The blockchain, disruption and money

Last week the Economist joined the groups of blockchain enthusiasts, announcing that the blockchain will change everything.  I fully agree with this forecast. However, contrary to what most people think, who will make profits – and if there are profits to be made – is far from obvious.

What is the blockchain

The blockchain is the technology that powers the bitcoin network. Think of a huge spreadsheet with two columns: a name (or an ID) and a number representing the number of bitcoin owned by each name. This spreadsheet is continuously updated to reflect transactions being made across the network.

The problem with such spreadsheet is how to make sure that all the transactions are legitimate, voluntary and there is no double spending. Before the invention of the blockchain, the only way to maintain such spreadsheet was to have a trusted (often regulated) intermediary that maintains a “master” copy, and strictly regulates who has access to it, when/how transactions can  be recorded.  The blockchain instead allows to perform these same tasks is a fully decentralized way, where all people participating in the bitcoin network verify and record transactions. 

Why it matters

The blockchain matters because it can be applied to all situations in which a “central trusted party” is necessary for the market to function. For example, the second column may represent USD, or stocks in a company, or ownership of a car, .... Hence, the blockchain has the potential of radically change the allocation of market power in many industries.

To understand why, consider these two pictures.






The first one represents a so called “star”: a network in which all the transactions among different nodes must go through a central node. The second picture instead is a “fully connected network” in which each node can communicate directly with all other nodes. The important thing to note is that, in the star network, the central node has market power. Because all parties trust the central node but do not trust each other, the central node becomes the only enabler of transactions and therefore can charge a fee for its service. In the “fully connected network” instead each node can deal directly with every other node and a “trusted third party” is not needed. No node has market power.

The blockchain will transform the structure of several markets from a “star” to a “fully connected network”. Interestingly, this transformation is not new: it has already happened in the market for information with the advent of the internet. Before the internet, the central nodes (traditional medias such as newspaper, TV, Radios) where controlling the information flowing across the network. In other words, if you wanted to get a piece of news across, or wanted to know about it, you had to go through these traditional media. The internet completely transformed this market: now every person can communicate directly with everybody else. The blockchain will bring about the same type of change in the financial sector (no more swift, western-union, credit card networks, …), public services (registry of ownership),  platforms (amazon, uber), ...

Where is the money?

The point I want to make is that it is far from clear who will make money out of this disruptive process (and if there is money to be made!). To illustrate my argument, suppose it is the late '80s and someone is pitching you the following business idea: 

“We are planning to use this awesome new technology (the internet) to deliver information way more efficiently. Think of all the costs that traditional media companies have to sustain to print, air, distribute their content. We can achieve the same outcome basically for free. Our goal is to replace these incumbents and make tons of money.”

This pitch is incorrect, because it fails to realize that the introduction of a new technology will reshape the market. In other words, the pitch assumes that there will still be a “central node” regulating the flow of information, and is planning to replace this central node. The problem is: such central node won't be there anymore. There is no money to be made by simply delivering information. Many blockchain proponents sound a lot like the above pitch. Simply replace “traditional media companies” with “credit cards”, “swift”, “central exchanges”, “platforms”, …

So, is there money to be made with the Blockchain? And where is it? Honestly, I do not know. But a parallel with the market for information is, again, useful. As it turns out, when information is available to everybody for free, the scarce resource becomes people's attention. Hence, the companies making money in the internet age are the ones that can control this new scarce resource: your attention. In the blockchain era, trust will not be a scarce resource anymore and no trusted third parties will be needed. What will be the scarce resource then? Who will make money in the new blockchain era depends on the answer to this question.