Since 2015, the blockchain industry has generated a variety of economic concepts and supported them with relevant technologies: initial coin offerings, initial exchange offerings, security token offerings, data access object, permissioned ledgers, stablecoins, decentralized finance, etc. In a short time frame, some of these went all the way from their heydays to oblivion. Emerging concepts, like DeFi, and corporate stablecoins, e.g., Libra, are at risk of repeating this trajectory. Let’s be honest — the wishful dreams of many enthusiasts about global tokenomics are unlikely to happen in the nearest future. So, what’s wrong with these concepts?
Legal rights and enforcement
A few years ago, many naive investors easily bought into exhortations of “a unique financial and legal nature” of tokens and their relations. But when the hype cooled down, people started seeking answers about their legal rights and interests. Who needs tokens of corporate rights, securities and real estate, which are not pegged to real legal rights and obligations?
Even stablecoins might not be so stable. In Clause 3 of Tether’s service agreement, the picky reader finds that Tether (USDT) tokens might be delayed in redemption to the user and even replaced with estate other than United States dollars. How would you react if you were trying to withdraw cash from your account, and the bank clerk said: “Sorry, we cannot give you your dollars back but bonds of ‘Company X’ instead, and not today, but in three months?”
And if these securities have no value at all, it will be an absolutely legal transaction because the financial institution did not promise to return your money.
Supposedly, the market will demand players to tie tokens they issue with legal obligations and liquid property rights at some point. So, investors may eventually convert their, say, three tokens into three square feet of property, or a block of crypto shares into corporate shares or crypto shares as the shares of that corporation.
But there are some problems. Tokens are far from the reality of laws and legal rights because of the technical specifics. A blockchain is an append-only database of transactions, and retroactivity or access of third parties is impossible. Only the owner of the private key to the address where tokens are recorded can authorize further transactions. It causes a long list of legal considerations, but to make it clear, let us name the major ones.
There is no way how a user: can inherit a token; can enforce a lawful court decision, for instance, to resolve a dispute; or can restore access if the private key is lost.
If the token is the primary source of knowledge about your legal right for anything, you lose this right by losing access to this record, as you cannot dispose of it — i.e., perform any transaction. You cannot simply create another token to represent the same right. Any buyer will have legitimate doubts that someone else suddenly finds the private key to the lost token. Tokens representing the same right in the system will create a sort of double-spending problem. This model runs the risk of uncertainty in who owns what, and it is unlikely that massive tokenization will happen under these circumstances.
Decentralization and intermediaries
To address these problems, some startups design ad hoc solutions, most of which are questionable. For example, a token issuer leaves a backdoor in the smart contract to manually resolve users’ disputes when they arise. Or tokens are used as an indication or intention for acquiring legal rights, but meanwhile, they are backed with traditional paper transactions. Why would anyone declare “decentralization and elimination of middlemen” to end up with a smart contract heavily relied on a third party? Or what is the value of such a token if not the token, but the paper that represents your rights? Who even needs these double standards? Why is blockchain technology needed at all if one can keep the ledger on a spreadsheet?
Digital identity and erasure
To make the problems complex, we must add issues with digital identity and privacy. In the world of strict Know Your Customer rules, nobody wants to deal with pseudonym identities. However, the creation of identities on a blockchain is not an option — at least you cannot expose any personal data in open form. Once any data is published on the ledger, it cannot be erased.
For the same reasons, it is believed that blockchain technology is intolerant to mistakes, and there is no way to correct them.
Scalability and volatility
Another consideration is scalability and price volatility. Many credible public blockchains cannot handle mass transactions. Transaction fees will inevitably increase, exacerbating the problem of price volatility of cryptocurrency.
To run a smart contract or even a simple transaction, you will need some coins to spend. With rising fees and exchange rates, these expenses become unpredictable to plan.
Is a permissioned ledger an alternative? Spoiler: No
The first blockchain — Bitcoin — appeared as an uncensored decentralized distributed ledger. A permissioned ledger means that someone controls it, and I doubt it is correct to call such a system a blockchain. Therefore, let’s just call this type of technology “permissioned ledger.” Additionally, the stronghold of European technologies, the European Union Agency for Cybersecurity, uses this term in its report, omitting to call it “permissioned blockchain” contrary to their colleagues from the U.S. National Institute of Standards and Technology. Indeed, “permissioned blockchain” is a rhetorical oxymoron.
The basic feature of blockchain technology is its openness and competitiveness. This is the real guarantee for the immutability of the ledger and double-spend protection. Decentralization is not a state; it is a dynamic process of the struggle of good and evil where the economic incentive of mining always wins. This component is normally absent in a permissioned (private, enterprise, federated, etc.) system where the control over the system is initially predesigned. And this system is granted not to sole control by one admin but shared among participants of a private consortium. For users and outside observers, this inner circle remains a closed and censored system where even retroactivity (altering transaction history) and erasure of transactions might be legitimate options.
Permissioned blockchains are presented as an alternative to public blockchains, as they can address the aforementioned problems, but it is still too early to release blockchains, as permissioned systems raise the legitimate question of: Why is it better than any other centralized system? Especially when we are talking about traditional land registries and other public property registries that exist. Governments around the world have got used to traditional centralized systems, which they have been using as property databases for decades.