Who will control cryptocurrency?

Original Title: 《Who will control crypto?》

Original Authors: Saffron Huang, Josh Stark

Compilation: Block unicorn

Assuming Ethereum succeeds, blockchains are widely used for global commerce and coordination. Anyone with an internet connection and a mobile phone can directly access the global network for money, value, and identity. Every day, billions of people interact with the L2 chain ecosystem guaranteed by Ethereum. Security practices are improved at every layer of the stack, and major hacking incidents are virtually nonexistent. It becomes common for businesses and individuals to create crypto tokens, with national currencies issued on the blockchain.

The legal, social, and economic norms of society are universally reconfigured within new organizations, interaction patterns, and digital objects (such as NFTs); the global economy adopts the blockchain's "API" as the default.

However, over time, changes will gradually occur behind the scenes. The decentralized protocols that sparked this revolution slowly lose market share to more centralized alternatives.

In this context of success, the libertarian sentiment within the vast crypto community today is declining. Convenience and cost become more important. Governments and central banks have time to catch up and launch their own centralized blockchains, specifically issuing their national currencies and bonds on these blockchains, attracting economic activity to these "national chains." Businesses and individuals use them for tax purposes. In some countries, governments require that their national chains be the only legally used blockchains for their citizens.

Many people will use national chains, as doing so involves almost no friction; they differ from the cumbersome paperwork and bank letter verification systems of the past. People can use their wallets, which they are accustomed to in decentralized blockchains, to do most of the same things. Governments may even require the most popular wallets to only allow access to the chains they choose, just as some countries today require large internet companies to restrict access to certain content.

Every application on open blockchains will ultimately be deployed on national chains. Your favorite decentralized exchanges, alternative tokens, and NFT games can all be used in this closed garden. Governments offer tax incentives to attract users to transfer assets to national chains, with other benefits of using national chains including automatic tax calculations and VAT deductions.

Under government pressure, the world's largest tech companies urge users to migrate to national chains. The most popular phones come pre-installed with government-recognized blockchain wallets, featuring simple instructions and intuitive user interfaces for setting up wallets, transferring assets from open chains to national chains, and calculating taxes. While people can use open chain wallets or interact with national chains through third-party clients, not doing so becomes very easy.

These national chains provide governments with significant influence over their national economies and citizen activities. The way they wield this power varies around the world; in some places, comprehensive financial oversight and occasional audits become the norm. In other countries, this power turns into political power; factions compete to influence the features and parameters of national chains. They may add whitelisted or blacklisted addresses, add or remove privacy-enhancing features, or introduce new automatic tax enforcement. Economic reforms, gender and sexual behavior, foreign affairs, and other issues become debates over whether to modify national chains for effective enforcement.

In some countries, laws have been introduced attempting to limit government control over national chains. However, in most cases, allowing the state easy access to individual transaction data slowly becomes a (sometimes reluctantly) accepted privacy norm, even as people revisit the arguments about the merits of privacy versus security.

Even if government control over state-owned chains has legal limitations, laws can change in unpredictable ways. At certain times and in certain places, switching back to decentralized chains is legal, but not always. When activities are banned, almost everyone's complete transaction history is on national chains, and this vast amount of data is nearly impossible to erase; everything from the past can be unearthed by powerful hackers in astonishing ways.

National chains are better maintained than open chains because they are centralized. This allows core engineers to easily and quickly upgrade national chains, aiding domestic and international mass adoption. Open chains are considered less reliable and become less trusted. The conventional view is that national chains are virtually immune to hacking; the power of law and authority swiftly punishes any hacking attempts. On decentralized blockchains, hackers can easily rewrite blockchain states, and consumers are less protected. Some privately suggest that powerful actors may intentionally challenge decentralized protocols through small-scale sabotage and attacks—not to destroy them, but to prove their unreliability and fracture their shrinking communities, thereby confirming to citizens their right to freely choose national chains.

Over time, decentralized networks gradually fade from public view.

Main Control and Cycles

The power to decide who and how to control a technology is turbulent. The open networks that sparked the crypto revolution may not last until the end of this century. The national chain scenario is one of many possible trajectories for the future, in which part or all of the blockchain ecosystem ultimately falls under the control of one or a few participants. We believe this resembles the "cycle" process described by legal scholar Tim Wu.

