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Four Cognitive Mistakes About Blockchain

Updated on August 6, 2018

In recent years, some so-called “blockchain giants” have deified and omnipotent the blockchain. They don’t ask for understanding, and they use their own big horns to pass on rumors so that the entire society has many misunderstandings about the blockchain. For this reason, this paper attempts to clarify four social misunderstandings about the blockchain using four inequalities.

Misunderstanding 1: difficult to tamper = not tampered

For a long time, the data on the blockchain was considered irrevocable, especially for the Bitcoin system, and it is generally believed that its protection capability is indispensable. However, as early as 2013, the academic community has confirmed that the Bitcoin network is not perfect, and there are many cheating strategies. A study by the Bank of England cited a study by Deck and Wattenhofer (2013) that examined the time of information dissemination on the Bitcoin network and concluded that a node that is quite central in the network does not need to control the strict majority ( 51%) Computing Resources. Eyal and Siser (2013) discussed that a “selfish” node in the Bitcoin network intentionally did not broadcast the verification successfully for block N, instead of seizing the time difference broadcast to other nodes in the network and immediately verifying block N+1. Obtaining revenue (Bitcoin) that exceeds the proportion of its own computing resources indicates that even if a “selfish” node is far from other nodes in the network, it can get more than its own calculations even if it controls 1/3 of the computing resources. The corresponding revenue for the resource.

In reality, the Bitcoin gold BTG was maliciously attacked on May 24th this year. A miner obtained at least 51% of the Bitcoin gold network’s computing power, temporarily controlled the BTG blockchain, quickly withdrew coins after recharging the exchange, and then reversed the block and successfully implemented a dual-flower attack. It is understood that the attacker may steal more than 388,200 BTGs from the exchange, worth up to 18.6 million US dollars. It can be seen that, at least for those altcoin blockchain systems, as long as the economic incentive is sufficient, 51% of attacks do not exist only in theory. Therefore, we cannot think that the blockchain system is “safe and secure” in terms of anti-tampering, and the problem of information security will still exist, even in certain aspects (such as decentralization, network structure, etc.) caused by excessive growth of financial assets. Economic incentives have become the “top of Akers” in the blockchain.

Therefore, it is difficult to tamper with and cannot be changed.

Misunderstanding 2: Trust = Credit

For a long time, some “blockchains” have used the article “blockchain is a machine of trustlessness” of the “The Economist” magazine, and have pointedly pointed out in various occasions that blockchains can automatically create credits. Then blockchain can perfectly solve the problem of information asymmetry in the financial field. Regardless of whether information asymmetry that exists extensively cannot be eliminated by a certain technical solution. There are obstacles to understanding trust and credit at the economic and financial levels.

In terms of language and common sense, the “Ethics” says that “trust” has three meanings. One is to believe and to use it; the other is to follow and listen; the third is to believe and dare to trust. It can be seen that in life and economic activities, people often use “trust” to mean “believe and dare to trust”. For example, person A believes in person B, referring to A’s belief that B is worthy of trust and can be entrusted to something. “Credit” has four meanings. One is to use people in good faith; the other is to believe in and adopt; third is to obtain trust by performing things that are agreed upon with someone, and fourth is not to provide material guarantees and not to pay cash immediately. Based on trust, such as credit loans, credit transactions. It can be seen that “credit” is an important code of conduct for human social communication activities and is endogenous to credit entities. From this, it can be seen that “trust” in linguistic common sense is not the same as “credit.”

On the economic level, the distinction between “trust” and “credit” is more obvious. In market transactions, “trust” and “credit” are both related and different, and have different constraints. First of all, from the transaction timing, the moment when the market transaction occurs is the demarcation point, and the “trust” is “looking back” (that is, the trust occurs before the transaction). The two sides of the transaction trust each other and the transaction can be reached only after the contract takes effect. Otherwise, the market transaction will be terminated (middle). “Credit” is a forward-looking, that is, credit is the transaction after the trust is reached and ex-post. Of course, after a party to a transaction obtains the trust of the other party, it can also conclude a transaction by deceiving the counterparty by concealing the information, that is, “do not trust.” Secondly, from the perspective of the transaction subject, for a certain transaction subject, its trust always comes from the counter-party. And “credit” is inherent in the endogenous trading entity itself. Obeying the credit in the transaction not only reflects its own consciousness but also is affected objectively by external factors after the transaction is achieved. Finally, from the perspective of transactional influence, as mentioned above, the trust attitude of the two parties directly determines whether the transaction can be achieved, and the credit history of the transaction history of the parties in the past determines the other party’s trust attitude, that is, the transaction subject uses Bayesian inference ( Bayesian inference gives the probability that the other party will abide by the credit in the future and then decides whether the current transaction, that is, the credit of the transaction subject only affects the occurrence of future transactions.

