Keeping it Difficult for miners.
As the example shows, if a miner can try different nonces faster, then he stands a better chance of winning the next block. Therefore, miners constantly add bigger and better computers to crunch numbers faster than the next guy. Additionally, new miners can come online and start to compete for the bitcoin block prize.
But doesn’t that mean that blocks will get mined faster and faster, causing bitcoin rewards to be awarded faster, thereby flooding the system with lots of bitcoin? The Bitcoin algorithm takes care of that.
Every two weeks, the algorithm increases the required number of 0s a hash value must begin with.
This is to ensure that the total network mining capacity (known as hashing power) can only generate one block roughly every 10 minutes. At the moment, given the increase in transaction volumes on the Bitcoin network, transactions are queued and can take anywhere from one to three hours to be confirmed. New measures to scale the network are being introduced, although it’s not necessary to go into the finer details now.
Bitcoin is the “Proof Of Concept”. The real magic comes next
In the media, bitcoin tends to hog the headlines when it comes to cryptocurrencies. But Bitcoin itself is just the proof of concept for blockchain. Bitcoin’s success has shown the world it is possible for independent and fragmented entities (miners) to enable strangers to exchange value with no need for an intermediary. And it can be done in a completely transparent, verifiable and open way.
As email is one use case for the Internet, so too is Bitcoin a single use case for blockchain. But here I’m not just talking about Bitcoin. I’m talking about two critical innovations that are built on top of the blockchain. These two innovations are what will solve those fundamental conflicts we talked about earlier –the conflict between a business and its customers, and between employees and the companies they work for.
The term “smart contract” was originally coined back in 1994 by a legal scholar and cryptographer by the name of Nick Szabo. He realized that a decentralized ledger (like blockchain) could be used for digital or self-executing contracts. Instead of Bitcoin blocks containing transactions, these blocks could contain computer code that executed under certain conditions.
Here’s an example using Sally and Jim from earlier: Let’s say Jim is buying an iPhone from Sally, which she advertised online for one bitcoin. Jim doesn’t know Sally. So he only wants to pay for it when he takes delivery because he doesn’t necessarily trust her. Sally, on the other hand, doesn’t want to wait until Jim has the iPhone, in case he doesn’t pay.
In this case, bitcoin doesn’t really help. Bitcoin doesn’t solve the real-world trust issue that exists between the two.
That’s where a simple smart contract comes in.
A simple smart contract allows for Jim to pay the bitcoin to Sally into an escrow-style account built on a smart contract blockchain. Sally can see the bitcoin has been paid so Jim is a real customer. The smart contract states that when delivery is complete, the payment will be released to her. And Jim knows that if the UPS parcel never shows up, he can get his bitcoin released back to him.
How is this different from traditional escrow?
Firstly, there’s no centralized middle-man (i.e., the escrow company). Secondly, fees are either non-existent or minimal (with real estate transactions, escrow service can cost US$1,000 or more). Thirdly, current escrow systems work well for larger transaction sizes, but not smaller ones. A smart contract escrow is scalable to support both large and small transactions.
This kind of escrow is an extremely simple use case, so let’s expand it further to other businesses.
Example 1: Music royalties
A music industry artist (or their record label) is entitled to receive royalties every time their content is used for commercial purposes, i.e., sold through Apple’s iTunes or streamed on music-on-demand service Spotify.
When you pay to download music from iTunes, Apple takes a 30 percent cut before paying the remainder to the record label, who pays their artist accordingly. But the Berklee College of Music estimates that anywhere from 20 to 50 percent of royalties never make it to the musicians themselves.
Now imagine if you will, a blockchain-based version of iTunes where artists upload and sell their own copyright-protected music.
Your smart contract can define any kind of revenue split you want. If there’s no record label and the band is independent, then the smart contract can apportion an equal third share between the singer, drummer and guitar player.
