Tag: blockchain

BLOCKCHAIN PHYSICAL ASSETS

The blockchain originates out of the purely digital realm of Bitcoin. Thus blockchain networks themselves can only ever manage what is on the network. This is fine if the asset is simply a digital token. But going forwards we find ourselves increasingly wanting to use these networks to manage real-world assets. Thus these value networks will have to interface with the real economy and this interface between the physical and information realms creates major issues.

Economies are, at the end of the day, still very much physical systems of technology, land, natural resources, buildings etc. if we are serious about migrating our economic systems to the blockchain, major consideration has to be given to that interface to ensure that the tokens are securely and accurately connected to their underlying physical assets.

In a digital system like Bitcoin, there is always consistency. Transactions obey the rules of the software and there are no exceptions.

In the real world, there are often exceptions. Cars are stolen, houses destroyed, videos turn out not to be properly licensed, commodities fail to be delivered. Humans sometimes don’t obey the rules. Therefore the key challenge for any system that involves tokenizing real-world assets, is to ensure that the digital token stays linked to the real-world asset.

Very few people in the blockchain world have an appreciation for the complexities of the physical systems that run our economies and their regulation; such as containers passing through customs at a port.

There is a huge gap between this very light dematerialized culture of the blockchain and the very heavy culture of traditional physical assets and the national legal structures that they are embedded within.

Today this interface is secured by laws and ultimately the physical force of a government that backs those laws. If you have a legal document that says a piece of land is yours and someone comes and resides on it you can go to the government and they will physically remove that person from your property if need be.

Imagine a token that represents a fractional interest in a set of gold bars in a vault. If a gold bar is taken from the vault, how will that be reflected in the digital token? Who will make sure that the token value stays linked to the gold bars that should be in the safe? Who will bear the risk and how? If the buyer of a token can’t be sure that the token is properly linked to the real-world asset, then the value of the token will fall or even become zero if no one has faith in the correspondence between the two.

ARBITRATION

At present blockchain systems are still dependent upon traditional legal frameworks for this linkage between the digital representation of an asset and the asset itself.

Currently, arbitration is seen as one of the most effective ways of mapping between what is happening on the blockchain and what is happening with the physical asset and the legal systems it might be embedded within. Arbitration is a long since used method for creating legal agreements in international commerce where both parties agree to bind themselves into a legal contract of their making.

An arbitration award is legally binding on both sides and enforceable in the court of choice.

One way of linking legal systems to what is happening on a token network is through what is called a Ricardian Contract. A Ricardian contract places the essential elements of a legal agreement in a format that can be expressed and executed in software. The aim is to make the document both machine-readable and readable as an ordinary text document, such that lawyers and consenting parties may read the essentials of the contract conveniently.

From a legal perspective, the use of markup language embedded within a largely legal prose document leads to reduced transaction costs, faster dispute resolution, enhanced transparency and improved enforceability. From a computing perspective, the Ricardian contract is a software design pattern to digitize documents and have them executed within financial transactions, such as payments, without losing any of the richness of the contracting tradition.

It is robust through use of identification by cryptographic hash function, transparent through use of readable text for legal prose and efficient through markup language to extract essential information.

Mattereum is one such project that tries to use Ricardian contracts to create an effective linkage between records on the blockchain and the established off-chain legally binding dispute resolution of arbitration thus giving what happens on the blockchain full legal weight under natural language contract.

Mattereum is the first, what it calls “Internet of Agreements” infrastructure project for legally-enforceable smart contracts, enabling the sale and lease of physical property and other transfers of rights in assets. Mattereum is billed as a court that understands the nature of cryptocurrencies, making physical property and intellectual property transactable on a blockchain.

In a case where you might buy a physical asset using a fraction of a Bitcoin and the seller does not follow through, it is difficult to explain this to a judge in a small claims court. This is where Mattereum comes in, enabling technically competent arbitrators to make rulings in these cases instead of a judge. As the founder of the project, Vinay Gupta describes it “Mattereum.com is my bid to get the necessary legal frameworks in place to make direct control of physical property using the blockchain recognized in 150+ countries. I want to break the door open to the material world so you can change the status of a smart contract, and have a real-world court recognize that legal ownership of a fiat asset has changed hands. Fiddly, but it’s necessary infrastructure for all of our next steps together.”

TECHNOLOGY

The alternative to depending upon traditional centralized legal institutions is depending on technology. Code may be the law on the blockchain but outside of those networks, Big Data and IoT will be law.

Big Data is going to give us new insight into what happens when and where with high levels of statistical assurance. While at the same time IoT will put code into all of the technology around us that we are now so dependent upon and that is a new form of law enforcement. If you have the code that can stop a car or open a door lock then you control that system and can enforce whatever contract is on the blockchain.

As an illustration, we might think about a blockchain IoT securitization of gold. We create an automated warehouse, people are allocated secure sealed lots within the warehouse. We deposit a stock of gold in one area and when someone purchases a block of gold the system automatically moves it to the owner’s container and the owners gold token account is calculated by summing up the gold in their container. This is a simplified representation of a blockchain cyber-physical system where blockchain records and tokens are linked directly to the underlying asset through automated technology. By an extension of this model whole buildings, cars and other assets could be directly connected to blockchain tokens thus bridging the gap between the virtual token and the physical asset.

