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What Good Is A Blockchain?

Even as cryptocurrency continues to provide a wild ride for speculators, I’ve heard over and over that – whatever you think of bitcoin – blockchain technology is important and here to stay.

Blockchain enthusiasts may have a point. Supporters of blockchain technology argue that it has many potential uses and that it can offer real benefits beyond the world of cryptocurrency. To test that argument, first it’s worth discussing what a blockchain is.

In its most basic form, a blockchain is a database maintained across a decentralized computing network, and it is designed so users cannot change past entries. But every individual user can read the entire ledger, providing transparency. An algorithm ensures that all copies of the ledger are the same. Participants receive rewards as incentives, ensuring a robust network of computing power. A lot of these characteristics are not exclusive to blockchains; what makes a blockchain unique is that it is completely decentralized and includes any number of unknown participants.

Many people display rampant enthusiasm about blockchains’ potential to disrupt industries and reduce costs. As the BBC recently observed, many venture capitalists are quick to pounce on any startup that invokes the term “blockchain,” even if the company’s plans for how to actually use the technology are hazy, as with the “Long Blockchain Corporation,” formerly the Long Island Iced Tea Company. Some companies hope to capitalize on the trendiness of blockchain solutions, but others may see them as addressing actual problems or challenges.

The purported benefit of decentralization is that it is will eliminate – or at least deter – data tampering. With no single, central authority, the database lacks an obvious weak point for a bad actor to target. When a blockchain operates correctly, any participant trying to fraudulently change or remove an earlier entry will be easily identified and stopped. But if this is the case, why have there been so many instances of cryptocurrency exchange hacks? There have been numerous hacks over the years, with the two largest (Coincheck and Mt. Gox) representing combined losses of over $1 billion.

Many “hacks” are not actually exploiting technological vulnerabilities in a blockchain at all. Instead, they focus on the much more hackable human beings who use them. These attacks take the form of phishing or other fraudulent activity designed to give thieves access to cryptocurrency wallets. Before you decide you’re too tech savvy to ever fall for such tactics, remember that Steve Wozniak (the co-founder of Apple) reportedly lost about $70,000 due to a bitcoin scam. But saying that the problem is people, rather than code, only goes so far. After all, no blockchain-based system is human-free.

This is not to say that blockchains cannot be hacked directly, either. Scammers may also try “51% attacks,” in which they gain control of enough of the network to overcome its built-in fail-safes. Earlier this year, this sort of attack – also called a “rollback attack” – resulted in the loss of nearly $500,000 worth of Ethereum Classic.

Like most laypeople, I cannot claim to understand the nuts and bolts of blockchain technology. This is, itself, part of the problem. Blockchain enthusiasts want us to replace trust in people with trust in technology. This is all well and good – except for the fact that we already know technology sometimes fails. From the outside, most of us have no way to judge whether code is good or bad. And there is no equivalent of the Federal Deposit Insurance Corporation to assure blockchain users that their trust is not misplaced.

While some privacy advocates celebrate the fact that blockchains remove the need for intermediaries, those intermediaries can serve real functions within a system. If you lose your online banking password, you can call your bank and work with an employee to restore access to your account. If you lose your bitcoin wallet passcode, you have irrevocably lost the contents of your bitcoin wallet.

Cryptographer Bruce Schneier wrote an op-ed for Wired in which he makes clear that blockchains don’t end the need for trust. They simply shift it. “Blockchain enthusiasts point to more traditional forms of trust—bank processing fees, for example—as expensive,” Schneier wrote. “But blockchain trust is also costly; the cost is just hidden. For bitcoin, that’s the cost of the additional bitcoin mined, the transaction fees, and the enormous environmental waste.”

Even at their best, blockchains have serious drawbacks. The bitcoin blockchain, for example, processes transactions much more slowly than traditional credit card companies and consumes a lot of power to do so. Decentralized systems are generally less efficient and more expensive than their centralized counterparts. So adopting a blockchain-based system involves real drawbacks, even in a best-case scenario.

Blockchain technology may have some real applications, but based on what we have seen so far, it seems likely those applications will be limited in scope. Or someone may find ways to build in safeguards to make blockchains less vulnerable to the failings of the people who use them. But absent such advances, even with the recent resurgence in cryptocurrency prices, blockchains involve serious potential downsides that should make potential users think twice.

Managing Vice President Paul Jacobs, of our Atlanta office, is among the authors of our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. He wrote Chapter 12, "Retirement Plans"; Chapter 15, "Investment Approaches And Philosophy"; and Chapter 19, "A Second Act: Starting A New Venture." He also contributed to the firm’s book The High Achiever’s Guide To Wealth.

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