Why Blockchain Can Be Good For Competition

In the endless debate about when do you actually need a blockchain within a specific industry vertical versus not, it is easy to lose sight of the big picture.

Proponents of permissioned, distributed ledgers are often quick to point out the shortcomings of permissionless protocols such as Bitcoin or Ethereum. Because of their decentralized nature, they do not fit within existing regulatory frameworks, are difficult to monitor and control, and introduce new trade-offs in terms of speed, flexibility and energy consumption into what could otherwise be a seamless process of transaction reconciliation across organizations. Private blockchains, they say, can deliver all the benefits of this new, exciting wave of technological change without disrupting how businesses run their operations.

The catch is that permissioned blockchains take advantage of only one of the two, key costs affected by blockchain technology: the cost of verification. In and of itself, being able to cheaply verify the attributes of a specific transaction (e.g. who is involved, their credentials, etc.) without incurring additional costs or performing an extensive audit can be extremely valuable to society. For markets to thrive, buyers and sellers need to be able to trust the information they use to decide when and with whom to transact. Whenever the asymmetry of information between buyers and sellers is too large, markets unravel, and beneficial trades do not take place. Blockchain technology, by lowering the cost of verification, can make markets more secure and efficient, and expand the types of transactions we are willing to engage in.

Many of the systems used today across the globe to settle and reconcile transfers of value and digital assets could theoretically be made more efficient with a distributed ledger. Of course, for verification costs to actually drop, the data recorded on a blockchain needs to be accurate to begin with. While this is easy to achieve when all the information needed is generated and updated digitally (as in Bitcoin), when a distributed ledger is used to track offline events, the question of how to port such analog information back into the digital space is an unresolved one. This “last mile” problem constitutes a sizable entrepreneurial opportunity for startups and incumbents that realize that blockchain does not necessarily remove the need for intermediaries, but instead changes the nature of intermediation. Third-parties can still add substantial value to marketplaces (e.g. through curation), but a revenue model simply based on processing transactions is unlikely to be sustainable in the long run.

Where permissioned blockchains fall short is in taking advantage of the other, key cost impacted by the technology: the cost of networking. When combined with a native token, a permissionless blockchain can be used to bootstrap a digital platform without the need for a central intermediary. Driven purely by the incentives embedded within its protocol - which need to be carefully designed! - permissionless platforms enjoy the benefits of a shared network infrastructure, without the main cost it typically involves: market power.

As a result of network effects and economies of scale, the digital platforms that shape our lives today have accumulated a high degree of market power. In fact, they often act as the default, “shared infrastructure” within their industry vertical. While this may not always be visible through higher prices for consumers (as many of these products are given away for free), it is typically reflected in adjacent markets (e.g. advertising), and in the amount of data these businesses have accumulated relative to everyone else competing with them. Beyond the privacy risk of exposing large segments of our digital lives to a small number of players, data concentration has implications for competition - not just today, but also in the future. For instance, if we want a competitive market for artificial intelligence applications, we will need to unlock these data monopolies so that more than a handful of players can generate high quality predictions.

So How Can Blockchain Increase Competition And Lower Barriers To Entry?

To ensure a higher degree of competition, permissionless blockchains can be used to create digital marketplaces without assigning control - both over prices and access to data - to a single operator. When entrepreneurs and developers in this space talk about “censorship resistance”, it is important to realize that censorship is simply an expression of market power. By allowing individuals and firms to transact without assigning market power to a central intermediary, the digital platforms built on top of permissionless ledgers can turn concentrated markets into substantially more competitive ones. This can lower barriers to entry for startups and lead to new products and services.

By lowering the cost of networking, permissionless ledgers also allow for a fine-grained definition of digital property rights, including rights to the underlying data. While on current digital platforms the operator by default has access to all information exchanged, in this new regime, users and businesses will have substantially better control over digital privacy. New data licensing and monetization models will also be possible.

Of course, we could have achieved this before by developing an industry standard to ensure interoperability and low barriers to entry. The key difference is that with a native token, digital platforms can reward contributions of talent, capital and resources (e.g. computing, storage etc.) in a fundamentally novel way. Instead of having to price everyone’s contributions during the negotiations for the standard, this can all happen in an automatic fashion as the network organically develops.

At the same time, like industry standards, permissionless blockchains will have to develop substantially more reliable and effective forms of governance. For a platform to thrive, it needs to be able to evolve and adapt as new needs emerge. It also needs to address the risk for underinvestment in aspects of the technology that generate a positive externality between participants.

Possibly even more important, permissionless networks will have to identify problems individuals and organizations need solved. Only by addressing a real customer need, will these platforms be able to move from the investment and speculation phase, to actual growth. Permissioned blockchains, possibly because they are solving more narrow problems within a framework that businesses understand, have shown that there is demand for the ability to verify and reconcile transaction attributes at a lower cost. Now it’s on the permissionless camp to prove that if you also take advantage of the reduction in the cost of networking, you can actually design a better incentive, governance and innovation system that can outpace alternatives and create a substantially more competitive market.