SECURITY TOKENS

The first application of blockchain technology may have been in currencies, but people are becoming increasingly aware that a secure distributed ledger system of this kind could in fact potentially support all economic activity one day.

Today startups around the world are feverishly building new frameworks for migrating ever more spheres of financial and economic activity to distributed ledger technology.

Many believe that the next stage in this process is the conversion of capital markets to token networks as it is becoming increasingly apparent that the management of securities of any kind, from stocks and bonds to real estate, could be brought into the age of information through tokenization.

There is currently great interest by financial intermediaries and technologists in figuring out how to move real-world assets onto blockchains to gain the advantages of distributed ledgers, while keeping the characteristics of the asset.

The conversion of capital markets to token networks would create many efficiencies. It could take the somewhat elite world of high finance and make it accessible to any and all. Creating new opportunities for investors and new sources of equity for organizations.

Our capital markets of various kinds today hold trillions of dollars of assets that are being used far from their potential. Locked up by high transaction costs, low transparency, layers of middlemen and bureaucracy.

The tokenization of this system could radically improve the efficiency of transaction processing by removing the layers of bureaucracy created by centralization. It could unlock vast amounts of currently locked up fix capital. It could create a quantum leap in transparency, opening up capital market data to advanced analytics in unimaginable new ways. Likewise distributed ledgers are tamper-proof making them less susceptible to fraud.

CAPITAL MARKETS

Our world is full of different forms of assets: oil, basic foodstuff, stocks, carbon credits, real estate, gold, etc. Many of these assets are difficult to subdivide or physically move around. So buyers and sellers instead trade pieces of paper that represent ownership of part or all of those assets.

However this existing system composed of paper and lengthy legal agreements is cumbersome. Assets are difficult to transfer and can be hard to track.

Tokenization of securities is the process of converting rights to an asset into a digital token on a blockchain.

Any asset that is currently traded on a capital market as a security, such as commodities, shares, bonds, or various forms of derivatives, could be tokenized by linking them to a blockchain register.

Indeed any asset at all could be securitized by linking it to a digital token. This might include any form of property, such as a house. It might include loans or mortgages, all of these could be converted into security tokens and traded on markets.

The most obvious use of this system is the raising of initial funding for a new project. Already huge amounts of funds have been diverted from traditional forms of venture capital in to directly funding projects through ICOs.

Many industry observers believe that mainstream companies will one-day issue shares through ICOs, either in place of or in addition to traditional public offerings.

ICOs are a good example of where we are heading as we shift more of capital markets onto the blockchain. They illustrate the capacity to open up these markets to the many, as venture capital has gone from the domain of a few investors, to being accessible to anyone on the planet with internet connection and a few dollars.

They illustrate the direct peer-to-peer nature of token economies. But what we have seen so far is really just the tip of the iceberg as what has happened to venture capitalism could literally happen to all of capitalism. As all capital could be tokenized. A number of platforms are currently in operation or being built to do exactly this.

TOKEN PLATFORMS

LAToken is one such platform. LAToken is an asset tokenization platform that allows users to convert tangible assets, such as real estate or precious artworks, into tokens, thereby making them sellable in fractions. You can tokenize your asset on their platform and sell it in fractions to investors. Investors may then sell the tokens on a secondary market and you can buy back the asset later on, or sell it on the settlement date.

Imagine an artwork by a famous artist with 100 copies. The art prints could be tokenized by having ownership held by a company that has a standing offer to the public to redeem tokens for either a single art print or a fraction of one copy. In this way, buyers could obtain an easy-to-transfer token and a secondary market could transact in fractions of the art prints.

This could potentially be a source of financing for the artist and a way for the broader public to participate in the art market that is currently inaccessible to most.

Likewise, commodities could be converted into security tokens and traded.

Imagine a group of companies that want to trade aluminum with one another. Normally they’d exchange paperwork and keep their own lists of trades. If they could move to a blockchain-based system for trading their aluminum, they could potentially reduce paperwork and have more robust record-keeping.

SELF-SECURITIZATION

One of the fascinating aspects of distributed ledger networks is that they can enable people to securitize their own assets.

Tokenization is an extension of the more traditional process of securitization, which is the conversion of an illiquid asset into a record that can be traded to increase liquidity.

Whereas previously the creation of securities was the domain of large highly regulated centralized organizations, blockchain networks can automate this process and make it accessible to all. People and organizations of any kind could securitize any asset that they own. They simply lock it on the blockchain and receive liquidity in return, when the liquid capital is returned the illiquid asset is unfrozen.

Sweetbridge is one token platform that is essentially enabling people to be their own banks when it comes to loans. This is done through creating a blockchain network where people can register and lock up their own assets as collateral, against which they can borrow money at low-interest rates or even no interests rates at all.

Users are essentially lending themselves money without a credit check because they are lending it against their own assets they have locked up.

What is happening is that when you lock an asset into the network, the network grows in value and gives you the tokens equal to that growth in its value, which you can then exchange for other tokens of fiat currency. Because you are creating the currency and not renting it from somebody else you don’t need to pay much interest on it or even no interest at all.

