Understanding the transition to the digital era
People keep repeating that money is already digital and question the usability of blockchain. But if you come to think of it, in the traditional financial systems the value transfer is not truly digital.
The digital money that banks are displaying is not truly transferring value in a digital way. It’s just a display of numbers with no sophisticated transfer of value behind it. No hard currency is transferred from one bank to the other the moment you make a wire transfer (and that’s why it’s efficient). It’s just a display that we blindly trust that it’s true. Let’s call it a display currency.
Why is this the case? Let’s dive a bit deeper
If you look at the traditional financial infrastructure, there are always five components in place:
- custody is one organization
- issuance is another one (central bank)
- payment systems a separate one
- audit at another place
- the state providing the governance.
In almost every transaction, all of the above components have a role in order for the system to function efficiently.
If you look at bitcoin, we have all the components of the above-mentioned fiat system, but all managed by the same piece of code. Bitcoin network provides the payment system, the issuance, the audit, the governance, the custody, all in one network.
So what did bitcoin truly achieve?
What bitcoin achieved was a real transfer of value; the truly transition from the paper to the digital era. The moment you transfer a bitcoin to someone, you instantly transfer the actual asset. This happens without involving any trusted 3rd party. Just using math.
It’s a hard concept to understand since the line is thin, but if you do, you will see that the bitcoin network achieved a disruption on the traditional financial infrastructure play.
But what is all that noise?
The last few years we’ve seen a plethora of teams trying to repeat the genius infrastructure of bitcoin.
Teams are introducing new coins, promising innovations. But what kind of disruptions these truly are?
The differences between all these coins and services are nothing more but new infrastructure plays as we transition from the paper to the digital era.
What kind of infrastructure?
As we mentioned above, a payment system to function in a secure way it needs a few processes in it:
- Governance,
- Custody,
- Issuance and distribution,
- Transaction processing,
- Audit
Before bitcoin all the above where separate entities and fully centralized.
But it doesn’t need all 5 to be decentralized in order to create a digital asset. For example, there might be a digital asset without auditing at all because some people would like to keep their transaction history completely private from the public or any central authority.
So, today the 3 states of the above 5 processes can be:
- Centralized
- Decentralized
- None
For example, the Central Bank network has all the above 5 processes fully centralized and this is why you receive a central bank currency (display currency).
Bitcoin is a fully decentralized network and this is why the digital asset that you receive is fully decentralized as well (cryptocurrency).
ZCash and Monero are decentralized networks but auditing is not possible since you can’t see the history of transactions (still a cryptocurrency).
Ripple has centralized governance and issuance (the team does both of them) but all other processes are decentralized (not a cryptocurrency since it’s centralized but it’s auditable digital currency).
Tether, or now Gemini dollar, are backed by the USD, centralized since under control of a certain organization (not cryptocurrencies, just new form of digital assets).
There is one more obstacle we have to overcome
Interconnectivity of the mentioned systems above.
For example, right now, if you want to open a website, you can do it from any browser, any device. But if you want to manage your fiat assets you cannot use Wells Fargo unless you open an account there, you can’t transfer money to another country unless Swift gets involved. Same goes for the crypto space. If you have 10 different currencies and you want to transfer value from one asset to another, you will need to use a third party service (like an exchange or atomic swaps) that will allow you to do this.
In the current state, we can describe it as having to use different browsers for different websites.
At the end, we will have a universal infrastructure, a financial internet where all assets will “talk” to each other.
Ok, but why do they need a blockchain?
As mentioned above, all the above assets are becoming digital assets and will be basically defined by the infrastructure (payment system) in which they ‘exist’.
Why? Because the basic feature that accounting system needs in order to be reliable is security. And blockchain provides the security features. It’s a mechanism for reaching consensus between multiple parties who don’t trust each other. In other words, the blockhain digitalizes the trust and the memory factor. All you need in order to transfer value.
So, blockchain is not about currency, but rather about consensus regarding the state of some digital asset. In order to achieve consensus, you need participation. In order to incentivize people to participate in such a network, you reward them with a currency. It can be a new coin built from scratch that it’s only used for this network or an existing one.
We should never forget that blockchain is just a tool for a system, like a camera for a photo, a hammer for a nail, or an engine for a car.
The creation of new digital assets
If you think about it, these are assets that we never had imagined before the digital era. Thanks to digitalization we now have the flexibility to practically create assets that never existed before. And this happened by introducing two more states, decentralized and none (for now, maybe more in the future).
As a conclusion, there are three major types of digital assets:
- Display assets. Everything is fully centralized and there is no sophisticated transfer of value. It’s just a display and we just trust the banks that the numbers that we see represent the truth.
- Cryptocurrencies. The ultimate level of decentralization on the infrastructure level. The trust factor is ultimately eliminated. There is no part that is centralized.
- Hybrid digital assets. Some parts of the infrastructure are centralized, while others are decentralized or they don’t exist.
Digital assets are different to the tokenization of analog assets.
Don’t confuse the tokenization of analog assets with digital assets. These are two completely different things.
The former is when we take an analog asset such as real estate and we use blockchain in order to automate the ownership rights. Instead of using lawyers, we turn the analog asset and its ownerships rights into a package that we call it a token. The house didn’t turn digital, it’s still a house. We just automated the ownership infustructure using the technology of blockchain.
The latter, transformed completely the asset into a digital form. For example, bitcoin didn’t turn dollar (analog asset) into a token. Bitcoin is a stand alone digital money by itself. It made the analog asset obsolete.
Conclusion
As we can see above, digital assets acquire specific features depending on the context.
Currently, we make analogies with the assets that we understand and we know, “bitcoin is the new gold”, “ether is the new dollar” but what we actually build it’s something way bigger.
We gradually transit from the paper to the digital era structuring a universal infrastructure, a trust-less network where all assets will “talk” to each other and people will use them freely according to their needs.
Eventually, we will not even realize which asset we use each time. The same way we don’t really know which protocol we use every time we open a new website. Can you imagine how far this can go?
We are lucky to be in the beginning of this era.
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