When a customer buys an album, the money is automatically and immediately sent into the three separate bitcoin wallets specified in the smart contract.
If there’s a record label, the smart contract can define that 30 percent goes to the label and the rest goes to the singer, drummer and guitar player.
Example 2: Lotteries
Lotteries, along with traditional and online gambling, are highly regulated, extremely opaque and very inefficient.
When we talk about efficiency, we’re looking specifically at the payout ratio –how much of the total ticket sales revenue is paid out to punters in prize money?
The higher the payout ratio, the better value you get for your bet.
For example, if you were gambling on a coin toss, the odds are 50/50. If you bet a dollar on heads, you should get a dollar if heads comes up. If tails comes up, you lose your dollar.
But would you bet a dollar on a coin toss if when it landed on heads you only got 50 cents… and you still lost your dollar if it came up tails?
Probably not, right? That’s a payout ratio of just 50 percent. You’re winning half of what the odds say you should receive when you win.
Well, if you play the lottery in the U.K., then you aren’t getting much better odds. Take a look at the numbers below for the National Lottery in the U.K. for the year ending31 March 2017.
Prize money payouts were less than 57 percent of ticket sales (i.e. revenue) thanks to taxes and commissions.
Imagine, on the other hand, a global lottery blockchain built on simple smart contracts. Punters from all over the world would be able to send a specified dollar amount in bitcoin (in a smart contract) to the blockchain. That smart contract would contain their lottery number choices, the draw date and their bitcoin address where winnings can be paid.
The blockchain would hold the money in a bitcoin wallet. All participants would be able to see the number of tickets purchased. At a pre-specified time, a mathematically provably-fair random number drawing process would take place. This simply codes that self-executes.
The code would execute smart contracts that immediately distribute prize money payouts to the winner(s).
The entire lottery blockchain is completely transparent, it runs autonomously (it purely exists as self-executing code), it’s provably fair and it can provide a payout ratio far higher than any existing traditional lotteries.
Decentralized Autonomous Organisations
The music distribution platform and the global lottery are examples of Decentralised Autonomous Organisations, also known as DAOs.
What is DAO? It’s an entity that uses the power of the blockchain, coupled with smart contracts, to operate a completely transparent business enterprise that typically aligns its stakeholders with its users/customers.
So how does a DAO come into existence? Let’s look at the lottery example:
One entrepreneur thinks there’s a market for a global blockchain-based bitcoin lottery so he decides to create a DAO called BlockLottery as a fair and efficient means of letting people all over the world take part in a weekly lottery draw. His customers will enjoy complete transparency. They can participate in anonymously online. If so inclined, they might “forget” to mention any big wins to their tax authorities (of course not recommended). And there are no oversized novelty cheques involved.
In order for this BlockLottery DAO to be successful, it needs to accomplish three things:
- It must be completely transparent: Anyone who participates in the lottery needs to be able to see that the number drawing and the money collection/payout process is coded robustly. If that can’t be verified then nobody will trust the lottery.
- It needs to be decentralized: Would you participate in a global online lottery if it was being run by a company that has the power to simply shut down its servers and its websites and disappear with the ticket proceeds? No.
Decentralization means there’s no single point of failure. Bitcoin has nodes (miners) all over the world, so if one or a few go down, the network carries on regardless. The BlockLottery blockchain needs to be similarly decentralized.
- It needs distribution, initial capital, and vested interests: It will require some initial capital to get off the ground, build the infrastructure, build awareness and advertising.
Additionally, you want to create an alignment of interests. You want the miners who support the network, as well as the customers and the stakeholders (explained shortly) all to be unified.
BlockLottery builds its blockchain platform and creates a custom cryptocurrency called LotteryCoin. (Please note the terms cryptocurrency, coin, or token are used interchangeably).
Think of these cryptocurrencies as being similar to shares. (We will set aside regulatory concerns for the time being.) Let’s say that as an owner of either of these coins, you are entitled to a share of the lottery ticket revenue.