Where this gets exciting is not in developed economies, it is in places where you have a highly ineffective and inefficient formal economic system and a high level of informality, such as the developing nations of Africa and Asia.

In these environments, interest rates tend to be very high and loans tend to be very difficult and yet these are the roots of the supply chains of the world. This is where the food is grown, where the minerals come from. In these frontier markets it can be really tough to get financing of any kind and if you do it’s very expensive. It may be 10 to 20 percent. With a security token platform like that of Sweetbridge, no credit rating would be needed. You just lock up some asset and get liquidity in return at a low-interest rate.

This can be revolutionary, making a massive difference, not just for global trade but in the lives of the most vulnerable.

REAL ESTATE

Real Estate is another asset class that is set to move to token networks in the coming years.

The stock of real estate assets is enormous, it is the biggest asset class in the world, valued at well over 200 trillion dollars.

At just 1.4 trillion in transactions every year, most of this market sits stagnant and does not really trade. Real estate is a very illiquid market and one of the least transparent. Buying and selling property especially on the global market across borders is full of frictions, middlemen, and lengthy procedures.

You can hold a piece of a corporate or a government debt in a bond, but it is very difficult to hold a piece of property and there is a lot of friction to trading property. While at the same time for many assets in real estate people will pay up to 20% more for one that is liquid versus one that is not. So tokenizing these assets could release huge amounts of untapped or underused resources.

Atlant is one platform that is working to tokenize real estate. It does this by linking the property to a special purpose vehicle (SPV) which is then converted into tokens. The property is purchased and transferred to the SPV. The SPV is split into many shares that can then be traded on the platform with almost no friction. Now a person sitting in Taiwan can at the click of a button invest in the creation of a new factory in Poland or a section of an office space in Mexico City.

Likewise, through this tokenization of property, the physical asset can be split up into extremely small units of equity, that make the whole market greatly more liquid. Say for example you have a shopping center, the platform can tokenize it by dividing it into a million centimeters of floor space. People can then exchange those small units or rent the property they own out.

PHYSICAL LINKAGE

In all of this conversation around the tokenization of real-world assets remains one big elephant in the room, which is the question of how exactly do you put assets on the blockchain?

The linkage between the information software layer of the blockchain network and the physical real-world asset is of course of critical significance and in many cases remains an unanswered question as to how exactly that linkage is secured. So in the next module we will pick up on this very topic.

UTILITY TOKENS

A token is a generic quantified unit of value that is registered on a blockchain network.

Today tokens are understood to come in two kinds: utility tokens, and securities tokens.

Security tokens represent fixed assets of some kind, it may be a piece of property such as a house or a share in a company.

A utility token is a more liquid medium of exchange that gives one access to the value created by a blockchain network. Utility tokens really represent access to a service delivered by a blockchain based ecosystem.

To understand token economies it is best to think in terms of services and not products. Utility tokens represent the service delivered by a network. The utility tokens are quantified units of services that can be accessed within a given network.

Tokens are generic units of value. This means that they can represent any kind of value. Wherever there is a network delivering a service, a token can be created to define that value.

We can create a token for any different type of network and service.

For example, a community watch scheme where people look out for each other’s houses to make sure there are no trespassers or burglars. This is a community that is delivering a valued service of securing peoples houses.

We can then define an economy around that community, by creating a token that quantifies the service delivered and a blockchain system that keeps track of who is delivering the service and who is using it.

This utility token is then used as a medium for the exchange of that service. Those who consume the service have to give tokens to those the provide it. In this example, we can see how token economics works to formalize what was previously informal and merges economics and social communities in new ways.

The service can be of many kinds. Health care services, for which we might have a health coin; it could be cleaning services, a clean coin; a transport service.

For example, the DAV Token is a form of utility token. The DAV network is a blockchain platform currently under development that connects transport and logistics service providers with those who need those services – in particular, it focuses on connecting autonomous vehicles.

Members of the ecosystem can earn DAV Tokens by providing transportation services, by say, letting your self-driving car give rides to passengers when you’re not using it, or having your drone help with deliveries. While users of the service pay tokens to be transported anywhere or to send and receive packages through the network.

A utility token, such as that of the DAV Token, should then reflect the quality and quantity of the service that the network can deliver. The better the quality the more people will want it, and the greater the quantity of service delivered, the more tokens will be needed.

DIGITAL CURRENCIES

Some people classify digital currencies as a third type of token, but they can just as easily be understood as a utility token.

For example, we might think of Bitcoin. Ultimately, Bitcoin’s value comes from its capacity to be exchanged for some service or exchange for some other currency that can be used within a national economy, such as the Euro.

Currencies like the Dollar or RMB have value because we believe they have value. But ultimately they rest upon the fact that they are supported by the massive real economies of the US or China. Really they are utility tokens that give you access to the services delivered by those economies.

If the Japanese real economy disappeared tomorrow the currency would crash because people would stop being able to buy things with it.

Currencies are just mediums of exchange and agreements about what we value but they are supported by real economies and governments that make sure those currencies can be used to access the goods and services within their economy.

Bitcoin may not be directly linked to any one national economy, but at the end of the day, it is linked to the global economy in one’s capacity to exchange it for other fiat currencies that are linked to national economies.

