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What Problem Does Blockchain Solve?

by Dan Robles on September 14, 2016

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A great deal is being said about Blockchain Technology.  But what exactly is the problem does blockchain solve?

The main problem that blockchain solves results from the fact that computer databases simply cannot talk to each other without a layer of expensive fault-prone human administration or bureaucratic central authority controlling every node. Blockchain technology, on the other hand, is a single, decentralized database managed by software and shared by multiple users, without any third party authority. This makes processing transactions less costly and less error-prone. This software enables process efficiency because new links can form as needed, and improves organizational efficiency because no management gatekeepers are needed.

The applicability of blockchains may include everywhere that many people may want to interact with a computer database. It is easy to imagine a tremendous breadth and depth of potential applications and markets.

Centralization

The traditional way to enable databases to communicate with each other is to consolidate and combine them into a single database, hoping that enough commonality would exist to patch them together. This approach is typical of mergers and acquisitions of corporations where two somewhat similar entities combine their data under a central authority. Efficiencies are gained in scale and elimination of redundancy. Unfortunately, centralization can also lead to inefficiencies such as top-heavy hierarchy, monopoly, obfuscation, stagnation and vulnerability to external shocks. Failures would often trigger blanket legislation and government regulations. Meanwhile, the original problem remains; how do these new mega databases communicate with other mega databases?

See also: How Blockchain Will Reorganize Society  

Decentralization

The other way to eliminate intermediaries and enable data to be shared between organizations is for everyone to share the same database. Multiple writers can retrieve and populate data simultaneously with no controls, consensus or centralized authority. Natural organic links would form, and operations would become faster, cheaper and easier to perform and maintain. The network effect can take hold where the value of the network would grow exponentially. Unfortunately, there would be no way to stop a person from cheating another person, or going back to change the conditions of a contract, or giving himself a raise, or double spending a unit of account, etc. For decentralized databases, these are precisely the problems that blockchain solves.

Before Bitcoin, if a person sent a contract over email, each party would hold an identical copy that could be easily manipulated. After Bitcoin, a person can send a contract electronically, and the receiving party would hold the only valid copy. While this may sound trivial at first, it is extraordinarily difficult for a computer to do. But it would allow computers to perform some of the functions that administrators routinely perform today at nearly every interaction with a computer.

Not unlike what happened with mechanization in the last century, once achieved, the software-managed architecture will be faster, more reliable and cheaper while the marginal cost of adding additional capacity approaches zero. Centralized databases scale at the speed of bureaucracy. Blockchain may scale up to handle large and complex transactions or scale down to accommodate billions of micro-transaction with little difference in operations cost. Also like what happened with mechanization, society will certainly reorganize around these new forms of value creation and exchange. This is already evident with the extraordinary amount of venture and investment capital and creative new decentralized autonomous organizations (DAOs) pouring into blockchain space.

Blockchain technology makes business cases that may never have been viable become brilliantly viable today. To use an engineering example, the invention of the hydrostatic wheel bearing eliminated enough mechanical friction from a steam locomotive that it could become a viable engine of economic growth. Likewise, blockchain technology holds the potential to eliminate a tremendous amount of friction from everyday transactions and agreements. For anyone reading this article while standing in line at the DMV, that is a problem that deserves to be solved.

The innovation has just begun.

Adapted from:

Insurance: The Highest and Best Use of Blockchain technology, July 2016 National Center for Insurance Policy and Research / National Association of Insurance Commissioners Newsletter: http://www.naic.org/cipr_newsletter_archive/vol19_blockchain.pdf

Blockchains, databases, reification: are bottom up standards possible? Vinay Gupta 2015 https://youtu.be/AbacROAa4xY

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