Many may know about the dilemma that blockchains face, but some may not know what to do with the information. So why does it matter? This article, the first in a three-part series, answers that question and more.
You’d be surprised by how much this dilemma dictates virtually every decision made by today’s companies trying to build the decentralized world of the future. As some, or most, blockchains strive for mass adoption and real-world applications of their technology, they all have to ask themselves: How to overcome the blockchain dilemma?
Practically any company operating in the decentralized space with aspirations to grow and scale its operations will be forced to align their strategies to this question. And that can have great implications, not only for them, but also for the thousands of people who support them financially or in other ways.
Blockchains and Their Different Security Protocols
Not all blockchains are created equal. Essentially, they are separated into three ‘generations’. Take the most prominent ones today, Bitcoin and Ethereum, which resemble the first two generations. Bitcoin’s blockchain merely exists to store transaction records of Bitcoin, but Ethereum’s is more like a platform, where developers can write and execute code for their own purposes.
In a nutshell, if Bitcoin is nothing more than “digital gold”, then Ethereum might be something like iron that you can melt and create things that have utility for different purposes. Now enter generation three, which can combine that iron with other ores like carbon to create even more things, like steel, for more use cases.
The inherent distinctions between these blockchains stem from their vastly different security protocols. While Bitcoin uses proof-of-work (PoW) to secure its network — real-world computing power — Ethereum developed a system called proof-of-stake (PoS). PoS uses the virtual staking power of a token as a security measure.
Knowing those differences and why they matter becomes helpful if not crucial to traders. They change not only how the different protocols go about scalability, but also their mere ability to do so. This, in turn, changes the underlying reasons for investing in them. Bitcoin wouldn’t be valuable if people didn’t believe it has value; Ethereum wouldn’t be valuable if people didn’t believe it has utility. No one buys gold because it’s useful, but people buy iron because you can use it to build things.
The Significance of Triangles and Trade-offs
When most people think about trade-offs they think about them on a binary scale: “Pizza or Thai for dinner?” Trade-offs in real life occur when there are two desirable outcomes, but you can only choose one, thereby eliminating the other. You can’t have your cake and eat it too.
What seems like a simple definition then suddenly becomes really complex when it comes to technology, and you have to scale it up to 10 or even more dimensions. To say the least, our brains aren’t good at contemplating 10 dimensions at once. There needs to be a set of rules for information in order to derive valuable meaning from it: It needs to be easy to visualize, its concept easy to grasp, and changes easy to measure. Three seems to be the golden middle here that checks all boxes, and many variations of those are used in traditional strategic management (like the scope triangle).
Now how to apply this concept? As an investor, you work with a set amount of funds. There are multiple promising projects, but putting more into one means you can put less into another. You are now trying to gain an understanding of your potential investment opportunities.
You want to find the cherry that yields the most profit in order to minimize trade-offs. Knowing triangles is a valuable tool to examine the trade-offs between certain approaches: you can now evaluate them, helping you find that cherry (later on how this works with Bitcoin and Ethereum).
Three Metrics That Don’t Get Along
In the context of public blockchains, the impossible triangle presents the idea that a blockchain can have decentralization, security and scalability all to varying degrees — but cannot achieve all three to an extent that is sufficient. Being able to evaluate a coin based on this can help to separate the wheat from the chaff. The three dimensions are as follows:
- Decentralization means that no single entity controls the network. Anyone is able to join the network and participate as a block-validating node. In a fully decentralized network, all nodes have the same access to data and the same voting rights.
- Security refers to the measures in place that prevent adversaries from validating fraudulent transactions. In a perfectly secure blockchain, it is impossible to create fraudulent data without controlling more than 50% of the protocol’s security assets; at the same time, it is close to impossible to gain that control.
- Scalability is the number of transactions a blockchain is able to handle without slowing down or becoming too costly. On a strongly scalable blockchain, the whole globe would be able to use the system to record transactions, with nearly instant execution at any given time or day and almost no transaction fees.
Now, the logical approach for most blockchains is to perfect the dimensions in this exact order. That’s mainly because decentralization and security are the fundamental ideas of blockchain. This order, however, creates a certain set of boundaries when trying to expand the triangle in any one direction.
The Bitcoin blockchain, for example, uses the PoW system, which has proven to be exceptionally secure (it has never been hacked). The only problem lies with its use of physical processing power: it becomes cripplingly slow. Meanwhile, Ethereum (a generation 2 blockchain) uses PoS, which in theory should enable it to scale better than Bitcoin’s protocol. This is crucial as it is trying to offer a platform for developers to write code on — it needs to be scalable. The problem: it is not as fundamentally secure.
Let’s come back to the point above on boundaries. With Bitcoin, you can tweak the code here and there to squeeze a bit more out of the protocol, but its fundamental approach to security sets a clear boundary: it will never be as scalable. In contrast, Ethereum has set a different goal, but its reliance on a virtual recourse means it will probably never catch up to Bitcoin in terms of security. Now when it comes to evaluating coins, things like the security protocol, transaction fees, block sizes, and block creation times all come into play. As you now know about these trade-offs, seeing claims of high TPS with a PoW security protocol should at least ring some alarm bells. Similarly, a well-thought-out protocol that provides ways for scalability should also mention how it plans to combat the compromises on security or decentralization.
Comparing with Centralized Systems and Outlook
Say, for an instance, you think that security (to the best of your knowledge) will be the number one most important factor of decentralized systems in the future, while electricity usage and scalability are not as important. Now considering that you see Bitcoin’s future not as a global payment system that will run the world of finance, but rather as a form of digital storage of value, then you wouldn’t really see scalability as important.
In fact, you would probably evaluate the high factor of security as way more significant to Bitcoin’s success. Based on that, you might decide to invest in Bitcoin rather than Ethereum.
Any blockchain today seeking mass adoption in the future has to compare itself to the current benchmarks in the traditional financial world. Visa’s 50-year-old centralized payment protocol is able to handle up to 50,000 transactions every second, while the current load sits at just below 2,000 at the time of writing. Those are numbers any blockchain would dream of hitting today. It may seem like people currently don’t have any other option than to abide by Visa’s centralized system.
If, however, blockchain technology would be able to manage today’s global throughput while still offering decentralization and better security, we would potentially be rewriting tomorrow’s history books today. And there are ideas with promising approaches. However, the key word here is reliability. It’s what transforms the impossible triangle into the possible triangle.
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