Thus we can see how currencies are a form of utility token that provides access to the services created by a given economy. Whereas fiat currencies provide access to a national economy, tokens provide access to a blockchain based network economy.

ICO

Because tokens have a price, they can be issued and sold at the inception of a new network to fund its development. Similar to the way startups have used crowdfunding platforms like Kickstarter to fund product development. The money is typically received in digital currency form and goes to the founding organization that is developing the network and issuing the tokens.

In the same way that a company increasing sales is an alternative to raising money, token launches can be an alternative to traditional equity-based financing and as we will discuss in a future module, can be an effective way to fund previously unfundable shared infrastructure, like open source projects.

Utility tokens, also called app coins or user tokens, represent future access to an organization’s product or service. The defining characteristic of utility tokens is that they are not designed as investments. If properly structured, this feature exempts utility tokens from legal regulation covering traditional forms of securities.

By creating utility tokens, a startup can sell “digital coupons” for the service it is developing, much as retailers accept pre-orders for a good that may only be available weeks later.

Filecoin, for instance, raised over two hundred million by selling tokens that will provide users with access to its decentralized cloud storage platform. Thus we can see that the traditional divides that defined the industrial age financial system become blurred and redefined within the new model of token economics.

The question is though, why do we need hundreds or thousands of different types of tokens? Why can’t we just pay for everything in Dollars like we used to or even in bitcoins, wouldn’t that be simpler?

Answering that question goes to the heart of the distinction between token economics and traditional industrial age economic systems and we will talk about this in the coming module.

TOKENIZATION

As we have discussed, economies are first and foremost about value: what humans value and how we strive to achieve the things we value. To have an economic system the first step is to take account of this value that is in the system.

The foundations of economics is being able to securely represent the underlying resources and exchanges within the real economy in some information system and then being able to exchange, analyze, distribute or otherwise alter it in various ways.

The critical aspect of this process is that the information accounting layer remains true to the underlying assets and exchanges within the real economy. Of course, many people will wish to alter these records to their advantage and thus we need some trusted source for maintaining and verifying them. Previously we have relied upon centralized institutions to take account of and vouch for the authenticity of these records of value.

However, the secure and trusted nature of blockchain networks makes it possible for us to directly associate the value of a real-world asset with a programmable asset and we call this tokenization.

“Tokenization is the process of converting rights to real-world assets into a digital token on a blockchain.”

Previously we could not create trusted records of value without the support of centralized institutions. Creating token systems at large scale has previously been the purview of states and empires.

The implication of having an automated distributed system like the blockchain is that everything could be securitized by everyone, as we greatly expand our capacity to define, measure and exchange value of all kind.

We can now set up blockchain networks that can store records of value and be trusted by members involved without anyone actually controlling or really owning the network.

IMPLICATIONS

The implications of this are many fold. Firstly we are no longer dependent upon lengthy and often expensive bureaucratic procedures for the registry of valued assets. People can literally securitize their own assets and have them validated by the network.

Secondly, we are no longer confined to assets that are large enough to be worth some centralized institution recording and tracking them. With digital technology, the cost of doing this is so low that we can securitize almost anything and with personal and mobile computing people can do this themselves.

Thirdly with parallel advances in big data and pervasive sensing, mobile computing and social networking, we are now able to track more types of value that previously went unaccounted for and assign tokens to them.

Lastly, the implications of blockchain tokenization should be considered, as token economies shift the locus of power both outwards to the individual and to the networks that manage these economies.

Previously we invested a massive amount of power and control within centralized organizations as they were the ones that got to define value within society and economy, but with token economics, the management of value records and exchanges shift to information networks with huge implications.

FORMAL ORGANIZATION

Centralized systems of organization for the recording and validation of assets have advantages, but they also have many limitations. Because they are centralized they create bottlenecks; there are a few people in the center trying to serve a large population.

If the administration is well developed this can work to a certain degree. Land registry in places like Germany and Singapore may work well but for most of the world it does not. In places like India or Africa centralized institutions are overwhelmed and under-resourced to provide for the mass of people and as a consequence, the majority of our global economy is undocumented and informal; not having access to legal rights, financial services, etc.

Likewise, centralized systems require many layers of hierarchy and regulation to ensure that people are acting according to the mandate of the organization. As the system gets larger more and more layers of bureaucracy build up. Take for example the administration of organic farming in a country like Ireland, there may be an organization for assessing and certifying the farmers, which will be assessed in turn by some national body which may, in turn, be assessed by the European Union. These different layers of bureaucracy create high overhead costs and over time create inertia.

COST OF TRANSACTION

The formal proceedings of large bureaucratic systems is often overbearingly complicated and expensive for people to avail of them.

For example, If you look at the administration that lies behind trying to issue 100 million shares and all the different institutions, you have to pay to keep shares and register them, to distribute them, keep track of them and regulate the whole system. It takes an enormous amount of work effort and cost. Thus most companies don’t get to access global capital markets via the offering of shares.

With the tokenization of assets, they move on to digital exchanges where they can exchange a very low cost and in very small increments.

Something like a building can be tokenized and instead of having to buy the whole building with huge legal and regulatory overhead costs you could now purchase one square centimeter of the building in seconds with very little overhead cost.