At the financial level, the abstract understanding of “trust” and “credit” in economics is placed under the specific circumstances of financial transactions. “Financial credit” refers more to the mutual fulfillment of financial transaction subjects under the premise of mutual trust. The financial contract, willingness and ability to repay debt. Specifically, “payment credit” means that the payer (debtor) fulfills the payment promise to the payee (creditor), and the uniqueness, irreversibility, and finality of the payment are specific requirements for “payment credit”. The cornerstone of financial credit. “Lending credit” is the inter-arrangement of the creditor’s lending currency, the debtor’s scheduled repayment and payment of certain interest funds (the fourth explanation of the aforementioned etymology for “credit”). “Securities credit” is a generalized credit activity such as credit rating, information disclosure, and DVP in the process of securities issuance, trading, and redemption. The highest level of financial credit is “monetary credit”, which refers to the currency that is regulated by national laws, the compulsory circulation, which does not rely on any physical object to play its own currency function, and the unlimited compensation for that currency.

It can be seen that trust in market transactions in economics does not necessarily result in credit. Only when the counterparty can obtain more benefits (at least no less) than “no credit” in the act of complying with credit can it produce “ Credit “this result. At the financial level, credit is also significantly affected by the impact of external factors on the uncertainty of trust in financial transactions, making trust even less a sufficient condition for financial credit. Therefore, if the blockchain can generate and maintain trust perfectly, it will not necessarily lead to credit, let alone financial credit. At this point, it is necessary to question the “credit head” of those who advocate that the blockchain can solve the supply chain finance, the “difficulty of financing the financing of the SMEs, the expensive financing”, the lack of credibility of the underlying assets of asset securitization, and even the replacement of legal currency credits. The style of argument.

Therefore trust is credit.

Misunderstanding 3: Monetary incentive = incentive compatibility

For a long time, many “experts” and “scholars” who are active in the media have worked with market participants to find various theoretical evidence for various “funny” behaviors of blockchains. Unluckily became their high-frequency word. What’s ridiculous is that these people either did not study the principal-agent theory well enough, understood any incentive for money as “encouraging compatibility,” or they knew that they were selling their dog meat.

In fact, “incentive compatibility” is the core concept of the mechanism design theory created by Hurwiez, the Nobel Prize winner in economics: in the market economy, every rational economic person will have self-interest. On the one hand, their personal behavior will act in accordance with the rules of self-interest; if there is a contract that allows agents to pursue their own interests, it will coincide with the principal’s goal of maximizing their own value. A contractual arrangement is “incentive compatibility.” Specifically, in the design of principal-agent contracts, there are two constraints on the maximum value (utility) of principals (such as business owners, shareholders, etc.). One is participation constraints (IP), that is, the optimal choice of the principal. Make the agent have the enthusiasm to participate, that is to say, the agents get more benefits than they do not participate in the contract. The second is the incentive constraint (IC), which means that the client’s optimal choice must be at the same time the agent’s choice of value (utility) maximization.

Monetary incentives are a form of economic incentives and the most widely used form of incentives. People also generally believe that monetary incentives are a very effective way. However, experimental economics studies have shown that people’s internal motives clearly affect the effect of monetary incentives. When there is no external incentive, people tend to explain their behavior with intrinsic motivation. When extrinsic motivation exists, they will use external reasons to explain their behavior, that is, extrinsic motivation replaces intrinsic motivation. There have been many investigations and studies that show that people’s intrinsic motives are reduced when monetary incentives are accepted. Therefore, improper monetary incentives have a negative incentive effect and impair the interests of the client. This is not “incentive compatibility”.