In order to distribute LotteryCoins, the entrepreneur holds an Initial Coin Offering (ICO). He outlines his business case along with technical details in a document called a whitepaper, which he publishes online.
The entrepreneur plans to auction off 1 million LotteryCoins to the general public.
His ICO ends up raising US$10 million in bitcoin (ICO’s usually raise funds using bitcoin). Investors give bitcoin and get newly minted LotteryCoin in return. These LotteryCoin are like shares, they provide economic value.
The US$10 million goes towards building the blockchain, marketing, and advertising and building a critical mass of users.
But who runs the blockchain?
There need to be embedded economic incentives in any sustainable DAO.
In the case of Bitcoin, miners (or nodes) support the Bitcoin network by performing cryptographic proofs and keeping copies of the blockchain in return for a chance of winning some bitcoin.
In our BlockLottery example, the entrepreneur would need people to run nodes (i.e. be miners) for his blockchain networks. He needs enough of them to ensure that the network is decentralized and that there is no single point of failure.
In order to incentivize them to commit computational resources for doing this, he needs to give them some economic return. The blockchain can code in a certain percentage of profits or revenue to be distributed amongst the nodes in return for running the network.
Let’s say that 5 percent of all ticket sales go into a pot that is distributed amongst the miners along with the LotteryCoin holders.
Now once the blockchain is launched, nobody can unilaterally alter it. Nobody can “rig” the lottery, for example.
But where DAOs are truly beginning to shine, is where they can take the vested interests of token owners, miners, and customers and use them to evolve.
Let me explain.
Let’s say the BlockLottery blockchain has been launched and is up and running. Every week, US$10 million worth of global BlockLottery tickets are sold.
Every weekend, the winning results are drawn, and prizes are automatically credited to the winning ticket holders. The miners and token holders get their cut as well.
But the blockchain also reserves 1 percent of revenues for “Special Projects”.
Let’s say I’m a holder of BlockLottery coins and I want to help increase their value. I’ve got an idea to include a monthly mega PowerBall draw in addition to the weekly regular lottery. So I put together a proposal, get a coder to put together the necessary programming and then I submit it to the community for Special Project approval.
I tell the community that for US$10,000 I can put this all together and help implement it in the BlockLottery blockchain.
The token holders vote on the proposal, and if I’m successful a smart contract is created. The smart contract lays out what I have to provide (i.e., the monthly mega PowerBall draw code along with technical specifications), and the terms associated with it (i.e., deadline and cost).
When I complete my task and it gets approved by the community, my fee is paid to me and the new lottery product is released, thereby increasing the value of the BlockLottery tokens.
If this sounds far-fetched then rest assured, DAOs are already here, and they are already governing and improving themselves by using these kinds of community contracts.
And why not? When you step back and think about it, the vested interests are all aligned:
The contractor: I want to increase the value of the network and I have an idea how to do it, with a newly added PowerBall monthly draw. I want to implement it, and get paid for doing so. I want to build a solid reputation so I make sure I deliver what I say I will, which means next time I might be able to put forward an even more lucrative idea. My payment is also a smart contract, which means if I don’t do what I say I will, I don’t get paid.
The community: The community wants contractors to put forward good ideas to help build the value of tokens and increase ticket revenue. Ideas can be anything from technical to marketing. The community wants to encourage stakeholders to keep coming forward with good ideas, by rewarding people for executing well and ditching folks who don’t deliver.
Although DAOs are built on code, they still require people. The robotics revolution replaced a hundred assembly line workers with a few machines, but we still need someone to keep an eye on the machines. In this case, we have a vested community keeping an eye on our lottery blockchain.
The customer: He’s already getting the best payout ratio of any large lottery in the world, and now he’s getting more games added. If he owns tokens as well, then he’s also far more likely to recommend BlockLottery to his friends.
When you add all this up, how can a traditional lottery possibly compete with this business model?