MULTIVALUE

Thirdly, information technology is expanding our capacity to quantify value and tokenization enables us to capture different forms of value; social capital, natural capital and financial capital. The thing to appreciate is that this is not just about the blockchain, this paradigm shift in economics is possible because of very fundamental changes in information technology that go far beyond the blockchain itself.

A key aspect here is datafication, the fact that we are quantifying and turning more and more aspects of our world into data.

In a world of scarce information, we were limited in what types of value we could quantify and how much we could keep track of. But in a world of pervasive information and communications, we find that we are spontaneously quantifying and tracking all sorts of new forms of value that previously when unaccounted for. Social networking is one good example of this.

Token systems enable us to ascribe value to everything that we value and create markets around that.

One of the great advantages of token economies is that we can create token networks for the things that people value.

In our existing economy, we are fully dependent upon centralized institutions to define value. Centralized institutions will only do things that are in their interests. If something is not in the mandate or interests of a centralized organization we find that it will not get done.

We may find that it is not in the interests of any centralized organization to remove the trash from the side of the road but by creating a token system, we could incentivize people to clear the rubbish.

In a traditional free market system, we may not be able to place a value on the functionality of an ecosystem, and the government authorities may have every incentive to simply sell out the nations natural resources. But by creating an eco token we could try to capture and manage that value via the token network.

Take for example Plastic Bank. The Plastic Bank creates social and environmental impact in areas with high levels of poverty and plastic pollution by turning plastic waste into a cryptocurrency. By enabling the exchange of plastic for Blockchain secured digital tokens, they reveal the value in plastic. This empowers recycling ecosystems around the world and stops the flow of plastic into oceans by creating a market that connects those who can use plastic waste for recycling and those who have time to collect it.

DECENTRALIZATION

The capacity for communities of people to directly define what they value and create economies around that without depending upon a centralized institution to do that for them is truly revolutionary.

It is truly a restructuring of the very fabric of our civilization with massive implications and repercussions that will take decades to play out.

It removes current bottlenecks that have limited the availability of formal economic and financial structures to a small minority of the global population and makes it possible to extend the most advanced and sophisticated legal frameworks and market systems to anywhere on the planet.

It enables us to extend the exchange of value and market mechanisms to very small, high volume exchanges, such as between machines and computers.

It allows communities to define what it is they value instead of that being decided by a centralized authority.

And as we will discuss it allows us to incorporate a broader spectrum of values into market exchanges.

“So everyone has different value systems. And every community or every organization, embodies those values system. But today we only have one way of actually transferring this value around and that’s through fiat currency. The idea is actually to have multiplicity. So right now we have a monopoly of value sets, which is the market value set. And if we can create new values with a new value system which are basically represented by those tokens on the blockchain but in fact what it is, is the ability for communities to express what they value by transferring tokens” – Primavera De Filippi, CNRS & Harvard

TRIPLE-ENTRY ACCOUNTING

One of the great innovations made possible with the advent of blockchain technology is the development of triple-entry accounting.

Triple-entry accounting is a term for a new method of accounting, that was proposed in the 1980’s. It was more recently popularized when Ian Grigg associated it with blockchain technology. Triple entry accounting is an enhancement to the traditional double entry system in which all accounting entries involving outside parties are cryptographically sealed and linked through a smart contract to a third entity. But to understand the value of this we need to appreciate a little bit the history of accounting systems and where we are coming from.

SINGLE-ENTRY ACCOUNTING

There is evidence that even during the Mesopotamian era, some four or five thousand years ago, a fairly complex accounting of property, purchases, and expenditures existed on tablets.

Extensive accounting methods also existed in Greece since the fifth century B.C.

By the middle ages a fairly advanced system of accounting had developed, but before the advent of double-entry accounting, accountants relied on a chart of balance sheet accounts to record financial transactions. This single-entry accounting system is a method of bookkeeping relying on a one-sided accounting entry to maintain financial information. This creates a system that is very difficult to examine for accountability.

Consider the extreme problems such a system would pose today. Companies would publish balance sheets without Income Statements. There would be no way for investors to scrutinize the changes in equity.

With a single-entry system, all you have to do is remove a line in the ledger and that money no longer exists. There was no way to verify, no way to audit, no way to reconcile, for people to agree. Likewise, it would be nearly impossible to build a single entry system, that by itself supports the reporting needs of public corporations, companies that sell shares of stock to the public.

DOUBLE-ENTRY ACCOUNTING

The development of double-entry accounting opened the realm of accounting into a whole new world.

Double entry bookkeeping revolutionized the field of financial accounting during the Renaissance period some six hundred years ago. By the 1400’s, a Franciscan friar finally codified the double-entry system and it swiftly became the standard with the merchants of the Italian states. Whereas simple ledgers had long been the standard for record keeping for merchants, the church and state treasuries, the growth of long-distance trade and creation of the first joint stock companies resulted in firms whose records were too voluminous and complicated to provide any assurance of accuracy to their users.

Modern financial accounting is based on a double entry system. Described simply, double entry bookkeeping allows firms to maintain records that reflect what the firm owns and owes and also what the firm has earned and spent over any given period of time. The idea is you want to minimize the errors in your bookkeeping so what you do is that for each transaction you do two entries in your books.