Therefore, the blockchain technology geeks “originally created” IXOs (X stands for 26 letters, constitutes ICO, IBO, IMO, IDO, IFO, IHO, etc.) and the so-called permit economy are faced with inconsistent incentives. The problem of tolerance, that is, the investor (consigner) is in the information disadvantaged party, has no way to know the intrinsic motivation and change of the blockchain project sponsor (agent), when the investor accepts the terms of the IXO and gives the project sponsor large monetary incentives. When there is no effective supervision and restriction on the project sponsor, whether the project sponsor’s intrinsic motivation will reduce the success or failure of the project, and therefore the investor faces great moral hazard. On the other hand, due to the informational disadvantage of investors, the lemon market is the inevitable result of bad money expelling good money. It can be seen that IXO fraud is not accidental, both at home and abroad.

Therefore, monetary incentives and incentives are compatible

Misunderstanding 4: Smart Contract = Perfect Contract

For a long time, “smart contract” has been hailed as Ethereum’s epoch-making creation of “smart contract”, packaging smart contracts into perfect contracts without any risks, able to solve the risk of default in market transactions, and even “Large coffee” takes the smart contract and the complete contract for granted.

First of all, like the aforementioned “trust” and “credit”, even smart contracts can completely solve the opportunistic behavior of both parties, but they cannot solve the credit risk. At the same time, the understanding of smart contracts is limited to “automatic execution”, the level of “non-human intervention” is superficial, and there have been several cases of human losses caused by manual attacks that cannot be interfered with by the automatic execution of smart contracts. In fact, in the financial contract, the irrevocable and renegotiation of the contract are not contradictory (in theory, it involves the more complex theory of corporate finance, not to repeat). The opposite of the two is only computer programmers. The paranoid understanding.

Second, the understanding of smart contracts requires a combination of distributed consensus (DC) and information distribution mechanisms. First, various types of distributed consensus, such as POW and POS, use one or more mathematical algorithms to simulate the “emergence” of the real world. Essentially, they are all competitive and simultaneous voting under resource constraints (simultaneous). The (voting) mechanism, in principle, contributes to economic efficiency. Second, to reach a distributed consensus requires the distribution of information among participating nodes. The “extreme” information distribution is the Bitcoin blockchain system, in which all transaction information (node identity information is hidden) is distributed (the term “broadcast”) to each node in the blockchain network to form a distributed consensus public Information (public information), so nowadays common blockchain systems face outstanding privacy protection or private information protection issues in practical applications, which has resulted in how to balance trade-offs in blockchain applications. The problem of distributed consensus and information distribution, that is, the higher the degree of decentralization of distributed consensus, the higher the requirement of blockchain system for information distribution. Third, theoretical and empirical research shows that information distribution has a negative impact on the competition between industrial organizations and the market, that is, the higher the level of information distribution, the more likely it is to generate collusion. Therefore, information dissemination is not only the premise but also the product of a block consensus smart contract that relies on distributed consensus, which in turn makes Carter’s industrial organization characteristics appear in the blockchain system. As the “Financial Times” of the UK commented on May 11th, 2015: Blockchain technology is actually a cartel-style management. The nodes do not trust each other but still need to work together to maintain the value and stability of the blockchain system. Of course, competition among different blockchain systems can temporarily ease the possibility and degree of collusion, but the existence of network effects will enable a few blockchain platforms to have greater market power than traditional Internet platforms in the long term ). Therefore, people need to balance the difficulties of maintaining fair competition in the market and maintaining distributed consensus when using large-scale blockchain smart contracts.

Finally, we may wish to do a virtual experiment. Assume that in a blockchain economic system, manufacturers use smart contracts for pricing, and stipulate that the lowest bidder to consumers will be automatically executed by smart contracts and take away all the producer surplus. For other simultaneous vendors, as discussed above, due to the trade-off relationship between distributed consensus and information distribution, rational vendors would conspire to give away the highest price of consumer surplus (think about Bitcoin) in order to avoid the automatic execution of the smart contract. Price formation mechanism). This ideological experiment tells us that, especially in government departments, the blockchain platform that superimposes information distribution and network effects will form an unprecedented monopoly, which is undoubtedly an unprecedented social and economic challenge.

Therefore, smart contracts are perfect contracts.

© 2018 Vidrih Marko


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