In his book "The Master Switch" (2011), Tim Wu discusses a phenomenon in the information industry where an initially new and open medium of communication becomes a controlled and closed system. Wu uses examples from 19th and 20th century American industries, including telephony, broadcasting, film, and television, to create a narrative: in each industry, open heroes often lose to power and villainy. While he does not provide clear criteria for the final stage of the cycle, it can be viewed as a general process of capturing and controlling information technology. One or a few entities extract most of the industry's revenue, block new entrants, and tightly control the media.

What leads to this cycle? Tim Wu does not propose a clear, consistent causal mechanism for this process; each industry analyzed in the book has experienced very different ways of becoming closed and dominated by one or a few entities. In the case of telephony, AT&T's consolidation of power largely benefited from capital obtained through J.P. Morgan; in film, major studios invented new distribution models, such as chain theaters, leveraging vertical integration to destroy independent cinema owners.

However, this does not mean that some causal mechanism does not exist. For instance, regardless of the method of capture, once an industry is captured, it is difficult to be recaptured (especially in cases where antitrust laws are weak and network effects make scale profitable). If crypto is decentralized and power is dispersed merely because it is new and unregulated, then the arrow of time will surely bring attempts to capture power and money; some of these will succeed and be hard to reverse.

Alternatively, different media may be susceptible to different capture patterns, which can be discovered and exploited by interested parties. The best way to capture the blockchain ecosystem is likely very different from the best ways for television or radio, especially since many open chains are explicitly designed to avoid such outcomes.

Before proceeding, what do we mean by the cycles occurring in cryptocurrency? In this article, we will alternately use "capture" and "centralization"; both terms have their pros and cons. "Capture" defines this process as a rather deliberate, even nefarious one; "centralization" may have more ambiguous intentions regarding why some entities might have more control, but it is a controversial and poorly defined term. Now, let's define centralization or capture as: "One or a few entities can indeed exert excessive control over the medium and the free flow of competitors and users within and outside the ecosystem."

Our definition is broad because we are considering not just the centralization of the blockchain itself, but also the broader ecosystem and environment that influence how blockchains are used. Potential centralization can occur at least at three "layers": protocol layer, application layer, and social layer.

For example, if the design of a blockchain leads to a few people controlling most of the full nodes, making it easier to manipulate the network, then that blockchain may be centralized at the protocol layer. This is the type of centralization risk that people in the blockchain ecosystem tend to focus on.

However, even a decentralized blockchain ecosystem at the protocol layer may centralize in other ways. For instance, if a few centralized applications ultimately hold disproportionate control—perhaps because they effectively control how most users interact with the blockchain. This would be similar to today's internet, where, despite being built on "decentralized protocols," a large amount of traffic is controlled by Google and Facebook.

Finally, even if the protocol layer and application layer remain decentralized, there is a larger world beyond crypto. The "social layer" refers to everything else—how people, communities, ideologies, governments, legal systems, and other aspects influence cryptocurrency.

Our national chain scenario focuses on the capture at the social layer. Even if Ethereum itself may remain decentralized, nation-states can leverage their considerable power to influence people's actions—by creating incentives to use national chains and suppressing the use of decentralized blockchains. The blockchain can remain decentralized while the global market for digital value creation and transfer slowly falls under the control of a few centralized entities. If a blockchain remains decentralized forever but no one uses it, is it still useful?

Ways Cryptocurrency Might Be Captured

Admittedly, even with definitions and layered breakdowns, it is challenging to imagine what centralized or captured cryptocurrencies would look like, given the current environment's diversity, novelty, and rapid evolution. To gain some insight, we can look at historical and specific factors in cryptocurrency.

In "The Master Switch," Tim Wu discusses how many network industries become centralized because existing powers impose regulatory, financial, or physical force on new media to dominate or destroy it.

Regulatory Pressure

Regulatory actions have played a significant role in the centralization processes of previous network industries. In the radio industry, the U.S. government passed laws favoring the reduction of high-power stations, provided that radio interference made it necessary (Wu, 2011, p. 83). In the film industry, the Edison Trust largely relied on using patents, pricing, litigation, and other legal strategies to do things like prevent independent filmmakers and distributors from importing foreign films and banning certain stars (pp. 66-72).

By design, cryptocurrencies are more difficult to regulate and control than film or broadcasting. They are built to be decentralized, transnational, and maintain anonymity in many aspects. In previous industries, incumbents and government-friendly entities used regulation and enforcement to slow down or shut down competitors. Targeting any one entity responsible for cryptocurrency governance is challenging because most of its code is not "owned" by anyone. Regulation can lead to more centralization by pushing people toward more centralized chains, as they are easier to regulate. Governments can exert this pressure by unevenly regulating assets on different chains, causing people to turn to those with fewer nodes or more centralized consensus mechanisms.