The issue with double entry accounting is that there is not really any connection between the different sets of books each firm holds. The records are themselves separate, so if Bob wants to cheat a little bit he can say that maybe this transaction was only eight tokens and he doesn’t have to pay as much in taxes.

Likewise, as the organizational structure and sophistication of companies developed they were expected to share their records with outside stakeholders, such as investors, lenders and the state. This created the problem of how outsiders could trust the company’s books and thus required auditors.

Although you did your double entry accounting in your book there was absolutely no guarantee that the bank, or whomever else you were dealing with, saw the transaction the same way and recorded the same numbers. In fact, as part of an audit, one would have to write to the bank and ask did this organization really have this money at this date and do you agree on this number.

So all this massive amount of administration could be removed if we have an economy-wide accounting system.

TRIPLE-ENTRY ACCOUNTING

Triple-entry accounting can be thought of as a way of agreeing on objective economic reality.

Triple entry accounting is an enhancement to the traditional double-entry system in which all accounting entries involving outside parties are cryptographically sealed by a third entry. Thus placed side by side, the bookkeeping entries of both parties to a given transaction are congruent.

The third entry in the system, entered into the blockchain, is both a receipt and a transaction. It’s proof that something happened between two parties, which goes beyond the receipts that each party holds in double entry system.

Since the entries are distributed and cryptographically sealed, falsifying them or destroying them to conceal activity is practically impossible.

A seller books a debit to account for cash received, while a buyer books a credit for cash spent in the same transaction, but in separate sets of accounting records. This is where the blockchain comes in: instead of these entries being recorded separately in independent sets of ledgers, they occur in the form of a transaction between wallet addresses in the same distributed, public ledger, creating an interlocking system of permanent and objective accounting records.

The idea about triple-entry accounting is that instead of each firm having their own books the transaction goes through a contract and this contract includes everything about the transaction. This may record what the product was, the prices, who is the seller and who is the buyer. It’s digitally signed and it can have a hash that links to further public documentation.

So the books are now linked together by this third entry, the triple-entry, that can potentially be viewed for external auditing purposes.

Triple-entry is quite a confusing term because we are not creating a third entry, we are just linking two separate double entries. That link is created via a smart contract that works to ensure that the two double entries in separate legal entities are always the same; this is auto enforced by the smart contract and as with all smart contracts it is tamper proof.

TRIPLE-ENTRY ACCOUNTING ADVANTAGES

The advantages of a triple entry system are numerous in terms of reconciliation, transparency, trust, and auditing. Triple-entry accounting allows us to reconcile the balance, the transaction, and the reporting process, so that organizations can trust their own books.

Typically, each party is responsible for maintaining their own financial records. However, this can lead to fraud or other errors. The use of triple-entry accounting reduces this risk by keeping a non-biased record.

Many blockchains are publicly visible or easily exposed to external viewing, making them transparent.

With blockchain networks, the entry is the transaction, because the assets are on the blockchain. The ledger is not an account of what happened, it is what happened.

And as the ledger is tamper proof this makes it trustworthy.

For auditing, blockchain accounting is ideal as it creates a list of transactions, thus it creates an immutable history of all the exchanges within the system which could be mined using data analytics. There is a perfect audit trail.

“We came up with double-entry bookkeeping as a species over 500 years ago and it led to the accumulation of capital on a very large scale with the Industrial Revolution and with a lot of the institutions that we have today. When we’re able to further refine that with triple entry bookkeeping it really opens up whole new vistas and possibilities for corporate governance, the transfer of money, accounting. We have this globally distributed decentralized ledger that everybody has the exact same copy of and all the debits and credits that move the bitcoins or the Satoshis around in this ledger, everybody agrees on consensus that those transactions actually happen and boom you got that verification so you have the debit the credit and the confirmation by the Bitcoin network” – Trace Mayer

DISTRIBUTED LEDGER TECHNOLOGIES

When we are talking about economies we are typically referring to the information layer that resides on top of what may be called the real economy: the physical production and exchange of goods.

Accounting is the basics of how we create that information layer and bring all these physical objects and services into the information system of the economy, that we then exchange and analyze.

The earliest most rudimentary economies of pre-civilization may have existed purely in physical form. But an economy of any complexity requires that the real system is translated into a virtual information form. Not just physical assets and liquid currencies but also identity and contractual agreements.

At the end of the day it all has to be converted into an information format.

In order to form organizations and exchange goods and services we need to define ownership and keep track of exchanges and this is done by a series of ledgers. A system of ledgers forms the database of records of who owns what and what has been exchanged within the system.

Ledgers are everywhere. Ledgers do more than just record accounting transactions. A ledger consists simply of data structured by rules. Anytime we need a consensus about facts, we use a ledger.

Ledgers record the facts underpinning the modern economy. All of our economic institutions are, at the end of the day, networks of ledgers; some simpler, some more complex.

A firm is often described as a ‘nexus of contracts.’ A firm is, in fact, a ledger of contracts, people, technology and capital that are arranged in a particular fashion to deliver some function. Firms maintain ledgers in a variety of forms: of property; of employment and responsibility; of ownership and deployment; of suppliers and customers; of intellectual property and corporate privilege; of physical and human capital.

