstly, that value is highly individual and secondly that it is a mass illusion. Why does the money in our wallets have value? In principle, it is mainly made of cotton, but we humans assign value to this piece of cotton. A critical mass of people believes that it has value, and thus, it does. Money is what works as money, and the same goes for "digital assets." There is a critical mass of people who believe in the value of these assets. But why? For the first time, we can trace a good to a specific quantity and establish general rules for the extent to which a particular good may or may not be produced.

To give a few examples: Bitcoin has its value because it is limited to a specific number; more bitcoins are released into the system over time until it reaches a maximum of 21,000,000. It can be transferred quickly and easily worldwide, and it is very secure. It also creates trust because everyone can view the system. No one can say exactly how many euros or dollars are currently in circulation. How much gold is actually in the banks' vaults? How much gold or money is added to the system? The transfer of money is expensive, opaque, and sluggish. We get the impression that our financial system is efficient and entirely digital, but unfortunately, that's often not the case. Transferring money within the same bank is quick and easy: one number is reduced, the other is increased. The further the transfer has to go, the more complicated it becomes, as many different databases need to be reconciled. This process is sensitive because a formatting error or insufficient funds in a clearing account can lead to a reversal.

Therefore, the term "Internet of Money" has been established in the crypto scene, as payments can be processed quickly on various networks, and values can be transferred faster, more reliably, and more efficiently.

Now we could argue that a cryptocurrency is not suitable for payments because prices fluctuate too much. That's why so-called "Stablecoins" have been developed. In essence, an "analog" Euro/Dollar is exchanged for a "digital" Euro/Dollar. Several companies are currently exploring this concept, with the most recent major player being PayPal. The total market capitalization of Stablecoins (as of 20.11.23 - Coingecko) is approximately $128 billion with a daily trading volume of about $40 billion. The numbers speak for themselves: Stablecoins are used and in demand. People use Stablecoins for regular payments, lend them to generate returns, or secure their profits in a safe haven. The more business processes are executed on these networks, the more sense Stablecoins make, as everything can be settled within the same network. For example, payments could be tied to conditions: once the goods arrive at the warehouse, the supplier gets paid.

But what other business processes can run on a blockchain? All ownership rights that are somehow documented, such as stocks, bonds, debentures, deeds, patents, etc. All these securities can either be tokenized, meaning digitally functionalized, or issued as unique digital certificates (NFTs). The same arguments that hold true for Stablecoins can be applied here as well. The more of these processes are handled on the same network, the more efficient they become.

This brings me to my final example of decentralized exchanges (DEX) and the so-called "Automated Market Makers" (AMM). One can envision these exchanges as vending machines where one cryptocurrency can be exchanged for another.

There are at least two different cryptocurrencies or tokens that can be exchanged against each other without involving a third party. Anyone can see how these machines operate. Depending on the ratio of the two trading pairs at this machine, the price of the two trading pairs is determined. With these AMMs, trades can be executed more capital-efficiently, and supply and demand can be matched more quickly. Everything is transparent and traceable.

So why does this technology excite me?

In each of the previously mentioned areas, incredible innovation is happening. With great conviction and will, an effort is being made to create an improved and more transparent financial system. What makes this whole story exciting and interesting is the design mandate: everything should work without intermediaries as much as possible, and no one should be able to change the conditions or the rules of this system easily. A slogan of the blockchain world is: "Don't trust, verify" - you don't need to trust anyone on the blockchain since you can check whether the person you want to trade with really has the asset or money. Everything is open and transparent, so it can be verified which assets the counterparty holds. Instead of having to trust a counterparty or person, we now have to trust the code or technology. Do we rather trust in the traditional financial system or do we want a more transparent solution where one can more easily understand how it works and most importantly, verify it? I personally would prefer the latter. I am well aware that this is far from flawless but I believe it is a better system than we currently have. 

There will never be a flawless system, and there will always be some level of trust involved when making transactions. Trust in other people, trust in the code or a system. Not everyone is able to read and check the code for flaws or errors, so we have to trust that others have done so for us, highlighting and rectifying errors in the process. I also believe that if someone has a significant influence on a system, it will be abused sooner or later. Hacking remains a significant issue in the crypto space. The more people use crypto, the more attractive it becomes for hackers to closely examine individual protocols and exploit vulnerabilities to enrich themselves. Unfortunately, there is no flawless system, and blockchain networks are just as susceptible to errors as any other systems. Nevertheless, from my perspective, the benefits outweigh the drawbacks, and we must strive to continually enhance the security of these systems.

Entirely new designs for money, payment processing, trading systems, etc., are being created. The repeating pattern is the approach that there should be no central authority with significant influence on the system or the rules within the system. For example: There are many different types of Stablecoins; these do not always have to be backed by fiat money but can be secured differently. The idea is to have a stable means of payment. What does stable mean? For example, a Dai Stablecoin always has the value of one dollar. Some projects try to create a Stablecoin that is inflation-resistant, i.e., one that retains its purchasing power. Something like this is not possible with our current monetary system, but in the crypto space, financial systems can be completely rethought. And here lies the magic of this technology for me, in rethinking our current systems.

Through my countless conversations, whether in the professional environment, at meetups, or conferences, I have learned one thing: it is not about the technology per se, but what it makes possible. I have to roll my eyes every time I talk to so-called maximalists (Bitcoin, Ethereum, Solana, etc.). Here, the argument is usually very dogmatic about why only this one technology can be the solution to all our problems. There is a reason why we live in a specialized economy today: everyone can do something better than another. This principle also applies to technologies. The blockchain system is not a remedy for all problems, but in my eyes, it can improve and make our financial system more trustworthy. I am convinced that the design approach of blockchains is the better alternative to the centralized design approaches we currently have. I like the promise of Web3, making everything a bit more democratic and transparent.

To finish off this article, I can only encourage everyone to look at the various design approaches of Stablecoins or DEXs and try to understand the advantages and disadvantages. It is certainly not all that glitters, but its definitely food for thought.