In any case, regulation is likely to significantly impact how cryptocurrencies appear in people's lives, such as through restrictions on fiat currencies, securities, and exchange regulations. Countries will largely determine whether there is sufficient social, regulatory, and technological infrastructure for people to use cryptocurrencies for payments or to purchase real estate; this is a good reason for the crypto community to engage in dialogue with policymakers and involve them.

Financing

Another way cycles occur historically is that large competitors have better funding than smaller ones. In some respects, cryptocurrencies are distinctly different. The first thing cryptocurrencies brought was decentralized crowdfunding and the creation of new speculative assets, which helped bypass the limitations of traditional funding sources. (Of course, regulation can change this.)

Nonetheless, centralized participants may tilt the balance toward one project or another. Money helps advocate for policymakers. Additionally, investing in new crypto projects is easy, blurring the lines between new and old industries; traditional venture capital holds many tokens in new protocols. Especially as web 2.0 giants are rebranding themselves as "Meta" or "Block" to grab a slice of the new pie, we should not overlook the power and influence of private enterprises on the fate of cryptocurrencies.

Control of Infrastructure

Another factor in past cycles is infrastructure; sustained control over physical infrastructure helps legacy giants like AT&T maintain dominance. Building on fundamentally centralized infrastructure or protocols gives the controllers of that protocol various advantages in the future. AT&T continually rose from the ashes and regained power because its control over telephone and cable lines gave it a significant voice not only in telephony but also in emerging industries like broadcasting, television, and the internet.

Crypto is not built on some fundamental centralized protocols. It uses highly decentralized networks that are not managed by any single entity, which can shut down or alter the protocol at any time. The TCP/IP protocol transmits data in a decentralized manner along different routes, not prioritizing or relying on any single path or node. If internet service providers attempt to block access to specific crypto network applications or data packets, it would require extensive international coordination to have an impact (unless subjected to a 51% attack, which is nearly impossible). Moreover, the most successful protocols—Bitcoin and Ethereum—are specifically designed to prevent any particular actor from gaining majority control.

However, there are still some factors related to material infrastructure that can lead to centralization.

Although internet protocols are decentralized, the internet still relies on physical infrastructure that can be controlled (or destroyed) by powerful actors (such as nation-states). Many countries have established significant control over how their citizens use the internet, and they can block users from accessing crypto applications. This can be a significant limitation for many, even if they do not completely shut down blockchain networks.

Protocols themselves can be weakened by excessive reliance on centralized services, such as cloud computing platforms like AWS. The Ethereum ecosystem is often criticized because many popular applications depend on a few specialized node services. Users and applications can switch to other node providers at any time, meaning AWS does not have hard power over the network, but reliance on services like AWS can introduce subtle means of influence. People may be censored without their knowledge; platforms may accumulate political or social influence that may not rise to the level of users needing to migrate, and other entities can exploit these services as vulnerabilities in the cryptocurrency ecosystem.

A more general operation is that the demand for specialized equipment means that those who supply or own this equipment have significant control. Bitcoin mining must be conducted on specialized hardware, manufactured only by a few suppliers, creating a significant barrier to entry. The startup costs and operational knowledge can be daunting, and companies that manufacture and distribute this equipment can directly or indirectly control who gets the equipment and how, with the geographical centralization of this tangible infrastructure potentially making it susceptible to manipulation by national policies and geopolitical factors.

Quality of Service

Customer demand for quality and scale also contributes to centralization. In "The Master Switch," AT&T had an early advantage in the radio field because they owned long-distance telephone infrastructure—which also happened to facilitate the transmission of radio programs. It was the only company capable of creating a broadcasting network; economies of scale meant it could produce a single program for 16 television stations, consolidating those revenues to create a single, higher-quality product (p. 76).

The novelty of technology can wear off, leading consumers to become dissatisfied with the quality, reliability, and security of services. This is a place where crypto technology can learn; it is an exciting and novel technology, but it is slow and expensive, and DApps are often hampered by poor user experiences, making it difficult for developers to build on certain protocols. This deters those uninterested in crypto from using blockchain services. Even those excited about the prospects of crypto may leave if quality remains low, returning to corporate platforms.