It is safe to say that our economies are ledgers all the way down and at the bottom we find a government backed legal system. Where a ledger requires coercion in order to be enforced, the government is required. Governments maintain ledgers of authority, privilege, responsibility, and access.

Governments are the trusted entity that keeps databases of citizenship, taxation obligations, social security entitlements, and property ownership.

USAGE OF LEDGERS

Ledgers can confirm ownership through property rights. For example, property title registers map who owns what and whether their land is subject to any conditions or restrictions.

Ledgers confirm identity. Businesses have identities recorded on government ledgers to track their existence and their status under tax law.

Ledgers confirm status. Citizenship is a ledger, recording who has what legal rights and what obligations people are subject to.

Employment is a ledger, giving those employed a contractual claim on payment in return for work.

Likewise, the electoral roll is a ledger.

Ledgers confirm authority. Ledgers identify who can access what bank account, who can validly sit in parliament, who can enter restricted areas, etc.

At their most fundamental level, ledgers map economic and social relationships. They can be understood as an agreement about the facts and when they change.

This consensus about what is in the ledger and its accuracy is one of the fundamental bases of a market economy.

DEVELOPMENT OF LEDGERS

Ledger technology has for thousands of years remained largely unchanged. Ledgers originate with the beginning of written communication. Ledgers and writing developed at the same time in the Ancient Middle East to record production, trade, and finance.

The ancient clay tablets with cuneiform script listed units of work, taxes, rations, etc.

The first international trade networks were arranged through a structured network of alliances that functioned a lot like a distributed ledger.

The modern era brought the first major changes to ledgers in the fourteenth century with the invention of double-entry bookkeeping. By recording both credits and debits, double entry bookkeeping conserved data across multiple ledgers, and allowed for the efficient reconciliation of information between ledgers.

The 1800s saw the next evolution in ledger technology with the rise of large bureaucracies and the corporation. These centralized ledgers enabled major increases in organizational size, scope, and efficiency, but relied completely on trust in the centralized institution.

In the latter half of the twentieth-century ledgers moved from analog to digital. For example, the national databases of passport ledgers were digitized and centralized. These databases are computable and searchable making them greatly more efficient,. However, a database still relies on trust: a digitized ledger is only as reliable as the organization that maintains it.

ECONOMIC STRUCTURE

We can see how the economic structure of modern capitalism has evolved around the structures of these centralized ledgers. The 2009 Nobel laureate in economics, Oliver Williamson, showed that people produce and exchange in markets, firms, or governments depending on the relative transaction costs of the different institutions. Building upon the work of Ronald Coase Williamson’s transaction cost approach provides a key to understanding what institutions manage ledgers and why.

It might seem strange that a ledger — a rather mundane and practical document associated mainly with accounting — would be described as a revolutionary technology. But the significance of the blockchain is fully based on the significance of ledgers as the foundations to our economy.

Because, at the end of the day, ledgers are nothing more than a kind of database or information system, how we record value is of course critically dependent upon the information technology that we have available to us.

Traditionally we have required centralized institutions of private enterprise or government in order to provide the authority needed for people to trust a given ledger and the record of exchange.

However through advances in information technology, specifically the combination of distributed computing and cryptography, blockchain technology now provides the infrastructure for a network of computers to collaborate towards maintaining a shared, tamper-proof and trusted ledger.

Thus the blockchain provides an alternative to traditional centralized ledger systems of firms and governments. As such it is legitimate to say that the blockchain is an institutional technology. It is a new way to maintain a ledger — that is, coordinate economic activity — distinct from firms and governments.

A ledger of contracts and capital can now be decentralized and distributed in a way they could not before. Ledgers of identity, permission, privilege, and entitlement can be maintained and enforced without the need for private organizations or government backing.

The ledger is instead maintained by a distributed network of nodes. This changes the very foundations of economic activity with massive repercussions for how economies are structured and function. It literally rewires the channels through which we coordinate in the production and exchange of goods and services in society.

Ledgers are so pervasive — and the possible applications of the blockchain so all-encompassing — that some of the most fundamental principles governing our society are now up for grabs.

The blockchain is a distributed ledger that does not rely on a trusted central authority to maintain and validate the ledger. This means that we can create economic networks for the recording and exchange of value that are not dependent upon centralized systems.

Such a system for coordination via distributed ledgers would have many advantages. It would drastically reduce the cost of recording and thus make it possible for us to expand formal legal systems and economic activity. For example to the 2.4 billion people that currently have no formal ID or 70% of the global population that has no documented land rights. But also to record extremely small exchanges of value that are currently not feasible, and to account for new and different forms of value that are currently unaccounted for.

2017 witnessed the rise of a new model for the funding of technology companies called initial coin offerings (ICO). The amount of money raised in 2017 by startups via ICOs surpassed early-stage venture capital funding for internet companies.

This is the first example of these new token networks already replacing one area of the traditional financial system in a substantial way and we can note the speed with which that happened.

Within the space of just a few months, ICOs went from almost nowhere to today where new blockchain projects are able to attract hundreds of millions of dollars by offering tokens directly, for anyone with an internet connection to purchase.