When discussing how cryptocurrencies might be destroyed by centralized entities, we must ask—what are the motivations for others to shut down cryptocurrencies? In the past, dynamics like market erosion led to the suppression of new technologies. Considering the threat of FM broadcasting to AM, RCA vigorously suppressed and opposed Edwin Armstrong's invention of FM broadcasting, with such brutality that it even led to Armstrong's death (Wu, 2011, p. 134). Tape never emerged from Bell Labs because AT&T feared it would impact their telephone answering machine business (p. 106).

For crypto technology, existing private companies seem to easily invest in and gain the benefits of new technologies by purchasing tokens or marketing NFTs, which alleviates some of the motivations for destruction.

Even so, in the long run, a future of widespread integration of blockchain technology could be devastating for many incumbents who cannot avoid being replaced. Banks are an obvious example, showing how an industry may be threatened or forced to transform through new innovations like crypto payments, financing, and securities. The automation of "management" structures using smart contracts could threaten any industry that acts as an intermediary for agreements between people, including lawyers and traditional business managers. This is a large group of people who may have motivations to unite, dominate, or shut down the decentralized crypto world.

But in many ways, the crypto genie is out of the bottle. At this point, it is nearly impossible for incumbents to defeat blockchain technology, so we will see how they adapt and respond to this new future.

How Can Cryptocurrency Withstand Economic Cycles?

Satoshi's great leap was creating a protocol that, through the use of cryptography and economic incentives, can highly resist capture. The significance of blockchain lies in maintaining a fair and broadly decentralized relationship between the entities that maintain and participate in that blockchain. Only then do its contents—assets, smart contracts, various data—have the necessary persistence or hardness that allows humanity to rely on it. The capture resistance at the protocol layer is the foundation of credible neutrality; protecting it is a necessary condition for the success of the cryptocurrency ecosystem.

Other network technologies, such as broadcasting or the internet, are very different. Their fundamental design and value propositions do not consider who controls the underlying infrastructure. Radio waves or packets of information propagate at the same speed and can provide the same user experience, regardless of who owns the wires.

Maintaining credible neutrality at the protocol layer is necessary—but it is not sufficient to resist capture more broadly. The crypto community can learn from the experiences of others: the history of network technology's success or failure spans centuries; what can we learn from the past?

Maintaining Funding Advantages

Previous technological revolutions have failed because their inputs exceeded those of existing enterprises. Open-source work is crucial for crypto but often underfunded. So far, the crypto ecosystem has been able to address this issue by allowing decentralized markets to bet on their own futures and create new funding mechanisms.

New funding and innovation models can create space, resources, and flexibility to promote ongoing creative progress, allowing decentralized networks not only to survive but also to lead in terms of the quality and novelty of use cases at the application layer. If these use cases can generate significant economic and social value in a decentralized manner, particularly due to decentralization, people will use decentralized blockchains, migrate to them, and support them.

The funding advantages of open source need to be maintained over the long term; history tells us that fighting for the future of crypto will take decades, not quarterly finances.

Developing a Global Community for Cryptocurrency

Given that the internet is already established, blockchain may be the first truly post-internet technological movement. The cryptocurrency community has advantages that early broadcasting or the film industry did not have: the ability to expand to every corner of the globe with free internet access.

Many of the threats facing cryptocurrencies are nation-state specific. This includes powerful incumbents taking severe regulatory measures or actions, which are often limited to certain countries or regions. However, cryptocurrencies built on the internet are default global currencies, and deepening this advantage will be beneficial. Cultivating many independent, self-sufficient communities in different regions of the world will strengthen the ecosystem at all levels.

Cryptocurrency Must Be a Choice

In our national chain scenario, we assume that most people will prioritize convenience and ease of use. This presumes that people will only engage with blockchains as consumers; what if they engage with cryptocurrencies more as citizens?

One significant difference between crypto and previous network technologies is the strong specific value imprint in the creation of the ecosystem. Cryptographic technology has always been a clear political movement as well as a technological project.

Decentralized blockchains are used to provide something different from the highly centralized systems that dominate our world today. If people begin to recognize and value this difference, we can start to create an ecosystem where a large number of people can choose to join and prioritize these values over mere convenience. Democracy itself is rarely the most convenient or expedient way to manage a society. However, because many people value democratic ideals and are willing to fight to defend democracy, it has persisted for centuries.

For people to choose and support blockchains as they do democracy, they must understand the significance of blockchains and what they represent. If we ask people to vote through their choices—what exactly are they voting for? When state chains go live and developers, businesses, and users are asked to make choices, what will we say to them, and what will we show them?