The rise of ICOs as a new model for growing economic networks is no accident or random event, it taps into a new capacity of information technology – first seen with crowdfunding – for people to fund their own projects directly out of the future value the project is expected to deliver. The centralized third-party investor is removed which takes away the need to organize the project around investor profits – or to remove value from the network for shareholders. Instead, the network funds itself out of selling access to the future service that it will deliver. Thus retaining the value within the network.

Indeed this illustrates one of the important aspects to note: these networks are very autonomous. A network can fund its own initial development through an ICO, but not only that, it can then fund its own future growth through simply increasing the number of tokens and given those to members who present initiatives, projects or other forms of work that will be of benefit to the future success of the ecosystem.

The network inflates its own token, gives those new tokens to projects that will increase its future service delivery and thus will work to deflate the token in the future when more people demand that added future service.

In this way, no external profit-seeking third party, such as a bank or other financial institution, is needed. By removing that third party you have the potential to also remove a massive amount of overhead costs and regulation, likewise, you stop the value being taken out of the network and you align incentives between members better.

ICOs and prediction markets will be a central part of long-term economic development on token networks, but these will also be combined with advanced analytics as a primary mechanism for coordinating the network in the short term.

The convergence of advanced analytics and blockchain networks will be a major part of the workings of these token networks. Like with the existing digital platforms of the current internet, these blockchain networks are going to datafy everything, they are going to create massive amounts of data and will be highly amenable to complex analytics.

With the use of this big data, business and economics will move from the realm of speculation and intuition to becoming more of an actual science where data can be gained, theories tested, and new systems engineered in an iterative process with a much more complete and effective feedback loop.

Unlike our traditional economy, which existed historically outside of information systems, these economic networks exist by default within information systems. They thus are well defined in terms of software and they automatically create data. This means as soon as these networks are up and running we are going to start applying analytics to them, using that data to adjust the incentive structures, gain feedback and iterate on that in a fast pace learning process.

Likewise, being open source projects, anyone can see how the system is designed and coded and they will have the data to see how any changes perform. The functionality of these systems will shift to the software layer and if that is open source, anyone may contribute and earn tokens if their contribution is successful as measured by the feedback loop.

Today businesses have been largely secretive by default, run by a few with decisions ultimately made by the highest paid person in the room. Economies have been directed by whoever managed to get elected and abstract economic theories that have never been really tested on real data with direct feedback to see how they work in practice.

Scott Nelson CEO of Sweetbridge describes some of this well when he says “what we do need in addition is to understand that we are dealing with the actual invention of something extraordinarily new and very powerful and that is the ability to build economic games that actually are businesses and which are controlled by a community who’s vested in the game, and the countries that master this are going to be the railroad baron company countries of this century. I mean we are dealing with a sea change here that cannot be underestimated because the power of economic engines to be tuned and now measured, we can actually see the economic activity of the customer what they’re doing and get very direct feedback loops about how the customer is using the system and when the transparency is extremely high in the environment, this changes everything.”

We have almost zero experience with the design of large-scale decentralized economic networks. Added to this is the fact that we can’t just shut down existing systems while we migrate them to the new model; as an analogy, we can say that this is like rebuilding an airplane while it is flying with all of the passengers inside. The only thing we can say for sure is that this is going to be a rocky journey.

Nothing is promised and written in stone in this new emerging economic paradigm. There are always ways for resources and power to be re-concentrated in new ways, for potential to go unrealized or misdirected.

The only thing that can ensure the desired outcomes are really understanding the dynamics of these systems and using that to design and develop economic networks that truly enable people.

Systems that work by default to push capabilities and resources out to the edges of these networks and engage everyone, providing them with the tools to participate in a level playing field.

As Shermin Voshmgir of the Crypto Economics Institute notes “[Blockchain] is a very powerful technology and it will spawn further technologies, we can use it as a machine to promote universal freedom, to create a better decentralized society, with less bureaucracy which will be better suited to a globalized world, [but] if we don’t do it right the very same technology can become a machine for universal control, to prevent that we have to take all aspects into account.”

It is in the combination of advanced analytics, blockchain networks, and IoT that the Information Age comes of age, as information based networks gain their autonomy and break free from the supporting industrial age model. It is important to note these networks aren’t going to be contained and confined within the box of our existing model; we will increasingly find that all of these newly formed technology-based networks converge and work synergistically to provide a coherent and integrated set of new solutions that take us into a new paradigm.

With the blockchain, it is critical that we think outside the box of the established parameters that have defined our industrial economies for centuries now.

This is a new stage in the information revolution, these networks won’t be like the networks of yesterday or today, the Facebooks and the Amazons that are limited in capacity and very dependent upon existing structures. These new forms of decentralized organization will be greatly strengthened and gain much greater autonomy, within a decade or so these networks won’t be confined to operating within the model of the past and it is important to keep that in mind both the potential and risks that it offers.

This is not just another technology that you adopt. This is a fundamental re-architecture of how things work.

Those who don’t grasp that and try to fit it into the box will get left behind surprisingly fast, as innovation is currently being unleashed at a staggering pace, fueled by large amounts of capital, already billions of dollars are starting to flow into these new emerging networks.

As a recent paper on the subject notes. “This process is going to be extremely disruptive. The global economy faces (what we expect will be) a lengthy period of uncertainty about how the facts that underpin it will be restructured, dismantled, and reorganized.”